Non-disclosure agreements are an important tool for any business. As I’ve written here before, startups need to protect their intellectual property (IP), especially in the early stages when IP represents the vast majority of the company’s value. Make sure you have them. Make sure you use them. But please, make sure you don’t ask a venture capital firm (VC) to sign one before your initial pitch.
Why not? Well, to make a long story extremely short, VC’s simply won’t sign them. If you ask a VC to sign an NDA before your first meeting, they’ll politely refuse, close the door in your face, and you’ll be left to wander the streets alone with your tattered NDA in hand yelling to the heavens “why won’t anyone talk to me!!?” Don’t ask for an NDA before you even pitch, if for no other reason than the fact that it will probably ruin your attempts to get funding right from the start. This is all fairly common knowledge in startup hubs like Silicon Valley, but since our startup ecosystem is still pretty young I think it is worth going into more detail for my entrepreneurial Arizona brethren.
WHY WON’T VC’S SIGN NDA’S?
To understand why VC’s won’t sign an NDA, just consider the situation from their perspective. First, it imposes transaction costs on their dealings with you right from the start. They have to pay their lawyers to read the NDA, revise it, and negotiate with you as your lawyers review the revisions. Ugh, so exhausting. And all of that just to have an initial cup of coffee? No way. It’s just not worth it for them. There are a hundred startups lined up right behind you that aren’t asking for an NDA, and with a deep pool like that the VC will just elect to talk to the startups that keep the process quick and simple.
Second, it also exposes the VC firm to potential liability. VC’s talk to thousands of startups every year, many of them in the same industry, with somewhat similar technology, and maybe with a similar idea. Can you imagine trying to keep track of all of those NDA restrictions? Which VC partner talked to which startup, and who is disclosing what to whom? Every time they invested in a startup they would have to defend against accusations from other, similar startups with whom they previously had meetings. It bogs down their entire process, and basically breaks their business model by preventing them from engaging with enough startups to identify the winners. This would similarly threaten the VC’s portfolio companies, who would have to worry that every time they release a new product or feature, some other startup that met with the VC will come out of the woodwork crying foul.
IT MAKES YOU LOOK STUPID
When I said that everyone knows VC’s don’t sign NDA’s, I wasn’t merely using hyperbole. This is such common knowledge amongst entrepreneurs and investors that asking for an NDA before a pitch meeting will make you look extremely inexperienced. Worse, it means that you don’t have any mentors giving you good advice. Even worse than that, it makes you seem difficult to work with. First impressions are important, and asking for an NDA is a great way to get off on the wrong foot.
AN NDA PROBABLY DOESN’T HELP YOU ANYWAY
NDA’s are often valuable, but you don’t need them for your pitch meeting. Think about why you want an NDA at all: you don’t want anybody stealing 1) your secret sauce, or 2) your idea. Well guess what? If you have secret sauce, just keep it secret. You don’t need to share it in the initial pitch. Investors don’t need to see the code or do a deep dive on the nuts and bolts of your technology at this point. They want to hear about your story, your team, the value proposition, market validation, and a basic business plan. If you have critical IP that would cripple your company if it fell into the wrong hands, then don’t share it. You don’t need to, and the VC won’t ask for it.
Don’t worry about someone stealing your idea. News flash: ideas alone are almost worthless, and if all you have is an idea, then you have bigger problems. The value of a startup lies in it’s ability to execute their idea, which makes the quality of it’s team, it’s technical expertise, and it’s business plan and market strategy more valuable then the idea itself. If your big fear is that someone will steal the basic idea and launch a startup before you can, you must not have much faith in your ability to execute. At least, that’s how VC’s will interpret it. Furthermore, VC firms generally don’t go around stealing ideas from startups and then launching their own company using the stolen tech. “Brain rape” can happen, but good VC firms jealously protect their reputation, and shenanigans like that would destroy their credibility.
PROTECT YOURSELF THE RIGHT WAY
Now I’m not suggesting that there isn’t any risk that VC firms might use information from your pitch meeting for the benefit of their portfolio companies. Unfortunately, that kind of thing happens all the time, even if unintentionally. But there are better ways to protect yourself than an NDA. First, know who you’re talking to. Make sure you are meeting with credible and respected investors. Startup communities tend to be tight-knit, so if a VC has made some shady deals or screwed over startups in the past, it shouldn’t be too hard to discover.
As I mentioned earlier, probably the best way to protect yourself is simply to not disclose anything you can’t afford to lose. Don’t discuss your secret sauce, and don’t discuss deals or partners that have their own confidentiality restrictions. If you don’t share it, the VC can’t steal it. And use good judgment in the meeting. If the VC is really pressing for the code behind your tech, even after you’ve told them you can’t share it, something may be amiss.
Finally, get your IP portfolio in order. If you have truly innovative tech that should be protected by a patent, then by all means, protect it with a patent! It’s a first to file world, so you shouldn’t be waiting anyway. I know that patent attorneys can be expensive, but simply filing a provisional patent won’t break the bank. Frankly, if you are walking into a meeting with an investor and your critical IP isn’t secure, your chances of securing investment probably aren’t that good.
SO WHEN DO I ASK FOR AN NDA?
Once the VC firm is serious about investing in your company, then it might be appropriate to require an NDA. VC firms usually perform extensive due diligence before investing, so if this process would reveal your secret sauce you can safely break out the NDA. Just make sure to keep the NDA simple and short (1 page should do the trick). A five page document with weird clauses that keep them from talking to competitors or that impose other confusing limitations is not a good way to go.
Fundraising is a very stressful process, during which you will likely experience fear, excitement, urgency, paranoia, panic, and glee in equally overwhelming quantities. It can be hard to know exactly how far you should go to protect yourself, while at the same time trying to make a good impression on VC’s. My best advice is to find a good mentor to help you through this process. Strong guidance from an experienced entrepreneur is invaluable when navigating the VC minefield, and they can help you avoid many of the pitfalls that will derail a promising startup.
Disclaimer: This blog is not legal advice and is only for general, non-specific informational purposes. It is not intended to cover all the issues related to the topic discussed. If you have a legal matter, the specific facts that apply to you may require legal knowledge not addressed by this blog. If you need legal advice, consult an attorney.