Why VCs Don't Sign Non-Disclosure Agreements (NDAs)

· VC and Angels,Blog

VCs' Perspective

Fred Wilson: I have been in this business for 20 years and to my knowledge, I have never signed one (NDA).

Guy Kawasaki: “Before you even start addressing the hard stuff, never ask a venture capitalist to sign a non-disclosure agreement (NDA). They never do. This is because at any given moment, they are looking at three or four similar deals. They’re not about to create legal issues because they sign a NDA and then fund another, similar company–thereby making the paranoid entrepreneur believe the venture capitalist stole his idea.”
Mark Suster: "We don’t sign NDAs because it would be too time consuming to read and process them all, because we could never track all of the ones we’ve signed and because we see so many companies of which many are competitive. If we signed NDAs we’d constantly be in a litany of accusations every time we funded a company. It is highly likely that when we fund a company we saw some of the competitors." 

Brad Feld: "I’d add a few things:

[1.] Even if I was inclined to sign an NDA, I’d have to go through the process of reading it and deciding if it had any problems (many of them do — they are usually overreaching for the information being disclosed), dealing with my lawyer to change it, and you dealing with (and spending time with your lawyer) to accept or reject my requests. In some cases, I’d probably spend more time dealing with the NDA then with the entrepreneur and his idea. How stupid.

[2.] I’d have to keep track of all the NDA’s I signed. It’s “yet another legal document” in the pantheon of documents we have to keep track of. Hmmm — maybe we should consider funding a startup to automate the creation and tracking of NDA’s. Nah.

[3.] In 20 years of high tech (as an entrepreneur, angel investor, and VC), I’ve never been involved in a situation where an NDA is enforced except in an M&A context. It’s simply a waste of paper and time for anything but M&A.

As an entrepreneur, don’t think of this as “arrogance”, think of it as “practicality.” Your friend the VC is actually trying to save you time and money. If you think you have something super secret that no one else should know, just don’t tell me about it. Oh — and check your assumption in that case — especially since the value is in creating the thing, not simply having the idea."

Michael Tefula: "The VC business has an unwritten rule on NDAs. And people who violate this rule risk losing credibility with investors even before meeting with them. The rule is simple: never ask a VC to sign an NDA unless your company absolutely needs one. In the 2+ years I’ve been in the venture capital industry, and after having reviewed well over 300 deals and many hundreds of pitch decks, I’ve only ever signed 5 NDAs.

Exceptions to the rule are entirely possible and may include legitimate issues relating to a patent portfolio, unpublished technical knowledge, a yet to be announced corporate relationship, stealth mode companies, or matters of security. All these things sometimes need an NDA. But in all other cases and before a term sheet is signed, most VCs decline NDAs and move on..."

Synvest Capital: "An average VC sees 20 deals per week, which tallies to 1000 deals in a year. Signing an NDA for each of the deals they make could prohibit them from exploring other investment opportunities. If they happen to work with another potential entrepreneur whose idea they like, they would be stuck with the liability of the legal contract that they have with you.

Even if the investor agrees to sign the agreement, it requires him/her to review and track the compliance purposes. This can only be carried out by a professional attorney. The expenses and time to carry out everything could quickly become more irrational for a professional investor."

"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."

"Inadvertent Disclosure of Confidential Information: Venture capital firms often do not have the internal resources to adequately monitor compliance with NDAs, and the cost of implementing such resources would be onerous. The venture capital firm could be setting itself up for breach of contract. Further, it is possible the firm could inadvertently breach the NDA by disclosing information learned from a prospective portfolio company because of a lack of clarity in the NDA or miscommunication between the parties as to the scope of disclosed information that was contemplated as being kept confidential.

Restricting Investments in an Industry Sector: If the information the venture capital firm must protect under an NDA is general in nature, a prohibition on disclosing such information to third parties, or using such information with any party other than the prospective portfolio company, could effectively prevent the firm from making investments in a particular industry. This is particularly problematic if the venture capital firm ultimately decides not to invest in the prospective portfolio company with which it signed the NDA. The venture capital firm does not want to unintentionally cut off an industry segment, particularly a new one. Because new companies often evolve in the early stages, it is possible the type of information the venture capital firm has to keep confidential turns out to be different than the information initially contemplated when signing the NDA, leading to unintentional restrictions on the firm’s ability to make investments.

Being Exposed to Frivolous Litigation: Regarding very-early-stage portfolio companies, it can be unclear whether such a company actually has any confidential information, or simply has a business plan and some enthusiastic people. By signing an NDA, a venture capital firm could unintentionally agree that all information disclosed by the prospective portfolio company is confidential, and therefore subject to nondisclosure obligations. Given that a high percentage of early-stage portfolio companies ultimately fail, a venture capital firm may become the target of litigation (possibly frivolous) for breach of confidentiality because the possible proceeds from that claim may become the company’s largest asset"

"NDAs are Meaningless: 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: 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.

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: 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.

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."


What Founders Should Consider

Mike Lincoln: 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.

Are there times 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) if it is necessary to disclose that information to the potential investor. Secondly, if you are a more established, later stage company conducting limited conversations with potential investors, a limited NDA may be a reasonable request."

Brad Feld, Foundry Group: "There is one type of NDA that I’ll sign. Some large companies — for some reason — want to show you stuff, but then don’t want you to tell anyone about it “until they are ready.” I can usually deal with this as it’s not worth the ensuing arguement. However, I don’t need to sign an NDA for this — all they have to do is ask me to keep my trap shut “until they are ready.”"

Synvest Capital: "Many investors advise entrepreneurs just to share the cookie and not the recipe. It is totally up to the entrepreneur on what they want to show and what to hide. If you have something super-secret that no one else should know, just don’t tell. Simple as that. Asking the investor to sign the NDA is like you are questioning their credibility.

When you are in the market looking for prospective investors, make sure you find someone who already doesn’t have an investment in companies similar to yours. While most professional investors will refrain from investing in your company if they have already made similar investments, there lies the possibility of leaking confidential information to competitors."

My personal take is:

1. Choose VCs that don't have a competitive portfolio company. If you wouldn't talk to them without an NDA because you're sure that they would leak, then don't talk to them (vs. talking to them and requiring an NDA).

2. The more reputation and track record a VC has, the more surety that the VC will abide to keeping decks private from both portcos and other investors

3. Send pitch decks using Docsend and datarooms by sharing access that you can retract upon closure of the due-diligence process

4. Share the information that you're comfortable sharing, and don't share what you're not comfortable sharing without an NDA. If the VC is asking for more information, generally that's a positive sign as they are trying to evaluate and understand your business to make a decision to move you forward. So share the information that will help them make a decision, because without the information, they will most likely decide to not move forward due to insufficient conviction and data.

5. Generally, founders are most concerned about protecting the idea, top-line numbers, financial documents and proprietary IP like patents. Idea and top-line revenue, profit and cohort numbers along with cap table would generally not be covered by an NDA. Detailed financial documents like legal incorporation docs and proprietary IP could potentially be evaluated later after the term sheet has been signed and during the due-diligence process.