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A non-disclosure agreement (NDA) is used when two or more parties are discussing sensitive matters, and the parties agree that revealing confidential information could be damaging to one or both of them. They’re often used in business relationships such as hiring a contractor to work on your product, or working with another company to build a product together.
As a startup founder, you might think having a potential investor sign an NDA is the right thing to do. After all, you’re going to have to tell them everything before they’ll invest: details about your professional background, your products or services, your intellectual property, business plans, financials, and customers. Those are all things you’ve probably spent a lot of time thinking about, and they’re important to the success of your entrepreneurial venture.
However, professional investors usually won’t sign NDAs, except in a few narrow situations.
Asking an investor to sign an NDA will likely be interpreted as a naïve move - and will likely have the practical effect of an otherwise interested investor just not considering your deal.
But why won’t investors sign NDAs?
For investors:
It’s impractical. ISAV has invested in companies in industries ranging from pharmaceuticals to wastewater treatment to e-commerce to software to manufacturing. We invest in roughly 2% of the companies we look at, meaning that even a small venture fund like us looks at hundreds of investment opportunities each year, with no idea what will come next month. At the beginning, the odds are that we won’t invest in your company. So, binding our entire team to a generic NDA - where we might be learning about an industry for the first time - could prevent us from looking at other deals in that industry in the future, or speaking candidly with portfolio companies in that sector. That is simply not an option: we have a responsibility to our investors to find the best investment opportunities in our target industries; signing an NDA with the first one we talked to would be like proposing marriage on the first date, before we got to know each other.
It’s almost impossible to monitor at scale. Having hundreds of different NDAs with different terms, for years, across many companies (98% of which we didn’t invest in), in dozens of industries, is simply unmanageable and a compliance nightmare.
It’s expensive. Even with in-house counsel, we would spend time reviewing - and likely modifying - NDAs. We just don’t have time or money to spend on them.
It makes it hard to coordinate investments with others. VCs talk to each other, often about potentially investing together in deals, or sharing background information on deals that both are looking at. VCs will have asked for your permission to discuss specific or sensitive details of the deal with other investors. We often do this as a means to try to get deals done quickly and efficiently with investors we know and feel are likely to be interested. But if one or both is under an NDA, it makes it much harder and slower to get deals done when multiple investors are involved.
So what do you do instead of a general NDA? If you have sensitive information that you don’t want to disclose, you have a couple of options.
Hold back the sensitive information until the relationship with a potential investor has gotten much further, and you’ve built a relationship you can trust. While you’ll have to describe the main contours of your business to get anywhere with an investor, a good VC will understand reluctance to share truly confidential information. Just be selective and clear about what you’re holding back and why - there should be a very good reason to do so. An example might be a marquis customer - say, Walmart - that has an agreement with you that doesn’t allow you to disclose their name. Trust in a founder-investor relationship is crucial. If you wind up with capital from an investor you’re going to have a relationship for a long time! If you’re not feeling that a potential investor is trustworthy, run away.
For protectable information like patentable, trademarkable, or copyrightable work, get your registration and application filings done before you share it.
For information that is confidential, set expectations with the investor that “this part here, this is the confidential part, and needs to be handled carefully.” A good investor will confirm that they’ll do so.
Ask the VC to confirm that they have no obvious conflicts before meeting with them or disclosing sensitive information.
Reach out to other founders who’ve interacted with that investor, to ask about their impression of the investor’s integrity and trustworthiness.
If absolutely necessary, propose to the VC - once you’ve reached a stage where an investment is likely - that a very narrowly written NDA could be beneficial. VCs are business professionals, and if there’s a really good reason for a specific and focused NDA to be in place, we’ll sometimes agree to one.
Without an NDA, you’re relying on the investor’s integrity and their concern for their reputation. In venture capital, reputation matters a lot. VCs - especially young ones like ISAV - are hard to evaluate from the outside. VCs mostly operate on their reputation with founders, and will go to great lengths to protect their reputations. Divulging confidential information could severely damage a VCs reputation - reducing their opportunity to compete for deals.
Though ISAV is a young venture fund, we’re working hard to act with integrity - and to help Iowa’s founders understand how the VC world operates and why. We’re fortunate that the other investors and founders we’ve worked with do, too.