Why Startups Shouldn’t Ask Investors to Sign NDAs

Why Startups Shouldn't Ask Investors to Sign NDAs by Jerome Gentolia: Venturestab

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.

Jerome Gentolia is Co-Founder of ComeUnite and Tech-Launch Solutions

  • http://www.facebook.com/profile.php?id=22608917 Kevin Kane

    One solution if we are worried about the theft of our people is to anonymize the names of your team or core engineers or programmers on your investor proposal. You should assume the VC is interested in your people if they are not interested in your company. It is important to never share anything with other companies and ensure that you are as selfish as possible about your opportunity and the people that work with you. We should automatically assume the VC may share your team’s information with their other companies they invested in if they have no intention of investing in you; you must prevent that and be as selfish as possible about success.

  • http://twitter.com/ShrewdLease ShrewdLease

    If you do not have an NDA then any disclosure of your idea or invention is a public disclosure. So you are voiding any chance of securing future IP if you disclose to a potential financier. If you have already filed for a patent then you dont need an NDA. If your idea is truly revolutionary then any investor would see added value in protecting the IP. If the idea is not protected with an IP filing then anyone can copy it. So, if you are worried your idea will be copied, file for a patent before disclosure. Or have an NDA signed before disclosing. But you don’t want to wait too long now the patent rules are changing this year to first to file. No one can get in trouble for copying anything unless a patent issues.

  • Sera

    Then how can one trust the investor won’t walk away and steal their idea?
    This has happened to me once personally and the stratup I work for.
    The startup I work for, we pitched the idea to two investors in the early stages and THEY took the idea and executed it in lickty split speed with their own team and millions of dollars in funding from other investors (these two are now direct competitors of each other and now us). In the end, for 7 months we worked on a project with no salary until we had something tangible to show and use for customers and 9 months later we had our first investor that didn’t steal our idea.
    The two angel’s that took our idea, their product is regarded as pioneering and revolutionary (and still recognized that in TechCrunch articles and when I attend startup events, they are the ‘know it’ guys to know and take your idea to the next level)
    Right now I am facing the delimma that an angel who was an organizer at a startup weekend event came up with his own team of 6 folks and is executing an idea I came up with.
    I told him I found out because his director for ops pitched it to my boss and when I dropped the investors name, he said that the guy came up with the idea. Date – one month after I told him and worked on it with my team over the weekend…

    So how does an entrepreneur protect themselves? How can I make sure that this doesn’t happen for someone who is not very strong as a developer but understands the need and can come up with a good idea on how to execute and find value….

    • http://www.venturestab.com/ Jerome Gentolia

      As Steve Blank wrote in his blog:

      Someone Stole My Startup Idea – Part 2: They Raised Money With My Slides?!

      1. Your business concept is not a company. Lots of people have ideas. Typically they are just a set of untested hypotheses.

      2. Successful companies are about the learning, discovery, iteration on your initial ideas. If someone can do a better job iterating hypotheses and executing than you can, you deserve to fail.

      3. No business plan survives first contact with customers

      4. The real value is finding the product/market fit. That’s not found in a set of slides.

      You did the right thing by continuing to execute and ended up by getting funded eventually. I suggest you read the Steven Blank’s blog (see link below). He talked about the same experience you had, and what he did.

      Here’s the link to his blog:

      http://steveblank.com/2009/12/07/someone-stole-my-startup-idea-%E2%80%93-part-2-they-raised-money-with-my-slides/

    • http://www.venturestab.com Jerome Gentolia

      As Steve Blank wrote in his blog entitled:

      Someone Stole My Startup Idea – Part 2: They Raised Money With My Slides?!

      1. Your business concept is not a company. Lots of people have ideas. Typically they are just a set of untested hypotheses.

      2. Successful companies are about the learning, discovery, iteration on your initial ideas. If someone can do a better job iterating hypotheses and executing than you can, you deserve to fail.

      3. No business plan survives first contact with customers

      4. The real value is finding the product/market fit. That’s not found in a set of slides.

      You did the right thing by continuing to execute and ended up by getting funded eventually. I suggest you read the Steven Blank’s blog above. He talked about the same experience you had, and what he did.

  • Mikecallard

    NDAs are great if you have the money to pursue a breach through the courts the fact that you are seeking investment shows you wouldn’t. I agree with show the investors and get on with it.

  • Jeff M

    I agree completely.  I’ve had ideas stolen that I haven’t even TOLD anybody!  Get an idea, write a plan, and go get the money!

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  • Cherra Lee

    GREAT information, Jerome! This is a very important topic! I appreciate how you broke it down. I look forward to sharing this important information with fellow Inventors. However, it has been protocol to ask potential investors to sign a NDA. Inventors has receive so many mixed messages along their journey when
    seeking investors in regards to the NDA. I know because I have experienced it myself and I hear it all of the time from fellow Inventors. Is it so wrong when Inventors are simply trying
    to protect themselves?

    The real truth of the matter, there are two different views, from the ones who have and the have not. If this were not the case, then inventors would not ask investors to sign a NDA in the first place. As there are advocates for investors. I am an advocate for inventors. The big difference is… the investors have what new start-up companies need, FUNDING!

    Inventors work very hard, make sacrifices most can not imagine. So unless you have experienced that side of the spectrum, then you have no idea, not to mention, the horror stories of infringement, there is a lot that goes on behind the scene for inventors. Oh the list goes on. There are many wonderful deals that may go right past investors because they are judging a inventor based on the fact they are simply trying to protect themselves by asking you to sign a NDA. One thing is for certain… money can buy a lot of things, but it can not buy common sense and a peace of mind. Thanks again Jerome for posting this much needed article.

  • http://joel.is/ Joel Gascoigne

    Great article Jerome, I agree completely with this. One of the best quotes I’ve come across to describe why NDAs are bad is this one by Tim Ferriss:

    “entrepreneurs who [ask for an NDA] clearly overvalue ideas and therefore, almost by definition, undervalue execution”

    • http://www.venturestab.com/ Jerome Gentolia

      Joel,

      Thanks for stopping by. Yes a great quote from Tim Ferris indeed. This quote is included on the “Do More Faster” book by Brad Feld and Cohen. If you do not have a copy yet, I highly recommend it.

      Wish you the best!

  • Neil Dabney

    Your comments are very well reasoned and logical. I spent 35 years in investment banking and asset management and never signed one NDA. I always felt NDAs demonstrated ingenuine suspicion and lack of trust. NDAs used to be “one offs” and rarely used. Now they are all too commonplace. Last week I was asked to sign one and I refused to do so, and I immediately lost interest in the deal and the company’s management, who were naive and undoubtedly following canned advice from counsel. Thank you for your perspective and articulation of an important view.

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