Buying a Business? How to Avoid Inheriting a Trade Secret Disaster

Why Does Trade Secret Due Diligence Matter in M&A?

Trade secrets have no government registration, depend entirely on the owner’s conduct for legal protection, and often reside in the minds of key employees. These characteristics create risks that standard IP due diligence does not address.

Trade secrets differ from other intellectual property in ways that create unique risks in M&A transactions:

• No registration. Unlike a patent, whose interests the U.S. Patent and Trademark Office records in a public register (35 U.S.C. § 261), a trade secret has no comparable registration – no certificate confirming it exists and no public record defining its scope. If the seller says they have trade secrets, you need to verify independently.
• Protection depends on conduct. A trade secret loses its legal protection the moment the owner fails to take reasonable measures to keep it secret. If the target company has been careless (no NDAs, no access controls, open-door policies with proprietary information) you may be acquiring information that no longer qualifies for protection under Minnesota’s Uniform Trade Secrets Act (MUTSA), Minn. Stat. §§ 325C.01 to 325C.07. Trade secret rights turn on how information is acquired and handled, not on any filing: MUTSA defines “improper means” to include “theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means” (Minn. Stat. § 325C.01, subd. 2).
• People carry the value. A trade secret keeps its status only through efforts that are reasonable under the circumstances to maintain its secrecy (Minn. Stat. § 325C.01, subd. 5). As a practical matter, then, proprietary knowledge that lives in the minds of key employees who are under no confidentiality agreement is especially exposed – if those employees leave after the acquisition, both the information and its protection can go with them.
• Existing claims destroy value. Misappropriation is a wrong defined by MUTSA (Minn. Stat. § 325C.01, subd. 3), so an undisclosed misappropriation claim – by or against the target – is a legal exposure or asset that can dramatically affect the value and risk profile of the deal.

Minnesota M&A transactions should account for MUTSA protection status throughout the process. A target company’s trade secrets may lose protection if reasonable measures lapse during the transition, the period between signing and closing, or the months of integration that follow, when organizational attention is divided and security protocols may be inconsistent.

What Does the Trade Secret Due Diligence Process Look Like?

Effective trade secret due diligence moves through three phases: identification (cataloguing what the target actually has), valuation (determining what it is worth), and risk assessment (understanding what could erode or destroy that value).

The process moves through these phases:

Phase 1: Identification

The first task is determining what trade secrets the target company actually has. This is more difficult than it sounds. Many companies have never formally catalogued their trade secrets, and the people who understand the proprietary information may not think of it in legal terms.

What to request from the target:

• A complete inventory of information the company considers proprietary or confidential
• All confidentiality and non-disclosure agreements with employees, contractors, vendors, and partners
• All employment agreements, particularly those containing non-compete, non-solicitation, and invention assignment provisions
• Written trade secret policies, information security policies, and employee handbooks addressing confidentiality
• Documentation of access controls: who has access to what information, and how access is managed
• Any trade secret audits or assessments previously conducted
• Records of information shared with third parties, including under NDAs

What to investigate independently:

• Interview key employees and management about proprietary processes, customer information, formulas, algorithms, and know-how that give the company its competitive advantage
• Review IT systems for access controls, encryption, data loss prevention tools, and logging
• Examine physical security for sensitive areas, locked offices, restricted manufacturing areas, visitor protocols
• Assess whether the company’s practices actually match its written policies

The gap between what a company says it does and what it actually does regarding trade secret protection is often the most significant finding in due diligence.

Phase 2: Valuation

Trade secret valuation in M&A is inherently imprecise, but it’s essential for determining the purchase price and allocating value among assets. Common approaches include:

Cost approach: What would it cost to recreate the trade secret from scratch? This includes R&D costs, development time, failed experiments, and the opportunity cost of the development period. The cost approach often understates value because it doesn’t account for the competitive advantage the information provides.

Market approach: What have comparable trade secrets sold for in similar transactions? This approach is limited by the fact that trade secret transactions are, by nature, confidential, there’s little public data on comparable sales.

Income approach: What economic benefit does the trade secret generate? This typically involves projecting the incremental revenue or cost savings attributable to the trade secret over its expected useful life, discounted to present value. The income approach is generally considered the most reliable, but it requires assumptions about the trade secret’s longevity, the likelihood of independent discovery by competitors, and the company’s ability to continue exploiting the information.

Relief from royalty: What would the company have to pay to license the trade secret from a third party? This method estimates the royalty rate for comparable information and applies it to projected revenues.

No single method is definitive. Sophisticated buyers use multiple approaches and triangulate the results.

Phase 3: Risk Assessment

Identifying and valuing trade secrets is only useful if you also understand the risks that could erode or destroy that value. Key risk areas include:

Protection adequacy. Do the target’s protective measures meet the “efforts that are reasonable under the circumstances” standard required by MUTSA (Minn. Stat. § 325C.01, subd. 5)? If not, some or all of the identified trade secrets may not qualify for legal protection, meaning you’re paying for assets that can’t be defended in court.

Employee retention risk. Which employees hold critical trade secret knowledge? Are they under employment agreements with protective covenants? What is the likelihood they’ll stay post-acquisition? If key employees leave and take proprietary knowledge with them, the trade secrets’ value may evaporate.

Prior disclosure. Has the target disclosed trade secrets to third parties without adequate NDA protection? Has information leaked through patent applications, publications, conference presentations, or former employees? Patenting an invention publicly discloses it: a patent application’s specification must describe the invention fully enough “to enable any person skilled in the art . . . to make and use the same” (35 U.S.C. § 112(a)), and each application is generally published “promptly after the expiration of a period of 18 months from the earliest filing date” (35 U.S.C. § 122(b)). Once the information is published, it is generally known and readily ascertainable, so it no longer meets the trade secret definition (18 U.S.C. § 1839(3)).

Pending or threatened litigation. Is the target involved in any trade secret disputes, as plaintiff or defendant? Are there former employees at competitors who might have taken proprietary information?

Third-party claims. Does the target use information that might belong to others? Did key employees bring proprietary information from previous employers? This is a particularly dangerous risk, acquiring a company that is unknowingly using another company’s trade secrets can expose the buyer to misappropriation liability. Under MUTSA, misappropriation reaches a buyer who receives another’s trade secret by accident or mistake if, before a material change of its position, it “knew or had reason to know that it was a trade secret” (Minn. Stat. § 325C.01, subd. 3), so continued use after you learn of the trade secret’s origin, for example once the true owner asserts a claim, can itself be misappropriation.

What Questions Should You Ask the Target Company About Trade Secrets?

A structured questionnaire ensures you do not miss critical issues. Questions should cover identification and ownership, protection measures, and risk exposure. Essential questions include:

Identification and ownership:

• What information does the company consider its trade secrets?
• How was this information developed: internally, through acquisition, through joint development?
• Are there any disputes about ownership of proprietary information?
• Has the company acquired trade secrets from other entities, and are those acquisition agreements properly documented?

Protection measures:

• Who has access to each category of trade secret information?
• What physical, electronic, and contractual measures protect the information?
• When were confidentiality agreements last updated?
• What happens when an employee with trade secret access leaves the company?
• Has the company ever pursued a misappropriation claim? What was the outcome?

Risk exposure:

• Have any employees joined from competitors in the past five years? Did they bring information from their former employers?
• Has any trade secret information been published, presented, or disclosed outside of NDA-protected relationships?
• Are any key employees currently in disputes about restrictive covenants from prior employers?
• Has the company received any cease-and-desist letters or threats related to proprietary information?

What Red Flags Signal Trade Secret Problems During Due Diligence?

Missing written policies, key-person flight risk, active litigation, informal information sharing, and recent departures to competitors are the warning signs that demand closer scrutiny. Any one of these can indicate the target’s trade secrets are worth less than represented.

No Written Policies

If the target has no written trade secret policy, no confidentiality agreements, or no documented information security practices, the legal status of its “trade secrets” is questionable. MUTSA requires reasonable efforts to maintain secrecy. A complete absence of documentation suggests those efforts have not been made. Still, the absence of an explicit “confidential” label is a warning sign, not an automatic loss of protection: MUTSA provides that a trade secret’s existence “is not negated merely because an employee or other person has acquired the trade secret without express or specific notice that it is a trade secret” if, under all the circumstances, that person knows or has reason to know the owner intends secrecy to be maintained (Minn. Stat. § 325C.01, subd. 5).

Key Employee Flight Risk

When the target’s most valuable proprietary knowledge resides in the minds of a small number of employees who have no contractual restrictions, the trade secret value is only as stable as those employees’ willingness to stay. Due diligence should include an honest assessment of retention risk, not just whether protective agreements exist, but whether key people are likely to remain through the integration.

Pending or Recent Litigation

Active trade secret litigation against the target could mean the company has been misappropriating another entity’s secrets, creating liability the buyer would inherit. Litigation by the target against former employees might indicate systemic retention and protection problems.

Informal Information Sharing

Companies that routinely share proprietary information with vendors, customers, or partners without NDAs may have inadvertently destroyed trade secret protection. The information may still be valuable, but it may not be legally defensible.

Recent Employee Departures

A pattern of key employees leaving for competitors shortly before the acquisition is a significant red flag. It may indicate that valuable trade secrets have already been compromised, and the buyer may be acquiring assets that are worth less than they appear.

How Do Asset Purchases and Stock Purchases Differ for Trade Secrets?

The deal structure determines how trade secrets transfer, whether existing agreements remain in effect, and what liabilities the buyer inherits. Each approach has distinct advantages and risks for trade secret protection.

Asset Purchase

In an asset purchase, the buyer selects which assets to acquire. Trade secrets must be specifically identified and included in the purchased assets. Key considerations:

• Assignment provisions. The purchase agreement must explicitly assign trade secret rights to the buyer. Patents are personal property whose assignments the U.S. Patent and Trademark Office records in a public register, and even a patent must be assigned “by an instrument in writing,” with an unrecorded assignment void against a later good-faith purchaser (35 U.S.C. § 261). Trade secrets have no comparable registry, so trade secret rights move only through the purchase agreement’s express assignment language.
• Employee transitions. In an asset purchase the buyer decides which of the target’s people to hire, so you ordinarily should offer employment to the key employees who hold or can access the target’s trade secrets and bind them by confidentiality agreement – both to retain them and to preserve the protection you are buying, because a trade secret keeps its status only through efforts that are reasonable under the circumstances to maintain its secrecy (Minn. Stat. § 325C.01, subd. 5). In Minnesota you secure those trade secrets through confidentiality and nondisclosure agreements and the Minnesota Uniform Trade Secrets Act, not through employee non-competes: Minn. Stat. § 181.988 renders any employee covenant not to compete “void and unenforceable” for agreements entered into on or after July 1, 2023 (2023 Minn. Laws ch. 53, art. 6, § 1). The statute preserves one exception relevant to your deal: the seller of a business, its owners, and the buyer may agree on a “temporary and geographically restricted covenant not to compete” that prohibits the seller from carrying on a similar business (Minn. Stat. § 181.988, subd. 2(b)(1)), so you can still lawfully restrain the seller and its owners from competing even though you can no longer bind the acquired employees with non-competes.
• Third-party consents. If the target’s trade secrets are subject to a license or joint development agreement, obtain and review that agreement as part of due diligence, because its terms bear on how those rights move in the deal.
• Selective liability. One advantage of an asset purchase is that you generally do not inherit the seller’s liabilities, including any misappropriation claim against the seller. That default is codified: a transferee is liable for the transferor’s debts and liabilities “only to the extent provided in the contract or agreement between the transferee and the transferor or to the extent provided by this chapter or other statutes of this state,” an asset disposition under the statute “is not considered to be a merger or a de facto merger,” and a transferee “shall not be liable solely because it is deemed to be a continuation of the transferor” (Minn. Stat. § 302A.661, subd. 4). The rule is not absolute. Minnesota recognizes four exceptions under which a successor may be held liable for the transferor’s debts and liabilities: where the buyer expressly or impliedly agrees to assume them; where the transaction amounts to a consolidation or merger; where the buyer is merely a continuation of the seller; or where the transaction is entered into fraudulently to escape liability (Niccum v. Hydra Tool Corp., 438 N.W.2d 96, 97-98 (Minn. 1989), following J.F. Anderson Lumber Co. v. Myers, 296 Minn. 33, 206 N.W.2d 365 (1973)). Minnesota has kept these limits narrow, holding that “the traditional limitations on successor liability remain the law in this state” and declining to adopt the broader “product line” theory some states apply (Niccum, 438 N.W.2d at 98).

Stock Purchase

In a stock purchase, the buyer acquires the entire entity, including all its assets and liabilities. Trade secrets transfer automatically as company assets. Key considerations:

• Inherited liabilities. You acquire the company subject to its existing liabilities and claims, including any misappropriation claim by or against it, and those liabilities reduce what the shares are worth. As a shareholder, though, you are “under no obligation to the corporation or its creditors with respect to the shares . . . owned, except to pay to the corporation the full consideration for which the shares are issued or to be issued” (Minn. Stat. § 302A.425). Due diligence on litigation exposure is critical.
• Employee continuity. Because a Minnesota corporation has perpetual duration (Minn. Stat. § 302A.161, subd. 2), a stock purchase changes the shareholders but leaves the same corporate person in place, so employees continue with the same employer – reducing the risk of key-person departures triggered by the transition.

What Representations and Warranties Should Cover Trade Secrets?

The purchase agreement should include representations covering ownership, protection measures, non-infringement, and litigation status. These provisions force the seller to disclose problems and give the buyer contractual remedies if problems surface after closing.

Ownership and validity:

• The target owns or has the right to use all trade secrets necessary for its business operations
• No third party has a claim of ownership to the target’s trade secrets
• The target has not granted any licenses to its trade secrets except as disclosed

Protection measures:

• The target has taken reasonable measures to protect the confidentiality of its trade secrets
• All employees and contractors with access to trade secrets have signed appropriate confidentiality agreements
• The target is not aware of any unauthorized disclosure of its trade secrets

No infringement:

• The target’s business operations do not misappropriate any third party’s trade secrets
• The target has not received any claims or threats alleging misappropriation
• No current or former employee is subject to restrictive covenants from prior employers that would affect the target’s business

Litigation:

• There are no pending or threatened lawsuits involving the target’s trade secrets
• The target is not aware of any facts that could give rise to such a lawsuit

How Do You Protect Trade Secrets After the Acquisition Closes?

The transition period is when trade secrets are most vulnerable. Immediate steps include auditing access controls, updating agreements, communicating expectations to retained employees, and securing departing employees. MUTSA protection depends on ongoing efforts that are reasonable under the circumstances to maintain secrecy (Minn. Stat. § 325C.01, subd. 5), and the statute provides no transition grace period – if protective measures lapse during integration, a court could find the information lost trade secret status.

Immediate Steps

• Audit access controls. Determine who has access to trade secret information and whether that access is still appropriate under the new ownership structure.
• Update agreements. Ensure all employees (both retained from the target and brought in by the buyer) have current confidentiality and invention assignment agreements reflecting the new ownership.
• Communicate expectations. Key employees need to understand that trade secret protection obligations continue after the acquisition. Ambiguity during transitions leads to carelessness.
• Secure departing employees. If any target employees don’t make the transition, conduct exit interviews, collect company property and devices, and remind them of their ongoing confidentiality obligations.

Integration Challenges

Merging two companies’ information systems, teams, and processes creates trade secret risks:

• Commingling information. When the buyer’s employees gain access to the target’s trade secrets (and vice versa), the pool of people with access expands. This may be necessary for integration, but it should be managed deliberately.
• System migrations. Moving data between systems creates copies, temporary files, and access windows. Plan migrations with security in mind.
• Cultural differences. The target may have had a casual approach to information security. Imposing the buyer’s stricter standards takes time and training.
• Vendor and partner transitions. If the target’s vendors or partners need to be transitioned to the buyer’s systems or replaced, ensure that proprietary information is properly handled during the transition.

Maintaining Protection Status

MUTSA protection requires ongoing efforts that are reasonable under the circumstances to maintain secrecy (Minn. Stat. § 325C.01, subd. 5); an acquisition does not create a grace period. If protective measures lapse during integration (even temporarily) a court could later find that the information lost its trade secret status during that gap. The buyer should designate someone responsible for trade secret protection during the integration period and ensure that security measures are maintained or improved, not relaxed.

What Should a Trade Secret Due Diligence Checklist Include?

The following checklist ensures comprehensive coverage across all three phases of trade secret due diligence:

• Request and review the target’s trade secret inventory
• Obtain all NDAs, employment agreements, and contractor agreements
• Review written trade secret and information security policies
• Assess physical and electronic access controls
• Interview key employees about proprietary knowledge
• Identify key-person dependencies and retention risks
• Search for pending or threatened litigation involving trade secrets
• Investigate whether target employees brought information from prior employers
• Evaluate prior disclosures to third parties and adequacy of NDA coverage
• Determine whether trade secrets will transfer effectively under the deal structure
• Draft representations and warranties covering ownership, protection, and non-infringement
• Plan post-closing integration with trade secret security in mind
• Assign responsibility for maintaining protective measures during the transition

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For guidance specific to your situation, contact Aaron Hall, attorney for business owners, at aaronhall.com or 612-466-0040.

Learn more about trade secret protection for Minnesota businesses