Posted by Early Growth
May 1, 2014 | 4-minute read (785 words)
Non-Disclosure Agreements, or NDAs, are legal contracts designed to protect confidential information. They set out the the parties involved, the types of information to be protected, the timeframe covered, and the legal ramifications for violations. In practice, lots of companies in the startup world use them to apply to ANY information deemed to be sensitive.
But is using them a good strategy for your business? Not necessarily: it really depends on how you use them. While there are definitely potential benefits, NDAs also have several often overlooked caveats.
Signaling — An NDA puts other parties on notice that your IP is valuable, not lightly shared, and that you intend to defend it and your business. Also, to the extent that NDAs increase the comfort level of those talking, they can foster more open communication and exchange of ideas by making both parties feel they are protected.
Protection — Of course the tangible value of NDAs, and the reason they’re so prevalent in the startup ecosystem is that as contracts, they set out clear obligations and concrete remedies for addressing breaches of confidentiality. So signing one is an obvious deterrent to intentional or unintentional information leaks.
Recourse — Drawing up an NDA and getting the other party to sign it, or, for mutual NDAs, having both parties sign it, means that you can pursue each other legally, i.e., sue for damages if either one of you breaches it.
Restricted pool of potential investors — If you insist on an NDA for all discussions no matter how minor, you’ll quickly find yourself with a limited audience. Many investors won’t sign them because they don’t want to hamstring themselves when reviewing lots of businesses with similar concepts or products, don’t like the message of mistrust they convey, or simply because with so many entrepreneurs hitting them up, they don’t have to look at yours and don’t want to be bothered with the extra hassle of an NDA for something that might not be worth their time. And never use them when talking to VCs. That rookie mistake will get you laughed out of the room or worse, written off.
False sense of security — You might think everything’s good now that you have a signed NDA, but really all that does is give you the option to sue if someone violates the agreement. If someone does spill the beans about, say, your one-of-a-kind distribution method, you’d have to 1) prove that they did; 2) show that the information wasn’t available in some other fashion; 3) sue them; and 4) win. Each of these steps takes time and money and there’s no guarantee that you’d win.
Cost of enforcing — Considering the expense of a lawsuit, not just in money but in time, resources, and potential reputational damage, the costs might outweigh any potential benefit. Even if you do succeed in getting awarded damages, you won’t recover the time and energy spent.
They’re not always enforceable — NDAs, like prenups, don’t always hold up in court. Loopholes like making yours overly broad or vague could allow someone to avoid any repercussions. Forgetting to also include a prohibition on use/misappropriation of confidential information in addition to disclosure could do the same. And make sure that the leak doesn’t come from your side. Once confidential information is publicly available elsewhere, further disclosures aren’t subject to the NDA. It all adds up to this: if you find out someone leaked your confidential information, the protection you thought you had might be invalidated if you didn’t take appropriate steps to have a comprehensive agreement drafted or if you failed to properly safeguard your own information.
So when should you use an NDA? Sparingly; and only when the circumstances are appropriate. That means when you have confidential information such as trade secrets, a special production process or formula, copyrights, trademarks, or patents to protect. That said, NDAs should never take the place of solid IP protection. They are an extra layer of security, not substitutes.
What’s been your experience with NDAs? Tell us in the comments section below or contact Early Growth Financial Services for fundraising support.
David Ehrenberg is the founder and CEO of Early Growth Financial Services, an outsourced financial services firm that provides small to mid-sized companies with day-to-day accounting, strategic finance, CFO, tax, and valuation services and support. He’s a financial expert and startup mentor, whose passion is helping businesses focus on what they do best. Follow David @EarlyGrowthFS.