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DC Palter
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Apr 11

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SORRY, STARTUPS — INVESTORS WON’T SIGN YOUR NDA


HERE’S WHAT YOU NEED TO DO INSTEAD


Photo by Sander Meyer on Unsplash

In 20 years as CEO or CMO of tech businesses, I’ve signed thousands of
non-disclosure agreements (NDA).

I’m not against NDAs. They fill an important business purpose.

However, as an investor, they aren’t appropriate, so please don’t ask me to sign
one. Like VC firms and other experienced angel investors, I’ll walk away before
signing an NDA.

Here’s why venture investors won’t sign NDAs, and how to work around it.




WHY INVESTORS WON’T SIGN NDAS


NDAS ARE MEANINGLESS

Of the millions of NDAs that get signed every year, the only ones I’ve ever
heard of ever being enforced are when top employees jump to a competitor.

In every other situation, an NDA is nothing more than a formalized handshake.
Absent someone posting your source code online, it’s impossible to prove that
confidential information was misused and that the damages are more than the
millions of dollars in legal fees it’ll cost to sue the transgressor.

Either you trust someone, or you don’t. If you don’t trust an investor, don’t
give them your confidential information, even if they did sign a piece of paper.


THERE’S A COST TO SIGNING NDAS

If we take NDAs seriously, as we should for any legal agreement, there is a cost
associated with signing each one. If there was a single, standard template
everyone used (hey Y-Combinator, I’m looking at you), that might help the
problem.

Even though NDAs tend to be boilerplate, there’s a lot of variation. Each NDA
has to be reviewed for the specific terms: does it apply to everything that
might be considered confidential or only materials marked confidential; does it
expire in 2 years or 5 years or never; are we supposed to segregate all
confidential materials and return or destroy on demand; can anyone in the
organization view the materials or only members with a ‘need to know?’ Does it
preclude me from saying anything about the company without their permission?

Signing an NDA means having a lawyer review and negotiate changes, keeping track
of the NDAs and their specific requirements, and having the infrastructure to
segregate confidential info from non-confidential info.

A VC firm sees hundreds of decks per week. It’s not practical to sign NDAs for
even a small fraction of them.


WE SEE A LOT OF OVERLAPPING BUSINESSES

At least once a month, I see a pitch for a better EV battery. Or using machine
learning to identify potential drug candidates. Or building an inclusive,
supportive social media platform. Or protein bars. You can’t imagine how many
pitches I’ve seen for protein bars despite my lack of interest in CPG.

The businesses often overlap, at least superficially. At least for the
batteries, I’m likely to invest in one. (Pass on the protein bars, though I’m
happy to accept free samples.) I might join the startup’s board or even jump
aboard as the head of marketing.

Yes, I’ve heard the pitches from competitors. I’ve probably even taken part in
the diligence process and know a bit about the companies. I need the flexibility
to be able to work with the company I invest in, so I’m not signing an NDA,
which limits my flexibility to work with anyone else.


YOUR SECRETS AREN’T SO SPECIAL

As an investor spending a few minutes reading a pitch deck or at most a few days
doing diligence on a company, I shouldn’t have access to secrets that will make
or break your business.

This is different from an employee who’s deeply involved in the business. All
employees need to sign NDAs. So does a board member. An investor doesn’t.


I’M SCARED OF YOU

At least once a month, someone tells me how they once had the greatest idea in
the world. They pitched it to a customer or investor who stole it and made
billions.

I tell them I’m sorry to hear that. What I don’t say is that this is

exactly the kind of crazy person I need to avoid signing an NDA with.

Investors are not out to steal your brilliant idea. Neither are competitors.
Ideas, to be blunt, are worth nothing. It’s the product, the execution, and the
marketing that makes a successful business. I’m investing in the founders more
than the product itself.

The founders who think their brilliant ideas are gold are the people most likely
to sue me when a competitor that I invest in comes out with their own product.

My variation on Groucho Marx’s famous maxim is that the people who demand I sign
an NDA are exactly the people I need to avoid signing an NDA with.


THAT’S JUST HOW THE SYSTEM WORKS

In the end, this is how the industry works. Startups need money; VCs are handing
out checks. So they get to set the rules. And the rule is they don’t sign NDAs.

When a startup comes in, demanding an NDA before being willing to discuss their
business, that’s a huge red flag that says the entrepreneur doesn’t understand
the startup world. If they don’t know that NDAs are a non-starter, there are
usually a dozen other things they don’t know about building a successful
startup.

Asking for an NDA is an easy way to get weeded out. So if you want to get
funded, don’t do it.


HOW TO PROTECT YOUR BUSINESS WITHOUT AN NDA

Without an NDA, how do you protect yourself from critical secrets being leaked
to competitors?


DECIDE WHAT TRULY NEEDS TO BE PROTECTED

Does your customer list matter? No, your competitors already know most of it,
and even if they don’t, the list won’t help them.

The same is true for your financials, cap table, and strategy. An early-stage
startup’s strategy is likely to change tomorrow anyway.

Does your technology matter? Quite possibly. But only in the details that I will
neither understand nor want to know.

In other words, you can tell me you’re using graphene to make a better battery.
You can even show me the test data. But without the details of how to
manufacture it, I couldn’t replicate your product.

If I ask about the one or two core things you need to keep secret, just tell me
that needs to stay confidential, and I’m fine with that.

I would rather not even hear about those items than sign an NDA and have to
segregate that information in my mind.

There’s also the issue of patents. If you haven’t filed for patents yet and
disclosing the details without an NDA would limit the ability to apply for a
patent, then don’t disclose those specific details.


BE CAREFUL WITH CUSTOMER NDAS AND AGREEMENTS

It’s guaranteed that investors will want to look at your customer list.
Anticipate this.

If customers require you to sign an NDA, try to include a carve-out that allows
you to discuss it with potential investors and advisors.

Similarly, if you have one big customer or a technology license agreement with a
university or partner, there’s no way to evaluate the business without knowing
the business terms. Try to anticipate the need and find a way to make the
information available to potential investors without an NDA.


GET PERMISSIONS

If you can’t get a general carve-out in the customer NDAs and license
agreements, don’t bother arguing with the lawyers. Simply go back to the
end-user afterward, tell them you’re talking to investors and ask if it’s okay
for us to call them. They ought to say yes to the specific request without
having to change the NDA itself.


HAVE A TIERED DISCLOSURE PROCESS

In the pitch deck that gets circulated widely and often shared, you shouldn’t
give away too many critical details. A few customer names, technology overview,
and investment terms are sensitive but not critical to keep confidential.

During a pitch, you may need to divulge more. Decide what you’re comfortable
sharing in the larger group vs. waiting to see if there is interest in moving
forward into the diligence process.

As the discussions get more detailed with the few serious investors, you can
dive into a deeper level of disclosure to the small audience.

It’s perfectly fine to say that a few critical pieces of information can only be
disclosed during diligence. But if it’s general information like business
strategy or technology overview (rather than the details), it’ll turn away
potential investors.


IF ABSOLUTELY NEEDED, ASK FOR AN NDA AT THE END OF DILIGENCE

Once in a while, particularly for a hard tech startup, investors need to analyze
the technology to validate the company’s viability. This will usually be done
for the VC by a consultant who will sign an NDA.

The VC itself doesn’t need to know the secret sauce; they just need to know that
there is a secret sauce that works.

The NDA should only be required as the last step in the diligence process and
only with the consultant doing the evaluation, not with the VC firm.



In the end, investors will not sign an NDA and asking for one is likely to end
the discussion.

With or without an NDA, you have to assume the worst — that investors will
evaluate your company, then invest in a competitor. Some information may leak.
But shooting for the moon means taking calculated risks. That’s what being a
startup is all about. The risk-reward should point to divulging the information
investors need to know to evaluate the business.

So be prepared to divulge all but the most critical information without an NDA,
but be sure to protect the very few things that need protecting.



Thanks to fellow Chemical Angels member

Bill Byers
for suggesting this article and reviewing the details with me.






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Entrepreneur, angel investor, writer, sake snob. Editor-in-chief of Japonica,
the publication for everything Japan: https://medium.com/japonica-publication.


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