NONDISCLOSURE AGREEMENTS—A THING OF THE PAST?

Posted January 26, 2020

IN 2013, my client Jorge Vargas (not his real name) was seeking investors for a Hayward start-up that he was putting together that increases the efficiency of solar panels, connecting them to a novel racking system that provided an economical way of making the surplus energy available for heating water. A friend introduced Jorge to a partner at a Silicon Valley venture capital firm. At their first meeting, Jorge asked the partner to sign a nondisclosure agreement.

Such agreements, known as NDA’s, are intended to prevent an idea or technology from being stolen and copied. Mr. Vargas was especially concerned because the venture capital firm was already backing a competitor. “We knew the competitor didn’t have a cost-effective solution to the loss of heat problem with certain solar panels,” he said. “I didn’t want to pitch the partner about what we were doing and have them go back and say to the competitor, ‘This is how Vargas’ company does it.’”
But the VC partner refused to sign an NDA, leaving Mr. Vargas to decide whether to proceed with his pitch.

It is a common quandary, and not just in Silicon Valley. Ten years ago, it was not unusual for entrepreneurs to request, and potential investors to sign, nondisclosure agreements. But today the agreements are largely considered a thing of the past. In fact, some investors say they walk away from a founder who even suggests signing one.

This shift in attitude, which began in the early 2000s, had its origin in Silicon Valley. In the wake of the bursting of the dotcom bubble, entrepreneur became increasingly willing talk about their company to anyone who will listen. The declining use of NDA’s is certainly not in the interests of entrepreneurs. It favors the VC. Although it is rare that an investor steals an idea, it does happen. But in the reverberating chasm of the Silicon Valley, and the networks that aspire to be just like them, they’ve made the easier and less morally defensible position — no NDA’s — increasingly standard practice.

Even if a start-up manages to get an agreement signed, it can be tough to enforce. It’s very hard to prove that you kept information confidential, and it was only disclosed under an NDA. And litigating such cases can be expensive. The entrepreneur has to definitely prove that the investor took its idea and that it suffered damages and losses as a result of the investor’s actions. This meant committing legal and financial resources to pursue litigation, which often isn’t practical for a small business.Many investors say signing NDA’s is impractical for them, either. VC firms look at so many deals today that they could shut themselves out of an area by signing an NDA with one entrepreneur in that area. Also, each time an NDA is signed, it can stall the conversation because of the legal work involved. That can give a competitor the opportunity to get a foothold first.
In many cases where the VC investor refuses to sign the NDA, the entrepreneur gives his or her pitch anyway, in the hope that disclosure might open doors.

When deciding whether to ask for (or insist on) an NDA, consider the following principles.

1. Don’t ask for an NDA unless you have something to protect. The idea is only a small fraction of the value. Most of the value is in the execution.
2. Understand your prospective investor. Carefully consider who you are sharing your ideas with. Unless the investor is very well known, get references. Find out what other deals they have done. Call the companies involved in those deals to ask about their experiences. Determine whether the investor is trustworthy.
3. Consider whether to file for a provisional patent. The refusal of many VC’s to sign NDA’s is a reason why start-ups are increasingly seeking patent protection. A provisional application buys the entrepreneur some time and increases credibility.
4. Take care in what you disclose. Give enough information about what is unique and proprietary. Whenever possible, don’t disclose so much information that someone could replicate the business.

Christopher Shenfield, Attorney at Law, chris@shenfieldlaw.com, Tel 650.373.2054, www.shenfieldlaw.com