If there is one thing that I can tell you for certain about private equity it is that it will not take long to develop a strong dislike of the confidentiality agreement (CA). Also known as a non-disclosure agreement (NDA), this document is a legal agreement between parties to keep confidential the information required to review a transaction. While the objective is nearly always the same, the format never is. Lacking a uniform standard means that each CA must be reviewed and sometimes edited before it is executed. Worse still, a CA can vary in length from as little as one page to as many as ten. 

 

What makes the document such a chore is that it sits near the top of the private equity sourcing funnel. Each teaser comes with a CA attached or the offer to follow up with one should you be interested in the transaction outlined. Consequently, you must sift through all of the superficial data contained in teasers to decide which CAs to request and review. Once received, each CA must be carefully examined. While most contain standard language, occasionally some are drafted with aggressive terms that should be avoided.

 

That said, until the CA is executed all essential information related to the transaction remains unshared. As such, signing a CA is the first step to initiating due diligence. In this lesson we will explore why this document is so important and highlight items to be aware of. 

 

This section will outline the purpose of the CA at a high level. This is by no means a comprehensive list and should be used for educational purposes only. Different private equity firms will have different opinions on what is acceptable in a CA. 

 

While a new hire would never be asked to sign a CA without being coached, always seek legal counsel if you are uncertain about any item in a CA that you are reviewing. Otherwise, and again at a most superficial level, a CA should accomplish the following.

 

Define Confidential Information: Most CAs will use broad language to define Confidential Information. A simple example follows:

Confidential Information ("Information") is defined as any confidential information of the Target disclosed to, or otherwise received by Recipient. Confidential Information disclosed shall be either (a) disclosed in writing, or (b) disclosed verbally or visually.

 

The language defining confidential information will sometimes list items specifically, but in a manner that maintains the broad reach of the definition. This might include “any business plans, technical or financial information, forecasts, strategies, product or process information, and other similar, related information disclosed by the Company in written, oral or electronic form.”

 

The CA will also limit the definition of confidential information with the following language:

The foregoing restrictions shall not apply to any of the Information that (a) becomes generally available to the public other than as a result of a disclosure by you or your Representatives, (b) was available to you on a non-confidential basis prior to its disclosure to you by the Company or any of their respective Representatives, or (c) becomes available to you on a non-confidential basis from a source other than the Company or any of their respective Representatives, which source was not, to your knowledge, itself bound by a confidentiality agreement with the Company.

 

Prohibit the Sharing of Confidential Information: The primary concern from the target company’s perspective is that news of the potential transaction or details surrounding the company’s financial position and / or operations will put the company at a disadvantage or upset the company’s customers. Consequently, a well-drafted CA will prohibit sharing this information and limit its use to evaluating the transaction.

Recipient shall not use or exploit the Information for any purpose other than evaluating the desirability of entering into the Transaction.

 

Define the Transaction: The definition of the “Transaction” is typically included in the document. By way of example, the document might read, “…a possible transaction between [the Sponsor] and the [Target Company] (the ‘Transaction’).”

 

The CA should include language stating that the private equity firm is under no legal obligation of any kind whatsoever with respect to the Transaction.

 

Prohibit Solicitation of Employees: Any firm performing due diligence will be exposed to a list of the company’s employees. As due diligence continues, bidders will also learn which of the company’s employees are exceptionally talented. For this reason, most CAs will have a “no solicitation provision” to prohibit bidders from directly hiring employees of the target company.

 

The private equity firm should be careful to avoid language that prohibits hiring employees responding to a “general advertisement” not specifically targeting the company. With the number of CAs a private equity firm signs in any given year, a strict non solicitation provision that does not include this language would eventually make it difficult for the firm to hire employees, and potentially expose the firm to damages.

 

Consequence of Breach: In the event of a breach of any legal agreement, the nonbreaching party has a right to recover damages. The CA will frequently outline remedies available in the event of a breach of contract.

You agree that money damages may not be a sufficient remedy for any breach of this Agreement by you or your Representatives, and that the Company shall be entitled to seek specific performance and injunctive or other equitable relief as a remedy for any such breach, as well as any other remedies that may be available to the Company at law or at equity.

 

Return and / or Destruction of Materials: It is customary to see a request for the return or destruction of materials in the event that the private equity firms elects not to continue with the process. That said, avoid language requiring “certification” of such destruction. Lastly, it is customary to stipulate that one copy of the confidential information can be retained in connection with legal and document retention policies. 

 

No Representation or Warranty: In the process of due diligence a lot of information will be shared, but unless it is specifically detailed in the definitive agreements, none of this information shall be deemed to constitute a representation or warranty. (Representations and warranties are covered in the course focused on the stock purchase agreement.)

 

Term of the Agreement: All agreements should have a definite term. Rarely should this term exceed two years, and all obligations should expire at the conclusion of the term.

Governing Law: In the United States, Delaware and New York are common choices. The CA might list the state in which the target company is headquartered. Choice of law should be discussed with legal counsel. 

 

 

Non-Compete Language: This language should always be deleted. Under no circumstance should evaluating an opportunity prohibit the private equity firm from owning or making investments in a particular industry or business.

 

Non-Circumvent Language: This language is typically designed to prohibit the private equity firm from pursuing the transaction without the party identified in the document. If you are agreeing to this language, be absolutely certain that there is a good reason.

 

By way of example, one reason to include non-circumvent language would be the decision to work with an independent sponsor that had identified a transaction the private equity firm was otherwise unaware of. 

 

Undisclosed Target: Executing a CA with an undisclosed target should be avoided if possible. At the very least the target should be identified by the project name on the teaser. If possible, secure the right to terminate the agreement within two business days after the identity of the target is revealed if the private equity firm elects not to move forward. If this language is included, the receipt of confidential information may be delayed until this two-day period expires.

 

Affiliates: All references to the firm’s affiliates should be deleted. Avoid having affiliates included in the definition of “Representatives.”

 

If the opposing party will not agree to striking references to affiliates, then include language stating that for the purpose of the agreement the term “Affiliates” shall not include affiliates who do not receive confidential information or knowledge of the transaction from the private equity firm.