VideoLike many entrepreneurial start-ups, Andara Life Sciences had a secret to protect. Its provisional, nonpublic patent filings covered the Andara Oscillating Field Stimulator Device, part of a system for regenerating damaged spinal-cord tissue. "It was our most important asset," says Mark Carney, one of Andara's founders.
In 2005, when the private, Indianapolis-based company was considering options that included potential buyers, guarding that asset took on a whole new dimension. Andara Life Sciences, still less than a year old, did not want to reveal any trade secrets to would-be buyers who might walk away from the deal.
"There were times we thought this would just not happen," says Kimi Iguchi, vice president of finance at Foxborough, Massachusetts-based Cyberkinetics Neurotechnology Systems, which eventually bought Andara. "That is their jewel, and they wanted to protect it until we were very close." (Cyberkinetics recently made front-page news with its trial of brain implants that allow paralyzed patients to control computer cursors with their thoughts.)
A Touch of 007
Holding critical business information close to the vest is part of the merger game for a seller. "It's a cat-and-mouse process of the prospective company not wanting to disclose too much because it is concerned [that a deal] might not be consummated," says David Stowell, associate professor of finance at Northwestern University's Kellogg School of Management. The "cat" is usually the buyer, which may try to pry information loose as early as possible, most often for reasons of valuation. But buyers may have some of their proprietary data at risk, too, when the target does its own due diligence. In each case, across a variety of industries, companies handle the challenges of keeping secrets differently.
The types of information to be protected also vary widely. In the intellectual-property realm, it could be a software firm's code. In other cases, pricing methods, customer databases, or a range of nonpublic financial results are often among the most proprietary elements in a company's files.
"You always hold back customer lists and pricing information and wait until the acquiring party is fully entrenched in the process," and thus committed to the deal, says Mark Beucler, CFO of Lifeline Systems, acquired by Amsterdam-based Philips Electronics in March 2006.
Despite the case-by-case variances, some general techniques are helpful for both selling and buying companies in protecting proprietary information during M&A negotiations.
When drawing up confidentiality agreements, it helps to recognize that the nature of the material to be protected changes as a deal progresses. "There are multiple levels of confidential information that are dealt with differently — before talking, before a deal is consummated, in due diligence, and in closing," notes Marc Schoenfeld, a former finance chief for the American Express International unit of American Express Inc.
In some cases, companies include breakup-fee provisions, underscoring the importance of secrecy by adding the penalty of a hefty payment if the deal is called off due to proprietary information getting out. "Breakup fees say to the suitor, 'You can do real damage to me, and I want to know you are serious,'" says Randy MacDonald, CFO of TD Ameritrade, the Omaha-based company formed when Ameritrade acquired TD Waterhouse in January.
Some companies require the employees who are to be engaged in the deal to sign confidentiality agreements as well. When designing them, advises Schoenfeld, care should be taken to ensure that the agreements "have teeth and are respected."
Adding a James Bond touch, acquirers often test their imaginations by inventing code names for targets to prevent rumors within the company, and leakage without. Bill Kolb, partner with the Boston-based law firm Foley Hoag, tells of an acquisitive client that chose Greek deities as code names. "Some of the gods weren't nice gods," he says, and a few targets wondered if they were being insulted. TD Ameritrade won't discuss codes it has used, but says its technique involves choosing something associated with the target's name or headquarters. "For example, if we are dealing with a company in Louisville we might call it Project Slugger," says a spokesperson.
Two Types of Clean Rooms
Other common arrangements to keep proprietary information from being prematurely revealed include the use of third parties to hold information as negotiations advance, and the creation of restricted-access data rooms, often called clean rooms. In recent years, electronic "virtual" clean rooms, which provide online access to multiple suitors simultaneously via secure Websites, now often complement or supplant actual physical data rooms.
"Virtual data rooms are exploding in popularity," says Kolb. Executives who have used electronic clean rooms note that they can reduce travel-related costs and shorten the time needed for examining tax returns, budgets, and other financial and nonfinancial information.
Still, clean rooms — whether actual or virtual — should not replace face-to-face reviews, says Robert Holthausen, chair of the accounting department at the University of Pennsylvania's Wharton School. "I think these clean rooms are a mixed bag for both buyer and seller," he adds. In providing electronic access, companies setting up virtual clean rooms are allowing companies to retrieve data permanently, "not just look at it." And in general, he says, "anyone who conducted due diligence entirely from a clean room would be out of his or her mind."
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