Everyone who has ever raised money from venture capitalists knows that VCs don’t sign NDAs. Their reasoning is this: since they look at so many businesses and might fund a competitor, they cannot be encumbered by a non-disclosure agreement.
But I’m not sure that rationale makes sense.
What an NDA is
An NDA is a legal contract that protects the confidentiality of ideas, knowledge, processes, and other information between two or more parties. NDAs are common practices in the business world where, in order to create strong and trusting relationships, you often need to share confidential and sensitive information.
Most business executives, especially those in the technology industry, regularly sign NDAs because they treat confidentiality very seriously. Also, most employees sign an NDA when they join a company (and sometimes they sign an NDA when they are evaluating whether to join a company).
What an NDA is Not
An NDA is not a non-compete or an exclusive. Just because you sign an NDA with Coke doesn’t mean Pepsi cannot be your customer. It does mean that any confidential information you received from Coke cannot be revealed to Pepsi (or to anyone else). The information from Coke is their property. They just agreed to share it with you for a specific reason and you agreed not to share it with anyone else.
Now let’s get back to the world of venture capitalists. When you are raising money, it would be unfair for the VC to sign an exclusive with you since they might invest in your competitor. But it is also unfair that they can take all your data and insights and just give it to a competitor that they might invest in.
Here would be a sensible change to the fund-raising process:
• For the first meeting between the VC and the company (including the initial deck), an NDA should not be required. Any confidential information (like revenue numbers) can be left out of the initial deck.
• But for any additional meetings between the VCs and the entrepreneurs, an NDA should be in place. This will increase trust between entrepreneurs and VCs, foster a more open discussion and exchange of ideas, and underscore the seriousness of confidentiality of the process.
Of course, as an entrepreneur, I’ve never done this myself and I don’t know how VCs will react. (Even as an angel investor, I have never been asked to do it). Potentially, only entrepreneurs at hot companies could demand this. But this small tweak to the process might further the trust between entrepreneurs and their potential long-term business partners (the VCs).
@auren i disagree, mainly because a lot of times, the critical info in a pitch is not numbers or specifics, but apporaches and ideas. if a VC is meeting with a few teams going after a similar opportunity, NDAs could cause headaches especially if some of the approaches and ideas overlap.
i think a VC has a huge reputational stake on the line in any entrepreneur interaction to make sure confidentiality expectations are met.
i only sign NDAs with late stage companies, and only when i am about to receive financial details.
Is a non-disclosure agreement the right agreement to draft for a first meeting?
There might be a much more straightforward approach to this, one that does not require as much resolution of ambiguity between the entrepreneur and the VC. Consider the approach where you treat the key information to be protected as a trade secret. The entrepreneur impresses upon the VC the value of the trade secret and the efforts maintained to protect the trade secret by carefully marking all documents which would disclose the trade secret and visibly restricting their distribution. The VC in turn provides value by vetting the value of the allegedly valuable trade secret and is prepared to say “that’s not a secret, Paul Baran started a company doing that in 1985”.
A crafty entrepreneur is perpetually disclosing some relevant fragments of their trade knowledge at all times, in part to demonstrate competence, and in part to test whether what they know is really true.
As far as disclosure of trade secrets goes, I’d be much more worried about details leaking out inadvertently via ill-considered partners and subcontractors than via an investor.
Hi Auren
This is a good topic!
After twnety years my view is that an NDA is rarely worth the paper it is written on… for several reasons but top of the pile are (a) it is almost impossible to prove who released commercially sensitive data, (b) you find out when it is too late and and even if you could prove who did it, (c) how much would it cost (time and money) to pursue legal redress?
Cem has put his finger on it. Commercially sensitive or insightful information is almost never included in the business plan /proposal because it has been compartmentalised. Entrepreneurs must define what is commercially sensitive in advance of any negotiations much less presentations to any investor. This is a key internal check/process.
As an aside, I urge clients to use a Disclosure Diary where they list what information / documentation has been released to whom when and why. In some cases you can ask the VC or investor to acknowledge this by signing it and having it witnessed. This helps build trust once it is explained and in this way the entrepreneur controls the flow and release of information. This acknowledgement process is typically done without an NDA in place. My experience is that business angels will jump on this as a means of building trust but that VC are far more cautious.
NDAs do serve a purpose in that they illustrate your professionalism, but in my experience the terms / conditions only get negotiated after the deal is ‘more or less’ agreed. They ocopperfasten the investment.
If you expect an NDA to protect your idea or commercially sensitive data, you will be sorely disappointed.
Many of the VC’s I’ve dealt with are unwilling to sign an NDA before listenig to a pitch or reading a business plan, in fear that it may complicate there other business commitments, if there is overlap.
Cheers!
Auren,
I have a question for you.
I graduated at the top of my class with a bachelor’s degree in business administration and a minor in process management. I always made it clear that I was an entrepreneur and I’ve tried to run several businesses. But most of them have failed because of a lack of capital needed to really do a good job starting the companies. This is because I have a disability with epilepsy and I am at a disadvantage since I cannot drive and various other reasons.
Anyways, I have never once heard of a company being started with “venture capital.” I know that of the 2 Million companies that are started up each year, only about 600 are created using venture capital. So what is up with this statistic? Why is it that only such a small number of companies use venture capital?
For example, if I wanted to start a restaurant, I know I would fail because I don’t have any money saved up. I wouldn’t be able to rent a building to use; I wouldn’t be able to buy equipment for cooking, and I wouldn’t even be able to buy tables or chairs. A millionaire hockey player or baseball player (or a lying attorney, also known as a legal thief) would be able to easily start a restaurant. But I wouldn’t be able to start up a restaurant because I have no funds to do so.
With that in mind, please tell me how I would acquire the “venture capital” needed to start a business like a restaurant.
If I were to simply put an ad in a newspaper inviting people to a 50% ownership in my restaurant if they invested money in shares, I think it goes without saying I would end up with very little money. Is that sort of thing even legal? I know there are so many rules regarding “shares” in a company nowadays; that’s why I’m asking.
Thanks for your time and help.
Elsa Moreau
Enjoyed every bit of your blog.Really thank you! Want more.