How Venture Capitalists View The Non Disclosure Agreement

There is the misconception that an investor or a venture capital firm (VC) would not sign a Non Disclosure Agreement (NDA) so as to have more control over an entrepreneur’s intellectual property. It is not impossible, and as we stated before, investment due diligence is a two-way street. However, most venture capital firms are formalized and versed in proprietary disclosure procedures long before receiving a startup’s pitch.

VCs are not comfortable signing an NDA in the startup introduction phase, as:

• VC firms must protect their reputations. VC firms that gain a reputation of wanting to control intellectual property knowledge without vested interest may have a more difficult time attracting high-quality startups. Overemphasis on NDAs at inception can lead to disinterest and distrust.

• VC firms are in the business of sharing information with their portfolio companies. Often individual members of the firm have a fiduciary duty to disclose information in their capacity as portfolio company directors. An NDA could exacerbate unnecessary conflicting disclosure requirements.

• VC firms often invest at the cutting edge of technology development, where speed is critical. It is difficult to take the time to carefully assess the stipulations of a particular NDA before even an introductory presentation.

• A VC may view a constant overemphasis of signing an NDA before even a presentation as too much focus on product protection and less time spent on marketing, promotion and execution.

• VC firms often are viewed as “deep pockets.” This could make VCs attractive targets for NDA-based, proprietary conflict litigation. VCs are wary of NDAs too early in startup introduction process since these documents open them up to potential lawsuits.

• VC firms have strong legal capability with specialized business lawyers. However legal review is quite expensive and the VC would prefer to allocate funds to the next investment, rather to legal review before even examining a business plan.

• VCs that are good candidates to fund a startup are usually in high demand. The general partners manage funds, answer to limited partners, sit on the board of directors of several companies, mentor new entrepreneurs, and now are becoming instrumental in shaping economic tech and digital policy. They also spend copious time scanning numerous ideas via business plans and presentations. VCs and angel investors often examine at least two deals that are quite similar in technological ideas. Therefore, the likelihood of a VC losing sleep over an entrepreneur who threatens to withhold a business plan due to an NDA is very slim.

The best entrepreneur/investor relationships are built on mutual respect and trust. Requesting an NDA clearly is an indicator of an entrepreneur’s ability to use correct judgment and timing when approaching an angel investor and especially, a VC. We have cited the need for entrepreneurs and startups to protect their ideas and do due diligence when it comes to investors – and that still stands! Three alternatives to the traditional NDA dilemma are:

• Have the investors, angels, and VCs craft or provide their own NDA or initial agreement. Most likely the VC firm would have preliminary versions of an initial review agreement in writing, and they would feel more comfortable using this. Startups and entrepreneurs still have the right in this case to get the VC’s initial review agreement vetted by their own legal personnel.

• Consulting agreement: This works well with investment consultants who also can act as partial seed investors, while promoting for a startup. The difference here deals with verbiage leaning towards structured payment for services, and specific investment promotion rights and privileges (e.g. can share certain startup info a specified time and for X price or percentage).

• Matt Might, Associate Professor at Harvard Medical School, decided he couldn’t sign another NDA for his U Combinator software systems research group because every time he had to it cost him time and money for clause by clause legal review. Instead he offered to extend a PAANDA, or Professional Academic Alternative to Non-Disclosure Agreements. If the business plan is presented as an unpublished research or grant proposal, then the professional who is reviewing it has the obligation of signing a confidentiality agreement up to the point the proposal is published and funded. A PAANDA may work well with accelerators that are linked to both VCs and University research institutions.

Both VC’s and startups should have legal advice for every step of presenting, mentoring and funding. The investment process is definitely complex, and we cannot downplay this. However, it is important for a startup to do extensive angel and VC research well before the initial approach, to have an adequate judgment, and so build a proper relationship from inception to later stage.

 

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