A typical question young founders ask me is whether they should request investors to sign an NDA (Non-Disclosure Agreement) before speaking to them about their business. I can understand why a founder might think an NDA is a good thing. It inevitably stems from pride in his business concept, and his desire to protect that concept until he is able to commercialise it. But he will stifle the investor discussion before he starts it.
An NDA is a straightforward document. It requires persons who receive confidential information to keep it secret (until the information becomes public), only use it for the purpose for which it was disclosed, and give confidential documents back when finished or on request. Nonetheless, you only need an NDA in limited situations. Early stage investment is not one of them. Here’s why.
First, let’s look at the levers of power in the negotiation dynamic. There are more investment opportunities than there are investments. An investor can pass on viable opportunities (even hot deals) and still make good sound investments. Also, he who has the money, has the power. This is the quintessence of the negotiation dynamic for any founder seeking external capital.
An investor will look at a significant number of investment opportunities. He will pass on the vast majority of them. Once he passes, he will move to the next, and then the next, rarely reflecting on the rejections, focusing on the future. He has little interest in taking secrets and applying them in his business or passing them on to portfolio companies. There is an obvious reputation risk if he did such a thing. More fundamentally, his core business is to look for a return on investment, not to build a product or platform.
There is also a nasty legal complication for the investor. If each investment proposal comes with an NDA attached, then each NDA must be negotiated. Also, the investor must comply with that web of NDA’s even if the investment proposal is rejected. Many businesses start from a similar business concept or model, and aim for success with a tweak. How many proposals are along the lines of "This is Uber for the [fill in the blank] market"? An investor may struggle to demonstrate compliance with NDAs when it receives investment proposals for basically the same business opportunity from separate founders. It’s a claim waiting to happen.
Let’s now take the perspective of the founder.
The founder should want his investor engagement to focus on the core critical reasons why the investor should choose him. Anything that inhibits cutting to the chase, reduces the chance of a successful discussion. An NDA is an inhibitor.
Any founder worth his salt will have drive, ambition and grit. Novelty and creativity are optional extras. The successful business is rarely the first of its field. It is normally the execution of an idea that makes the difference. The real value of the business proposition may not be the idea (and the idea itself may not attract formal protection as intellectual property in any event).
Then, when does an NDA make sense? What are the exceptions to the rule? Two obvious and important exceptions spring to mind.
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If the founder has already started on basic product design or platform development, then some of that work may qualify for protection by way of intellectual property (IP) rights. Some IP rights (like patents, designs and trademarks) can only be obtained after an application has been filed and approved. One of the key requirements is novelty. If the founder discloses or commercially uses a work before filing for a patent or design application, then he may lose the ability to obtain valid protection for that work. This is particularly important in the field of patents, which is a form of IP right that protects the rights of creators of novel inventions (and can include software developments). Now, it is highly unlikely that a prospective investor will want to inspect the secret sauce of the business in detail (as in, diligence the source code, for instance), but if discussions go in that direction, an NDA is not only desirable – it is essential. From an IP purist’s point of view, it could even be better to file for IP protection before disclosure.
A second situation arises in investor engagements at a more mature stage – perhaps Series A, more likely later. At that stage, the investor will undertake more extensive due diligence for a potential investment, and this may include some sensitive disclosures. Then, an NDA is a normal, reasonable request.
Neither of these situations apply for a preliminary discussion by a pre-seed founder with a prospective investor though.
Lawyers are conservative, pessimistic souls. They live their lives on the principles that if it can go wrong, it will go wrong, and a remote possibility is a real probability. So, if there is a one in a million chance that a contract will have some use, then lawyers will want the contract. Lawyers like protection; that’s our business. Even so, if an early stage, pre-seed founder asks me should he ask an investor to sign an NDA before meeting for a chat over coffee, I do restrain myself.
My usual answer is no.
This article was sourced from http://sportsnewslist.com