Ah, the good old NDA, a founder's best friend. This little piece of paper promises to protect the ideas and secrets of a start-up company from employee and partner relationships gone awry.
But ask a VC to sign one and she will likely refuse even to consider investing in your company.
VCs hinge their reputations on their ability to behave ethically and use the utmost discretion when dealing with company secrets. Bill Burnham, a partner with the Silicon Valley company Softbank Capital Partners, says "large, established VC firms have very strict rules regarding treatment of confidential information."
But VCs shy away from getting into the NDA game with entrepreneurs because they don't want to be hampered by the process--which takes time and energy away from board responsibilities and new business. Considering that a VC can review a dozen business plans in a day, taking the time to review an NDA for each one isn't productive. So, if you want to get a VC's attention, ditch the NDA.
But do VCs always use discretion when it comes to company secrets? "Not always," says one entrepreneur who co-founded a software start-up in San Francisco. Before revealing confidential information to a VC that claimed to be interested in investing in the start-up, the entrepreneur voiced concerns about another company in the VC's portfolio that--though not a direct competitor--was in a similar market.
The VC assured the entrepreneur that the portfolio company would not enter the start-up's market, and promised confidentiality. The VC ended up not investing in the start-up, but instead called the entrepreneur a month later to suggest he team up with the VC's portfolio company in a partnership.
When the entrepreneur turned him down, the VC threatened that the portfolio company would compete against the start-up if the entrepreneur did not reconsider his position.
Says the entrepreneur: "It went from being, 'You have nothing to worry about,' to, 'If you don't partner with us, we'll compete directly in your space.' Although this was in the gray area of ethics, it caused me to stop and think whether I would trust this VC again. I would have to say 'no.'"
Investors shouldn't underestimate the value of dealing with established VC firms with long-standing reputations. The combination of a huge capital influx into the private equity market and triple-digit growth in VC firms over the last three years has allowed a large number of new, unestablished VC firms to crop up.
This fact worries established VCs who do play by the rules. "An entrepreneur should feel free to ask a VC what her policy is regarding company information. If the VC says she doesn't have one, that's probably a red flag," says Burnham.
What should entrepreneurs tell and what should they hold back? "Ideas are not proprietary; execution is," says Ira Ehrenpreis, a partner with Silicon Valley VC firm Technology Partners. "It's never the idea that should be held back. If a company needs to protect the idea itself, then the barrier to entry is generally not high enough for us to get interested. Of course, there's a staging process to how you reveal more detailed information such as the patent work or code."
John Hershey, a partner with Silicon Valley firm Infinity Capital, concurs: "PowerPoint slides aren't a substitute for the passion and know-how underlying them."