Banking & Finance, Law, and Small Business & Startups

Is your NDA DOA?

October 22, 2014
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A relatively recent phenomenon is changing the way investors do business, and it may be putting startups at risk.

When pitching to investors, startups must share a significant amount of information about what their company or product can do to win investments. The common way in which startups try to protect the confidentiality of their big ideas is through the execution of nondisclosure agreements, known as NDAs. Such contracts create a confidential relationship between the parties to protect against the disclosure of certain types of proprietary, confidential or trade-secret information. Once an NDA is in place, the disclosing party is in a better position to freely discuss all aspects of its business and provide the investor with the information he or she needs to make a fully informed decision of whether to invest.

So if NDAs are actually good for both parties, why are they steadily becoming so unfashionable in the major startup hubs in the United States?

The NDA is gradually falling out of favor with venture capitalists and angel investors in areas like Silicon Valley for several reasons — all of which stand to benefit the investor and hurt the startup. The general thought process behind the rejection of NDAs is that venture capitalists are at risk of freezing themselves out of entire business sectors by signing an NDA, and that the legal back and forth in negotiating such agreements hampers momentum and thwarts efforts to be first-to-market with a given idea. Furthermore, as a practical matter, NDAs are difficult and often very expensive to enforce through the legal process. For these reasons, many investors won’t sign an NDA and, when asked to sign one, they might walk away.

Notwithstanding the reasoning for this business-cultural shift, all startups should have a solid NDA in their “back pocket” they can readily present to outsiders — not just investors — before sharing information about their new business. However, it’s up to the entrepreneur to make a judgment call about whether to actually pull out the NDA depending on whom they’re dealing with. If asking an investor to sign an NDA could kill the deal, then startups should consider taking the following approach:

Research before you pitch

Generally speaking, a reputable investor is probably less likely to steal your idea because doing so would harm his or her own professional reputation. However, investors who already have investments in companies similar to yours may use your information to benefit the investors’ existing investments (i.e., use the competitive information you provide to their own advantage). Thus, startups should endeavor to learn as much as possible about the investors before making any meaningful disclosures without the protection of an NDA. To establish trust, entrepreneurs may ask potential investors what other deals they’ve been involved in (and then follow up with the companies about the investor’s role in the deal) and whether the investor has any references.

Just a taste

When talking to a potential investor, entrepreneurs should disclose only what makes their company special — not the underlying information that would enable someone to replicate it.

Third-party sharing

When making a pitch or sharing a business plan, startups can take their own effective measures to reduce the likelihood that their Pitch Decks and other documents stay reasonably secure from dissemination. For example, entrepreneurs should consider having a method in place to grant and revoke access to sensitive materials through an Internet-based closed sharing platform or should consider limiting pitches to in-person meetings only.

Sharing ideas with outsiders can be tricky, but it’s essential to excite and incentivize would-be investors to buy in. In a day and age where NDAs are becoming obsolete for purposes of winning investments, the key for startups is to move forward cautiously but strategically. 

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