Ever tried to share information about your startup with a VC and you asked for them to execute an NDA and got a blatant “no”? This happens quite often and there are a number of reasons why both European and Silicon Valley VCs decline startup’s requests to sign a non-disclosure agreement (NDA).
Why do VCs never sign NDAs – There are several different reasons why VCs are skeptical about and opposed to signing NDAs.
- Legal Friction – It is important to note that VCs are not in the business of stealing ideas of founders but in the business of allocating funds to the growth and expansion of those ideas. Accordingly, from an administrative and practical perspective, signing NDAs with all founders creates a layer of friction in the process, which they would rather avoid. VCs usually go through several thousand pitch decks and hundreds of screening calls with founders before offering a term sheet. From the administration point, reviewing, negotiating, and monitoring NDAs for multiple founders and startups lead to the expending of significant resources (legal, financial, etc.). This makes VCs reluctant to sign NDAs, especially at the early pitch stages when they cannot be certain that they would be proceeding with the investment. Also, NDAs may not be attractive to VCs if it would prevent them from sharing information with potential co-investors or if they would need to seek permission and a corresponding NDA each time they want to engage other co-investors. VC’s back-channeling about deal flow is a huge thing and most early-stage founders underappreciate and don’t realize VCs talk behind the founder’s back. In practice, NDAs do not actually protect the founders, because it could be an uphill task to enforce the NDA both from a financial and legal perspective.
- Nature of VC – Because of the nature of the VC business, NDAs also don’t work for VCs post-financing. A VC fund is generally obligated to disclose and report all the information concerning the startup to potential limited partners or GPs in order to seek their initial investment or follow-on investment. It should be noted that once an investment is made, the VC, as an investor, usually receives broad information rights over the company pursuant to the standard US-style Investor Rights Agreement and in some cases a management rights side letter. Even though the Investor Rights Agreement contains confidentiality provisions there is a carve-out that allows VCs to share the company information with its affiliates, limited partners, members, advisors, and consultants, among others. Thus, it is vital for the proper functioning of a VC fund that they are allowed a certain level of disclosure, and therefore, an NDA at the time of investment would mostly lead to friction and conflict for the VCs.
- Relationship Building – In this context, some VCs take the request to sign an NDA as a signal of lack of trust and are put off by such requests from founders. Keep in mind that VC is a relationship-building business, where VCs are in the business of talking to founders and co-investors and need a free flow of information. A few VC insiders note that it could also be seen as a lack of knowledge as to how the VC industry operates. VCs generally take the view that the team building the idea is actually what is valuable (in other words they need you to make it work). Thus, they genuinely do not intend to steal the idea, especially since this might have reputational consequences for them including with the regulators. Asking them to sign the NDA could mean to them that you do not appreciate this context.
Maybe an NDA is a Good Idea (after all) – Some say never ask for an NDA and in some instances, founders may find themselves not signing an NDA even when it may be crucial for the startup. There are really no hard and fast rules for deciding when to insist on an NDA. It’s typically a risk-benefit analysis, i.e. is it worth giving out information in exchange for the potential investment? Below are a few guidelines you could consider.
- Late Stage Investing – You should consider at what stage of the conversations you are in and at what stage your company is prior to opening the conversation about an NDA. Generally, for pre-seed/seed companies at the very early stage of introductory conversations, where confidential, technical, or proprietary information is not disclosed, then you should not start a conversation about an NDA. In such cases, founders should be able to present their initial pitch decks without any confidential or sensitive information. Additionally, in the early stages of financing, it is not advisable for founders to push for an NDA and instead focus on finding the right VC to catalyze growth. However, at later stages of financings, such as a Series B or Series C financing, when the startup has achieved some traction in the industry and the VC is doing preliminary due diligence, a company could push for an NDA.
- The nature of information being shared – For certain startups (deep tech startups with proprietary tech) even the early stages of communication could involve the sharing of information about the technology which is sensitive and confidential. You need to analyze the information you would be sharing regardless of the stage of communication, and decide whether or not you should share such information without an NDA. Regardless of the stage of communication, if you believe the information you are sharing should be protected by an NDA, then protect it.
- Customary carve-outs – If you insist on an NDA or you are at a stage where an NDA is necessary you can include some useful carve-outs that would ensure that certain disclosures do not constitute a breach by the VC. For instance, for VCs that may want to share your pitch with potential co-investors, this could be addressed with a carve-out for disclosures on an as-needed basis for discussions with co-investors with a clearly demonstrated interest in investing in the startup. Again this is typical for late-stage growth rounds.
In conclusion, in the world of startup financing, VCs are an ally to early-stage companies and in most instances, it is prudent for the founder to not obligate the VC to enter into an NDA in order to build trust and facilitate swift growth. In the rare instances discussed above where an NDA could be necessary, the founder should have a lawyer prepare one or look over your template to make sure your IP and confidential information is properly protected and the VCs are granted the carve-outs essential for their operations.