Why Startups Shouldn’t Ask Investors to Sign NDAs

NDA by birgerking via Flickr

Everyone will agree that non-disclosure agreements are essential for protecting intellectual property. However, startup entrepreneurs should never ever ask potential investors to sign an NDA, otherwise, they risk losing an audience with the investor.  Take it from Brad Feld, who, in his article Perfect Your Pitch, warns entrepreneurs not to make the mistake of asking an investor to sign an NDA. Feld writes:

“Asking the venture capitalist to sign a nondisclosure agreement, or NDA: This is a stupid idea perpetuated by lawyers. Most venture capitalists will not sign an NDA, so all you’re doing is putting up a barrier to get their attention and demonstrating your naivety.”

Mark Suster seconds this view. In Going to Raise VC? Here’s a Primer on Process, People and Powerpoint Deck, Suster asks:

“Will a VC sign an NDA (non-disclosure agreement)? No. If they did they would be in constant violation because VCs often see 3-4+ companies in every market that they operate.  NDAs would make it impossible to do business.   Asking for one to be signed shows naïveté.”

Why do potential investors consider NDAs a no-no? Here are a few reasons:

1.     NDAs are a waste of an investor’s precious time and resources

Investors that are worth your while are very busy people. They manage funds, answer to limited partners, sit on the board of directors of several companies, mentor new entrepreneurs, and attend meetings and conferences day and night. They also spend their time going through proposals of all sorts, from the mundane, been-there, done-that stuff to the really innovative and interesting. If you ask them to sign an NDA, they‘ll just ignore you. They couldn’t care less if you tell them that you won’t make a pitch unless they sign an NDA – they practically spend their waking hours sifting through hundreds of pitches already. One less pitch from a guy who wants them to sign an NDA first wouldn’t matter. Even if they have lawyers who can go through the NDA for them, they wouldn’t do so since having a lawyer go through such stuff entails a lot of money, money they’d rather spend on their next investment.

In Why a VC Will Take a Lighter to your NDA, Ryan Roberts says that:

“If VCs maintained the practice of signing NDAs for each submission they received, only two groups would benefit: lawyers and paper companies. Lawyers would benefit because they would get to draft, edit, and negotiate each NDA. Additionally, the VCs would have to retain a team of lawyers to keep track of all the NDAs they’ve signed with the fund-seeking entrepreneurs that have come before you. Therefore, NDAs would increase a VC’s transaction costs and potentially prevent a VC from even hearing your pitch. Both reduce the already slim chances you will get funding.”

2.     NDAs leave investors susceptible to legal action

Investors are wary of legal documents such as NDAs since these open them to potential lawsuits. NDAs also constrain investors from listening to other pitches involving technology that are just even remotely similar to yours.

In The No-Bull-Shiitake Investor Wishlist, renowned Silicon Valley venture capitalist Guy Kawasaki says something to this effect. Kawasaki writes:

“[D]on’t ask any potential investor to sign a nondisclosure agreement (NDA), because asking them to do so will make you look clueless. Venture capitalists and angel investors are often looking at three or four similar deals, so if they sign an NDA from one company and then fund another, they expose themselves to legal action. If you find an investor who is willing to sign and just to hear your idea, you probably don’t want his or her money.

I’ve never heard of a venture capitalist or angel investor ripping off an idea—frankly, few ideas are worth stealing. Even if your idea is worth stealing, the hard part is implementing the idea, not coming up with it. Finally, continuing the dating analogy, you probably won’t get very many dates if the first thing out of your mouth is “Will you sign a prenuptial?”

3.     NDAs raise red flags about your capacity to trust other people, which may potentially lead to problems with an investor later on.

When you ask an investor to sign an NDA before you make your pitch, what you’re essentially saying is that you don’t trust the investor with your idea. From the investor’s viewpoint, this is a red flag, and not an auspicious start to a potential partnership with you. The investor would probably steer clear of you, since they would want to avoid trust issues this early in the process. Moreover, requiring an NDA warns the investor that you are over-emphasizing your idea and not putting enough stress on execution, which, to investors, is more important than the idea itself.

If NDAs are to be avoided at all costs when seeking investors, how do you protect your ideas? The answer? Investors are more interested in how you plan to execute your idea. To an investor, your idea is useless without execution.

Since VCs probably have listened to hundreds, if not thousands, of ideas, they’ve learned to discern what ideas are useful and, conversely, useless. As you go along, you may need to change your ideas somewhat, based on feedback and data. Thus, there’s no need to protect them from potential investors, when you might have to change them later on.

Moreover, you should rethink your idea if an NDA is the only thing that would prevent other people from executing it without you. This only means that your idea is NOT good enough, and that modifications are in order so that others following in your wake after you’ve already executed your plan won’t put your margins in jeopardy.

Despite all the above, if you’re still uncomfortable sharing your secret sauce, learn to revise your pitch in such a way that you don’t divulge whatever it is you think should be kept from your investors. This way, you still get to to talk to them, without alienating them.

Keep in mind that investors DO NOT want to steal your idea. Far from it. Rather, they want to know how you plan to execute that idea. You may have a good, even a great, idea, but if you don’t know how to go about executing it, you wouldn’t probably get an investor to put his money with you. Cultivate your ability to sell/market your ideas, network with the right people, and form a strong management team – these will help increase your chances of getting money from investors. Successful execution is the key, and you should make sure to center your pitch on that, to increase your chances of getting that much-needed capital for taking your idea to the next level.