Buying a Company for Its Talent? Beware of Hidden Legal Risks.
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Innovation Entrepreneurship Sep 7, 2018

Buying a Company for Its Talent? Beware of Hidden Legal Risks.

Acquiring another firm’s trade secrets—even unintentionally—could prove costly.

An entrepreneur enters an established company.

Yevgenia Nayberg

Based on insights from

Mark McCareins

When Google subsidiary Waymo filed a lawsuit against Uber last year, the case was seen as a battle over the future of self-driving cars. A former Waymo engineer, Anthony Levandowski, had allegedly stolen files related to the company’s lidar technology—a light-detection sensor that helps autonomous vehicles “see”—and left to form his own startup, Ottomotto, which Uber then purchased. At issue was whether Uber’s decision to buy the startup was really just an attempt to poach trade secrets from one of its competitors.

For most observers, the case turned out to be fairly anticlimactic: after struggling to convince a judge that Uber had acted in bad faith, Waymo chose to settle for a mere $245 million. But for experts in trade-secret litigation, the lawsuit contained a dramatic twist—one with significant implications for corporate acquisitions. Late in the game—too late, as it happened—Waymo’s lawyers accused Uber of “misappropriation by acquisition”—acquiring a trade secret while having reason to know that the party who acquired it did so via improper means—shedding light on a little-known but important legal concept.

“Executives should pay attention to this,” says Mark McCareins, a clinical professor of business law at the Kellogg School. “Whether you’re selling a company or buying one, you don’t want the deal to unwind because of a trade-secret challenge.”

The risk for acquiring companies might be higher than they think, especially in an age where more and more startups are acquired not for their assets but their talent—a trend some have dubbed “acqui-hiring.” About five years ago, Yahoo led the way by snatching up struggling tech companies for their people. Facebook and Twitter have followed suit, and Apple has made no secret that its acquisition strategy involves poaching the best in the industry.

“The danger with these acquisitions is that a company might unintentionally obtain trade secrets and expose themselves to a lawsuit, even the prospect of paying damages,” McCareins says.

So what should business leaders know about trade-secret law in the age of “acqui-hiring”? And what precautions should they take?

Proceed with Caution—and Know the Risks

Acquisitions have always been a way for companies to gain the expertise of their competitors.

There can be a fine line, however, between acquiring knowledgable employees and acquiring employee knowledge, particularly if that knowledge takes the form of trade secrets owned by other companies.

A trade secret is any type of proprietary information or “know-how” that a business chooses to protect from its competitors: software, designs, business plans, even customer intelligence. “It doesn’t need to be cutting-edge technology,” McCareins says. “It can be anything of serious value—whether it’s stored on one of the company computers or employee devices or in a person’s head.”

It’s important, then, to proceed with caution when acquiring companies for their talent— especially in the wake of the Uber case, which ushered a new legal theory, “misappropriation by aquisition,” onto the national stage. Previous trade-secret cases had almost always involved a company that knowingly disclosed a competitor’s secret or used it directly to gain advantage. Going forward, McCareins says this is likely to change.

“I think you’ll see more lawyers try what Waymo’s lawyers eventually did—they’ll plead this new theory,” he says. “And I think the legal community will continue to develop a more robust framework. They’re still building this body of law.”

“When you acquire companies for their talent, that doesn’t mean you control their former business ethics or methodology. The smart move is to expect the worst and put a process in place.”  

A major challenge for companies on both sides of a trade-secret dispute is that sometimes an employee who is hired by a competitor will inevitably rely on trade secrets in the course of performing her new job, even if she never intends to. For instance, a new hire might continue to use her personal iPhone after switching companies, despite the fact that proprietary information is most likely stored somewhere on that device. While there is currently still some dispute over whether this would constitute a violation, more and more jurisdictions are beginning to recognize what’s known as the “inevitable disclosure” doctrine, which would make this an actionable offense even without proof of intent.

“This issue has been out there for a while,” McCareins says, “but it’s been getting more attention because a number of companies are buying startups for the sole purpose of acquiring talent. If they want to stay in the clear, they should ask themselves: ‘Does the talent I’m acquiring overlap with the knowledge this person has of the inner workings of other companies? And might that include trade secrets? If so, it’s incumbent on the acquiring company to take extra precautions.”

If an employee may have such knowledge, one solution McCareins recommends is to segregate that new hire from others in the company who operate in the relevant subject area. So, if your new employee has a marketing secret, sequestering them from the marketing department helps avoid exposure.

Expect the Worst—and Be Prepared

Taking precautions also means conducting “forensic due diligence,” which ensures that all electronic files and cybersecurity protocols are merged appropriately when one company acquires another.

Forensic due diligence entails a complete accounting of all information possessed by a new hire that might be considered a trade secret by the former employer. This process is completed before the new hire is on-boarded or in a position to share any of that information with the new employer. A third-party “clean team” should then evaluate the information and assess whether any of it could be considered a trade secret. Information that is judged to be in the public domain—as well as that which doesn’t reach trade-secret status—could then be shared. The remaining information should be stored by the third party.

McCareins says that Uber’s decision to hire Stroz Friedberg—a cyber-risk-management and security firm that specializes in this area—to conduct forensic due diligence on their behalf potentially saved them from a much worse fate. It was Stroz Friedberg who discovered the fact that Anthony Levandowsky, the former Waymo engineer, had stolen 14,000 files before he left to start Ottomotto.

“Uber realized they had a potential problem on their hands. They were acquiring a company, but they were really acquiring an individual, and they knew that he might have something in his head or on his computer that he probably shouldn’t have. So they gave this outside firm the task of putting up those walls.”

“When you acquire companies for their talent, that doesn’t mean you control their former business ethics or methodology. The smart move is to expect the worst and put a process in place.”

Clarify—and Document—Your Reasons for Making the Acquisition

Even companies making good-faith acquisitions in order to hire talent should also take steps to avoid the perception that their purchase was intended to steal a competitor’s secrets. “You don’t want to give a future judge any reason to be suspicious,” McCareins says.

For example, before any acquisition, companies should manage internal communications with an eye towards respecting trade-secret law. They should assume that such documents might be used in court to determine the underlying motivation for the acquisition. Note that it may not be enough to simply fail to mention any motivation at all—a company’s risk might be similar if there is no documented reason (such as increased market share, synergies, or consolidated operations) for making the deal, leading outsiders to conclude the worst. So companies should make the legitimate case for any acquisition—and document it internally—to avoid even the perception of wrongdoing.

McCarein’s advice to any company considering M&As is to be attuned to these issues at all times—not just when a problem begins to emerge, or when a lawsuit arrives.

“That’s just smart compliance,” he says. “You don’t want any surprises.”

About the Writer
Drew Calvert is a writer based in Los Angeles.
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