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Resources for Sound Business Decisions.™

Letters of Intent: Information Disclosure and Management Issues

Strategic and Tactical Considerations of Preliminary Transaction Documents in SMB Interest Transfers – Part 4 in a series.

“There are known knowns; there are things we know we know.
We also know there are known unknowns; that is to say we know there are some things we do not know.
But there are also unknown unknowns – the ones we don’t know we don’t know.”

Donald H. Rumsfeld, 13th US Secretary of Defense

The previous installment in this series focused on the issues of time and milestones in Preliminary Transaction Documents such as a letter of intent or memorandum of understanding. This edition will focus on issues pertaining to the disclosure and management of information that can be addressed in a Preliminary Doc.

The due diligence and contract negotiating phase provides a buyer with an opportunity to verify what is believed to be known, to learn about what is believed to be unknown, and try to discover Secretary Rumsfeld’s unknown unknowns.

Among other things, the due diligence process is a time for discovery and it is extremely information intensive. A good deal of that information will be confidential, proprietary and in some cases, exceptionally sensitive. The buyer and seller need to be comfortable that the propriety of confidential and otherwise sensitive information shall be respected and not abused or inappropriately used in any manner. This applies to information provided in print or digital formats as well as during the frank and candid conversations that will take place between the parties.

For that reason, confidentiality is frequently addressed in the Preliminary Doc. This is especially important to the seller, who has to live with the very real risk of information leaks and misuse of critical information that might hurt future operations or give an advantage to competitors.

In an SMB deal, the seller has several powerful motivations to keep sensitive information confidential and protected along with compelling reasons to keep word of the pending sale from leaking out to employees, creditors, customers, competitors and vendors. Inappropriate management of confidential and sensitive information can interfere with business relationships and seriously damage the company’s competitive standing and the effectiveness of future plans. These items will be reviewed in detail when we explore Preliminary Doc terms from a seller’s perspective.

Typically, the seller’s intermediary will request that potential buyers sign a non-disclosure agreement (NDA). It some cases, an intermediary’s NDA may include a non-circumvention clause designed to keep the buyer from going around the intermediary. Such NDAs are seldom mutual and they may not provide the buyer with protection for its confidential information. For that reason, a buyer may favor their own mutual NDA over the intermediary’s.

The buyer’s legal counsel will need to see copies of all NDAs and other agreements signed in order to get access to the Confidential Information Memorandum or Selling Book and other deal-related materials.

The issues of confidentiality and the disclosure of information can be addressed in a Preliminary Doc. The key points for consideration include:

Public disclosures or releases pertaining to the contemplated transaction:

      Premature and unauthorized announcements of a pending deal can hurt both buyer and seller. Whether or not an announcement is required is a topic for discussion with the party’s legal counsel. Either way, the buyer and seller need to coordinate with each other and be of one mind with respect to public disclosures and announcements.

Timely disclosure: Once the timeline is defined in the Preliminary Doc, there is no time to sit around waiting for the seller’s team to “get around” to providing requested information. Whether it is addressed in the Preliminary Doc or in conversation, a buyer wants to secure the commitment of the seller to provide requested information on a timely basis.

It will save time if the buyer has prepared a diligence document request at the same time that the Preliminary Doc is being drafted. An internal list of diligence-related questions and issues will also help to facilitate the process in an orderly way.

Access to employees, vendors and creditors: Depending upon the nature of the selling business, this can present a dilemma. On one hand, the buyer would like to talk with these people in order to get a better understanding of the business and may want to maintain a relationship with these people if the transaction is consummated.

On the other hand, the seller is painfully aware that part of the buyer’s due diligence process is to find reasons not to do the deal. So, the last thing the seller wants is for the employees, vendors and creditors to get “all riled up” about a pending sale or, even worse, to ask embarrassing questions if the buyer fails to go through with the sale.

If buyer and seller are engaged in productive conversation and are building a problem-solving rapport, this is an issue that can be broached prior to submission of the Preliminary Doc. The key question for the buyer is: are there certain people such as key employees, major customers or strategic vendors that you must talk with before you are willing to proceed with the deal?

Online (virtual) data room access: The old-fashioned “war room” filled with boxes of documents is being replaced by online data rooms that allow the parties to a deal to store, organize and manage the documents provided in due diligence as well as the Transaction Documents necessary to complete the deal. If an online data room is going to be provided, it is helpful to get the seller to agree to upload documents to it rather than providing hardcopies.

A buyer absolutely needs access to all of the information necessary for a proper due-diligence review, to get funding in place and to prepare a post-deal integration plan. This places the seller in a vulnerable position. By addressing the propriety and confidentiality of information, both parties can increase their comfort levels.

One way to increase mutual comfort is to agree upon a “step-wise” framework for releasing highly sensitive data. Under this approach, the most sensitive data is only provided after the diligence team has worked its way through “less sensitive” data previously provided without raising any red flags. A seller may be more comfortable with sensitive disclosures once the definitive agreement has been negotiated and signed.

If there are highly sensitive items that the seller is absolutely reluctant to disclose to the buyer or vice versa, a trusted third-party consultant or accounting firm can be engaged to perform a review and study of the information and then report back to the appropriate party. This is akin to a “black box” operation and provides a firewall between the sensitive information and the buyer, significantly reducing the risk of inappropriate disclosure.

The Preliminary Doc can provide a framework that allows buyer and seller to sort through the issues relating to the disclosure, management and treatment of confidential information. Addressing these issues upfront and showing a respect for the mutual propriety of each party’s information, can help create an atmosphere that is conducive to an open and candid exchange. Such an atmosphere will facilitate due diligence and help move the contemplated transaction toward closure.

The next installment in this series will explore the “other business issues” of mutual commitment.

Robert B. Machiz
© 2011 MoneySoft, Inc. All Rights Reserved Worldwide.

MoneySoft’s DealSense® Plus software system values and analyzes the economics of middle-market mergers and acquisitions. The latest version includes a Term Sheet that can be edited in Microsoft Word.

This Term Sheet can provide the framework for preparing Preliminary Transaction Documents such as Letters of Intent. The Term Sheet developed in DealSense Plus integrates valuation, deal structuring and ROI analysis with the terms of a proposed transaction so that the different functions of the M&A team such as finance, operations and legal can play from the same sheet of music.