Why VCs and Angel Groups May Torch your NDA and Your Company’s Candidacy for Startup Funding

You are having a great conversation with the lead from an Angel fund which appears to be a good investor match for your company. They invest in the technology space in which you operate, at the stage of development that your company occupies and within the level of investment you are seeking. They appear to be genuinely interested and he is requesting additional information from you.

“I’d be glad to share additional details related to our company” you excitedly respond, “however, I’d like to forward you a Non-disclosure Agreement, (NDA) to review and execute before doing so.” The fund manager reply is preceded by a “pregnant pause”, at which point you immediately ask yourself, “What just happened”?

A LOT JUST HAPPENED!

If the fund manager represents a well-established Angel fund with a solid history of investment and an impeccable reputation, you may have just insulted him personally and the fund as well. Angel groups and VCs operate in a tight knit industry. They work hard to build and maintain strong reputations of integrity, because without it, entrepreneurs would not be interested and their deal flow would dry up.

Angel and VC Funds are investors; they are not competitors of the entrepreneur. They invest in startup companies and as such have a stake in their success. They don’t typically build startups. Ideas, in and of themselves are just that, ideas! Without a seasoned management team to execute on the development of the idea, the startup possesses little value. Great management teams which can execute are not generally sitting idle awaiting the next idea.

Finally, assuming the Angel and VC funds are seeking scalable ideas with great management teams behind them driving the execution, and assuming your idea really is an original scalable idea in a market open to significant development potential, you just announced you may not be that experienced management team to execute and drive the idea. Essentially, you have announced to the investors you are inexperienced and naïve, as a savvy and experienced entrepreneur would know that Angel groups and VC seldom sign NDAs.

There are numerous reasons Angel and VC funds avoid NDAs:

  1. NDAs are Costly – NDAs are legal documents which, if done correctly typically require the review of an attorney. Boilerplate versions generally require effort from attorneys for the party that did not originate the document. Once commenced, such efforts seldom move forward leaving said boilerplate untouched. Typically the parties negotiate aspects of the agreement requiring modifications and re-writes to the original document, again requiring legal support.
  2. NDAs are Time Consuming – Imagine being a partner in a VC which executes NDAs with all entrepreneurial startups requesting them. If you are leading a VC fund which reviews information from several hundred to a thousand opportunities each year, imagine the effort behind administering and maintaining the terms and conditions of these various agreements.
  3. Executing NDAs Would Significantly Reduce Deal-Flow – Each time a fund’s manager executes an NDA in a given space, they find themselves limited as to the personnel that can entertain opportunities on the funds’ behalf in that space. The typical Angel or VC fund office does not possess large numbers of personnel. Additionally, the personnel they have may be experts in a particular space or subspace. Limiting their access may remove that VC from all future opportunities in that space, hence, radically reducing deal-flow.
  4. Angels and VCs Simultaneously Look at Multiple Similar Opportunities – It is not uncommon that an Angel or VC fund might have multiple entrepreneurs pitching them similar ideas at the same time. Requesting execution of NDAs in this situation could create a which comes first, the chicken or the egg type conundrum? Without executing NDAs, the entrepreneurs won’t provide the information the investors need to choose from amongst them. However, if the Angel and VC funds execute NDAs, they may only be able to look at one of the opportunities, the one for which they execute the NDA. On what basis do the investors decide which opportunity to choose?
  5. Executing NDAs Enhance the Angel Group or VC Funds Susceptibility to Litigation – If they subsequently invest in a company with a similar idea after executing an NDA with another, they may be accused of stealing the idea. Even if they didn’t and they win the law suit, they lose. The litigation is a time sink! Angel and VC Funds are simply unwilling to accept this increased risk of litigation.

The entrepreneur’s best bet is to segregate the secret sauce, that technology or information which is truly impactful and secret. Angel and VC funds are managed by sophisticated people. If they have a high interest in the opportunity and have completed their due diligence and are ready to invest, pending the opportunity to review this technology / secret sauce, a narrow NDA can be crafted to protect the startup, potentially with the support of an outside expert who can validate the technology, without constraining the fund.

 

NOTE: This article may discuss issues for which legal advice should be considered prior to a decision or agreement with a third party.  It should be noted that the author is not an attorney, and FundingSage is not a law firm.  FundingSage’s employees and affiliates do not provide legal advice.  We recommend you seek the services of an attorney if legal advice is required.


Tony Lettich

Tony Lettich has previous corporate venture capital experience and currently serves as Managing Director of The Angel Roundtable. He is a co-founder of FundingSage, which provides valuable information, tools and resources to entrepreneurs seeking to start, grow and fund a business.