A (final?) word on NDAs

29 Jan

Several times a month an entrepreneur I am intending to meet with hits me with an NDA demand. Often this happens over email so I find myself tapping out a reply where I itemize the reasons why I (and most of my venture colleagues) rarely sign NDAs, and why, in most cases, an entrepreneur should not even ask for one. I have tapped out the same ‘why I don’t sign NDAs’ content so many times that I now simply dig through my Sent Items folder and locate the most recent response I sent on this topic to the last entrepreneur who asked for an NDA, and I cut and paste it into my current reply.

What I find interesting is that there is a veritable banquet of information online and in book form for entrepreneurs about the mechanics of launching a start-up. Indeed, folks like Guy Kawasaki, have almost carved out an entire cottage industry of How-To manuals and seminars on navigating the rocky shoals of entrepreneurship successfully. I think highly of Guy and others like him who have laid a foundation of good insights and information for entrepreneurs to leverage. With all that information, however, the NDA question seems to come up more than most. As such, I thought a post on this subject was in order.

Foundry Group’s Seth Levine covered this subject recently, as have many VC bloggers over the past few years. Their posts are worthwhile reading. That said, here are my specifics in layman’s terms on why entrepreneurs should think carefully about bringing up this subject next time a meeting with a venture capitalist is in the offing.

1. The Urban Legend issue. I am not sure where this all started, but there remains a persistent fear among some entrepreneurs (usually the first-timers) that VCs steal ideas from entrepreneurs with abandon. For some entrepreneurs, this paranoia is so palpable that they simply cannot get past it. Unfortunately, this unhealthy pre-occupation ends up precluding them from getting any help from potential advisors, investors, and others who might actually like the idea and help the entrepreneur become successful. Too often, the end result is that the idea dies, unfunded and unrealized due to irrational fear and paranoia.

Have their been occasions in the past when some VCs have behaved unethically or inappropriately with sensitive information imparted by an entrepreneur? I am sure that there were such occasions, but I have never seen it on my watch, I have never heard any verifiable accounts of any note, and I doubt highly that it goes on nowadays with the many firms I collaborate with on investments, ideas or due diligence.

For one reason, it’s a career killer. VCs live and die in large part based upon their reputations in the community. Good reputations breed good relationships with fellow VCs, entrepreneurs, and partners. Those good relationships then breed good deal flow and a network of people to collaborate with on other investments. One clumsy attempt to ‘steal’ an idea from an entrepreneur will all but assuredly kill that venture investor’s career and virtually anything he or she touches. In short, it would be an absurdly dumb move.

Secondly, most venture capitalists are simply too busy working with their portfolio companies, managing their limited partner relationships, and balancing hectic lives to simply run off and start a company. Last I checked, a career in venture, if you are fortunate enough to build one, has a lot to recommend it. I love what I do and would wager that I speak for many of my colleagues in that regard. I, for one, certainly have no intention of leaving everything I have built over the past 15 years to steal someone else’s business idea, no matter how compelling. It would be much better to find a way to partner together and see this idea to fruition.

2. The Liability issue. For most venture investors, signing NDAs can only expose us to liability.  I probably meet with 200 companies a year and review investor collateral for another 200 or so. That figure is probably typical for a partner at an early stage venture fund. If I signed NDAs for every entrepreneur that requested one, I would never get anything else accomplished. Simple numerical probabilities dictate that eventually I am going to meet with another company that is intending to do something similar to a company that I have met with previously. [There are few “truly” original ideas out there, the saying goes.] Should I decide to subsequently invest in that company, then I and my fund would be exposed to litigation by an entrepreneur whose appeal for funding I may have earlier spurned and/or who is now convinced that I either stole his idea outright or I am using the “confidential” information he shared with me with the new company we just funded. In either instance, my fund and I now have an expensive lawsuit to grapple with, regardless of its questionable merits.

3. The Adverse Selection problem. We call this the “adverse selection” problem because oftentimes the companies that seek an NDA from us most aggressively are the ones that usually “have” very little–hence, their perceived compulsion to protect their largely unprotectable idea. The question it begs here is that ‘if your idea is that easy to steal, then there probably wasn’t much there of interest to us anyway.’ This is a subtle but important distinction for entrepreneurs to understand. Any experienced professional investor knows that if a portfolio company begins to gain traction, competition is a given. Indeed, in so many markets, competitors are almost literally lurking in the shadows watching while the early entrants validate the market and (hopefully) stub their toes. In short order, the marketplace is teeming with me-too companies and other competitive threats. If a portfolio company’s business is so easily stolen in such an eventuality, then someone wasn’t doing their homework at the venture fund.

Now, to be sure, there are times and circumstances where NDAs are absolutely a requirement and where they should come into play. Meetings with potential joint venture partners and/or certain vendors is one obvious place where NDAs should be considered. Another circumstance would be when a company has very specific and very sensitive technologythat could be enormously compromised by its disclosure. Truth be told, we see perhaps three or four companies a year where the technology is in such a state that an NDA would be appropriate. The rest of the time, the NDA request only serves to send the wrong message to investors and bogs down the process.

Like in most circumstances when pitching businesses to investors, your mileage may vary. In other words, a good entrepreneur needs to assess the circumstances he or she is operating within and decide what demands and burdens he wants to place on his prospective investors. Too many, and he sends the message that he is a naive entrepreneur that has both failed Entrepreneurship 101 and will likely need a lot of hand-holding down the road. Given how busy most of the good venture investors are already with their existing commitments, that alone can sink a prospective investment.

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2 Responses to “A (final?) word on NDAs”

  1. Randy Nichols January 29, 2008 at 11:22 pm #

    I found your site on google blog search and read a few of your other posts. Keep up the good work. Just added your RSS feed to my feed reader. Look forward to reading more from you.

    – Randy Nichols.

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