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.

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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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