I was recently asked the following question: “Dealing with investors is the most common situation for NDA questions for startups. From my experience it’s seen as a rookie mistake to ask for an NDA prior to due diligence.  Can you comment?”

 

The reality is that VCs see many projects and will not likely sign an NDA.

Startup companies are in the awkward position of needing to disclose just enough to obtain financing without putting their most valued information at risk. Startups may decide to share information with the VC, but should not divulge all their secrets until they receive a term sheet.

Consult with your advisors and legal counsel as to what must be disclosed; what is generic information that is not the “secret sauce”; and what can be genericized or anonymized (e.g. customer information).

Even after an investment is entered into, companies may still protect the information that is the source of their competitive advantage from their investors. This may also be done contractually, using language in the shareholders’ agreement to restrict the information rights of the shareholders. This is fair to do, because  investors may be involved in very similar projects.

This is in contrast with potential investors for a later stage company, investment bankers, and internal acquisition teams, who look at later-stage revenue positive projects and sign NDAs all the time. There’s a lot more at stake, and often the target company is required by their investors to ensure that their confidential information stays confidential.

This is also in contrast to negotiations to enter into a business relationship with another company or individual.

In these situations, it is important to enter into an NDA before disclosing any confidential information. The start-up should also consider making the NDA a ‘NNN’ – also containing Non- Compete, Non- Solicit, and Non- Circumvent provisions.

Even if the investor or prospective business associate has agreed to sign an NDA, it is still prudent to limit the disclosure of information to only that which is essential for the deal. The best protection for confidential information, is to keep it confidential!

 

Takeaways:

  • VCs will likely be reluctant to sign an NDA
  • receive professional advice about what information to disclose and what to ‘anonymize’
  • be cautious of disclosing too much before receiving a term sheet
  • if possible, protect your most valuable information by not disclosing it

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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