Every entrepreneur wants to protect their idea. Confidentiality is key to safeguarding intellectual property, and it’s only natural to want to protect your product or service so that you can get it to market before a competitor can. At first glance, when meeting with potential investors, asking them to sign a non-disclosure agreement (NDA) may seem like a prudent move. However, because doing so is often considered a faux pas and may be the wrong way to start a relationship between founder and investor, the aspiring entrepreneur may want to rethink such a request before making it.
If NDAs exist as a form of legal protection, what about them turn investors off? First, NDAs are often perceived as a waste of a VC’s time and money. ((Jerome Gentolia, Why Startups Shouldn’t Ask Investors to Sign NDAs, VentureStab (Feb. 18, 2011), http://www.venturestab.com/2011/02/why-startups-shouldn’t-ask-investors-to-sign-ndas/.)) Investors are busy people. They spend their days attending meetings, managing funds, dealing with limited partners, sitting on company boards, and mentoring entrepreneurs. They also spend a great deal of time sifting through pitches. ((Id.)) If asked to sign an NDA, they will likely just ignore the request. Even if an entrepreneur won’t make a pitch without an NDA, one less pitch probably won’t matter much to them. ((Id.)) They would have to spend time reading it, looking for problems with how it’s written, consulting with their attorney, and discussing it with the entrepreneur, possibly spending more time focused on the NDA than on the entrepreneur and their idea. Moreover, the NDA would be yet another legal document, among many, to have to keep track of. ((Brad Feld, Why Most VC’s Don’t Sign NDAs, Feld Thoughts (Feb. 14, 2006), http://www.feld.com/wp/archives/2006/02/why-most-vcs-dont-sign-ndas.html.)) In addition, this process doesn’t just take time, it also costs money. Naturally, the investor must pay an attorney to review the NDA; after all, they won’t simply sign one without having a lawyer read it, since it is legally binding whether an attorney reads it or not. ((Anil Dash, One More Time: No NDAs, Dashes.com (May 7, 2010, 11:55 PM), http://dashes.com/anil/2010/05/one-more-time-no-ndas.html.)) As a result, from the VC’s standpoint, NDAs increase transaction costs and reduce the already slim chances of providing funding. ((Ryan Roberts, Why a VC Will Take a Lighter to Your NDA, Startup Lawyer (Oct. 17, 2007), http://startuplawyer.com/venture-capital/why-a-vc-will-take-a-lighter-to-your-nda.))
Second, NDAs leave VCs vulnerable to legal action. ((Gentolia, supra note 1.)) Investors view these documents with suspicion because they leave them susceptible to potential lawsuits. ((Id.)) In addition, NDAs may also prevent them from hearing similar pitches. ((Id.)) This is particularly challenging because at any given time, investors are likely looking at a number of similar deals. ((Feld, supra note 4.)) As such, VCs will not want to create legal issues by signing an NDA with one company and then funding a similar one later on, leading an entrepreneur to believe the VC stole his idea. ((Id.)) At the extreme, an investor could potentially face legal liability simply by having someone talk to them about the same business idea, exposing them to a lawsuit through no fault of their own. ((Dash, supra note 5.)) On a related note, perhaps the best thing an investor could do for a startup is to talk about it. By honoring an NDA, if a VC were to meet a potential partner, employee, or investor for the business, they wouldn’t be able to tell them about it. ((Id.))
Third, asking for an NDA creates trust issues between investor and founder. ((Gentolia, supra note 1.)) When a founder asks an investor to sign an NDA, the message is that they don’t trust the investor with their idea. This raises red flags and is not a great way to begin a potential partnership. ((Id.)) Moreover, signaling distrust by asking for an NDA is a particularly poor context in which to ask the investor for a favor. ((Dash, supra note 5.)) In addition to wanting to avoid an entrepreneur with trust issues so early in the process, asking an investor to sign an NDA before hearing a pitch also tells them that you’re putting too much emphasis on your idea and not enough emphasis on execution. ((Gentolia, supra note 1.)) From the VC’s perspective, execution is more important than the idea itself, because without execution the idea is useless. ((Id.)) As Anil Dash, entrepreneur and blogger, points out, “[G]ood execution is hard to find, but good ideas are cheap.” ((Dash, supra note 5.))
Ultimately, most VCs don’t sign NDAs. ((Feld, supra note 4.)) Therefore, asking for one makes the entrepreneur appear amateur, ((Dash, supra note 5.)) reducing their credibility in the eyes of a potentially valuable business partner. As a result, they risk losing an audience with the investor. ((Gentolia, supra note 1.)) Rather than alienating them with a costly rookie mistake, startups should recognize the importance of building trust with investors, thereby paving the way for mutually beneficial long-term relationships.
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