According to Wikipedia, venture capital (VC) is financial capital provided to early-stage, high-potential, high-risk start-up companies on the back of a novel technology or business model – so is it really any wonder so much emphasis is placed on maintaining the confidentiality of information related to an entrepreneur’s innovation, novel technology or business model?
While we encourage a robust trade secret policy, as well as the use of non-disclosure agreements (NDAs) when the situation calls for it, start-ups often jump to the latter with- out considering whether an NDA is appropriately crafted or, more likely, whether it is appropriate at all.
Historically, venture capitalists (VCs) have been loath to sign NDAs, a position which has evolved for a variety of reasons.
Though NDAs are often viewed as commonplace, start-ups must remember that they are, at heart, a legally binding document. Most VCs are unwilling to accept the risk of litigation if they hear about a similar concept from another start-up, and since VCs – corporate venturers (CVs) included – are often looking at a number of similar deals at any given time, it is no stretch to imagine that the “paranoid entrepreneur” might view an investor’s choice to fund a similar company as breaching the NDA and stealing his or her idea.
If an NDA is too general in nature, as they all too often are, it might even prohibit VCs from investing in a par- ticular industry as publicly available information might now fall within the ambit of the NDA. This is particularly problematic for CVs as they support new projects which are likely to be linked to the industry in which they operate.
As with any other legally binding document, VCs are likely to require an attorney to review the terms and con- ditions of an NDA prior to signing it. VCs often lack the internal resources adequately to review each NDA from every company that approaches them, and subsequently monitor compliance, and the costs of implementing such a policy would be onerous. As one start-up lawyer once wrote: “Only two groups would benefit – lawyers and paper 4companies.”
There is a big difference between a conceptualised idea and an implemented idea. VCs look for people who can implement an idea, not merely come up with one. NDAs should be used only in situations where it is the how, not the what, that is being disclosed – that is, the unique proc- ess or innovation that will give the start-up its competitive advantage. It is an all-too-common fallacy, particularly in relation to CVs, that it will hear about an idea, recognise its brilliance and steal it or produce it itself. After all, ideas are a dime a dozen – it is the execution that has real value. Yet there has been a marked shift from the earlier reluc- tance of VCs to sign NDAs, predominantly due to the increasing number of VC firms and the rise of CVs, as well as a growing trend of investing in later-stage portfolio com- panies that may have already developed a trade secret policy that should be bound by an NDA.
Many new VCs – who have yet to build up the level of trust of more established VCs – have broken rank and accepted NDAs as a necessary part of discussions with start-up companies. Nonetheless, young entrepreneurs should be discerning in their use of NDAs and must remember to tailor and narrow the scope of an NDA. There are three things to remember.
There should be no need for NDAs prior to an initial meeting, as it is unlikely anything truly confidential will be discussed. Remember, it is the implementation rather than the idea that holds true value.
“Confidential information” should be narrowly defined. Before drafting an NDA, identify the type of information that will be shared and require that it be shared in writing. An NDA should not capture broad descriptions of technology or publicly available information that may be accessible from other sources.
NDAs should not include the restrictive “purpose” cov- enant, which restricts a fund from using the confidential information for “any purpose other than evaluating a possible transaction with the company”.
Though it might seem a risk to speak with a VC without an NDA in place, an internal trade secret policy might go a great way to alleviate some of that concern. After all, knowing the difference between the information that widely constitutes your idea versus the “bits and bytes” underpin- ning your competitive advantage means you willl be well placed to know what to disclose and what to keep secret.
To read more about the benefits of a robust trade secret policy, visit the Metis Partners blog.