First time entrepreneurs may be tempted to ask a VC to sign a non-disclosure agreement before pitching them or sending information to them. Here are four reasons why the investor won’t sign the NDA, and why the request may harm your chances to secure funding.
First, what is an NDA?
A well-drafted NDA provides protection for a startup company’s intellectual property. An NDA is an agreement between two or more parties that makes a party subject to legal liability if they reveal confidential information or use the information for an impermissible purpose. The NDA defines what is and is not confidential information.
Many founders believe that an NDA should be signed by a prospective investor to prevent the investor from revealing confidential information to competitors – or stealing the company’s business plan. However, professional investors nearly always refuse to sign NDAs, and in many cases are very open and public about their refusal to do so, and why. As a result, founders that request signed NDAs come across as inexperienced and naïve to potential investors.
Why won’t a professional investor sign my NDA?
- LEGAL: Signing an NDA places significant restraints on a professional investor that spends a substantial amount of time identifying potential investments within a defined industry or industries. Professional investors examine hundreds or even thousands of companies, many of which may be potentially competitive with one another or with existing companies in the investor’s portfolio. Adhering to hundreds of NDAs, which they’re asked to sign in many cases before knowing what a company does or what its growth strategy is, would create untenable conflicts and may prevent investors from offering candid industry advice and guidance to existing portfolio companies, which may conflict with the investor’s fiduciary duties to these portfolio companies. This dynamic would be particularly problematic for large VC firms with many investment professionals all signing up to NDAs that would bind the entire firm and its representatives.
- TRUST: Developing a successful relationship with your investors requires trust. If despite the dynamic laid out above, you request that your potential investor sign an NDA, the investor may perceive the request as a signal to that investor that you don’t trust him or her, or at a minimum that you don’t understand the early stage financing ecosystem. Many investors may simply view an NDA demand as rude. Not a great way to start off the relationship!
- EXPENSES: Drafting and reviewing an NDA requires the expenditure of legal fees for the investor and your company. If a professional investor agreed to sign NDAs, it would need to have them reviewed and tracked for compliance purposes. That time and expense could quickly become untenable for a professional investor.
- REPUTATION: A professional investor that becomes known for revealing confidential information would quickly lose the trust of the startup community, suffer from a damaged reputation, and may lose out on potential investment opportunities as a result. Would you want to work with a firm with a reputation for dishonesty? A successful professional investor must maintain the trust of the startup community. Market forces create a powerful dynamic that should give you some comfort in sharing your confidential information.
How can I protect intellectual property during a pitch?
VCs will not require detailed technical information in the initial meetings. In your slide decks, remove any sensitive information and don’t divulge technical, confidential information during your presentation. As you progress through a series of meetings with a prospective investor, you can hold information that you believe to be especially sensitive for later meetings when you have built a stronger relationship and when you believe that any perceived risk of divulging the information is balanced by the greater likelihood of a potential investment. Also, remember to perform your own vetting of potential investors, and rely on trusted referral sources.
What are the exceptions when I should request a signed NDA?
There are definitely exceptions to the rule; in special circumstances you might consider an NDA covering specific, highly confidential information (e.g. specific IP that forms the core of the company’s value and isn’t yet the subject of filed patents). Secondly, if you are a more established, later stage company conducting limited conversations with potential investors, a limited NDA may be a reasonable request. Lastly, if you require NDAs from investors contact a lawyer to insure the NDA is appropriately tailored and well-constructed. For example the general purpose Cooley GO Form of Non-Disclosure Agreement (One-Way) would probably not be appropriate for investor conversations without some customization.