Shhhh - The Promise Not To Tell

The great Non-Disclosure Agreement debate.  VCs 'never' sign them so we are all told with the reasons generally being centered around we VCs have to be free from any potential conflicts, we see all comers, etc, etc.

This question came up both at the TVG breakfast and yesterday so I'd thought I put down my commentary on this issue and what you might consider doing as you face this issue.

First, and most important: Never say anything confidential in the first meeting with a Venture Capitalist.  There is no reason why you shouldn't be able to explain what you do, what problem you solve, etc, without having to give away the secret sauce.  The first meeting should be treated as an introduction.

The argument about having to drop your draws, open the kimono, etc, to make a first impression is wrong. What you should be doing is convincing the potential investor that you have something which could make a good return on an investment.  What they should be doing is convincing you that they are a firm you'd like to do business with.

So, don't ask about an NDA in the first meeting. Assume the first meeting is exactly the same as if you got invited to keynote the Consumer Electronics Show to talk about your product/idea/service. Anything you'd wow the crowd with, there you go. Simple.

You might get "How do you do that" as a question. Simple answer: We have a proprietary process, etc, that we'd be delighted to share with you in great detail should our company and your firm decide there is a business transaction happening.  Anybody that tells you they need to totally understand, to the source code level, how something works before they can make a decision about the business/space, is just not being fair to you. If you have patents pending, disclosures going on with lawyers, etc, it will all come out in Due Diligence. In my opinion every drop of secret sauce knowledge is not required to gauge interest or move the process to more detailed stages.

A simple example.  Let's say you have a new web based translation service. This service allows a person to speak and the service translates your spoken word into 19 languages simultaneously both in streaming audio and live typed text on the screen. You present me with contracts valued at 2 million dollars for the first version and show me a model on how customer service orgs, governments, etc, will pay billions for this.  I say, whoa, that's cool. I get excited.  I don't need to know the secret sauce at that point to do some work and start to review. If you say, it is not a basement full of people but some amazing technology, that's good enough. I can make a call as to the next steps.  In fact, we can go pretty far down the path before I have to tear into the actual how.  That, in my opinion, is how it should work.

The place where you want confidentiality? The Term Sheet.  You want teeth in it that says nobody can talk about the deal, the terms, anything learned in due diligence, etc, regardless if the deal closes or not. That's what matters to you. Same simple example.  We go down the path, get you a term sheet and we are doing due diligence.  During that period of time, we determine that the management team has decided to move to Barbados.  We say, thanks, no, we're gone.  What you don't want it me talking about you, your technology, your people, or anything we did.  And, keep in mind, this happens all the time. Oh yeah, I saw that deal, oh yeah, I met him, etc, etc.  It isn't anything bad or evil, just is.

My personal opinion is this: I want control (as best as I can get it) over the flow of information if I am out raising money.  I wouldn't want one VC to know I am talking or have talked to any other VC.  I don't want any VC to know that another VC passed or why or whatever.  This is confidential stuff that you should keep close to the vest.  You can't stop the talk when you are having an informal meeting with a VC and she talks to another VC. That just happens.

But, if/when you get to that Term Sheet, make sure the confidentiality has some coverage for you as well.  Also, during that due diligence, you really do have to tell me what's happening.

Speaking strictly for myself, if I am at the point of term sheet/serious potential for investing,  I will sign an NDA that deals with a very well defined promise not to tell promise of what you tell me which is also covered in a strong confidentiality clause within the term sheet.

 

So, sorry, long post to make a point. That point being: At the appropriate time, getting comfort about the sensitive nature of your business is not a take it or leave it proposition on either side. We can and do keep secrets and promise not to tell.

Shhhh....

Comments

[Jeff]

Thank you for this. I have been wondering and not wanting to offend.

[Pat Phelan]

Excellent information thanks Rick
Now tell us more on the translation service,what a product!
Unless of course you are under N.D.A :-(

[Toby Getsch]

Thanks for sharing. There are always different perspectives, and I've been wondering how some of that thinking happens on different sides of the table (or the same sides, depending on how you view it all).

[Andy Beard]

You could have probably been able to mash together the technology for that translation application for quite some time.

At what stage would it be reasonable to require an NDA for Angel Investment, based upon a situation that a patent application might be possible (and theoretically will be made), but hasn't been undertaken?

[Rick Segal]

Andy,
Thanks for stopping by. Obviously, I made up the example but to your question.

With respect to an angel/seed idea that has potential patent possibility, there are a couple of things you can consider. The first is what is called a disclosure document. You file a simple form/letter with your lawyer which basically establishes the timeline, etc. It's not completely mandatory but if you do it, you are better protected when you talk to funding partners from the perspective that you have some minimal structure in place and you can legitimately say "I've got the patent process started".

The Angel Investor, or any funder, is going to have a diligence process that, at a certain state, will need enough information to assume risk. Once they get to that state and you are comfortable with a potential business relationshiop, you should be able to get some confidentiality provisions in place.

[Brad]

Andy,

I'm working on a business plan that involves a company that (as far as I can see) has little or no secret sauce. The only long term sustainable advantage that I can see is that I find it doubtful that there could be multiple clients servicing my market and I want to be there first.

The advantage I have right now is that it is an open ocean.

Am I doomed to fail? To speak to your point, I know that getting a VC to sign an NDA early is nigh impossible, but what advice would you give to someone who just sees an untapped market, but sees no secret sauce?

Thanks. Brad

[Rick Segal]

Brad,

there are many many business that are "execution plays" vs. pure technology/secret sauce plays.

In that case, I would maintain that if you have a solid plan to make money for you and the investor, explain the plan and try to give as much information as possible on what you are solving, how it makes money, etc, and explain it is an execution play requiring speed/smarts. There are many VCs out there that do this stuff and I'd argue that 90% of WEB 2.0 companies are mostly execution play.

[Jeremy Toeman]

Excellent article Rick.

One other thing to add in here to those who disagree: in all reality, if your idea is so early stage that the only way you think you can protect yourself is via NDA, you should'nt be going to VCs anyway. Go get some angel money from trusted sources.

To me, the only important NDAs are those related to huge corporate initiatives (e.g. iPhone) where media-related activities are the issue. Ideas are just too hard to protect by a little piece of paper.

[Steve Morsa]

Thanks for the good info and insight, Rick.

If I may offer another approach for your readers to consider which I'm using myself...

Because what I came up with--a new form of (PPC) advertising--could (as Bill Gross and his GoTo.com team did with their paid search creation back in 1998) clearly be IP protected, I choose to file a patent first (#11/250,908); then begin the process of presenting it to those companies and VCs I felt were best qualified to bring paid match to market...confident in the knowledge that my secret sauce, while publicly visible, was also well protected.

My approach also differs in that, because I'm not a coder myself and am unwilling to put my and my family and friends assets in play (I've been quoted 500k-1 million to build a fully operational system), I'm offering to license this new system; with the resultant lion's share of the profits accruing to the company which brings it to market.

As I'm fine with such a small piece of the pie (like paid search, paid match is going to be a very, very big pie), what's frankly surprised me about this logical approach is the (so far) general lack of foresight and vision by those who regularly proclaim how creative, innovative, and forward-thinking they and their firms are...yet seeming to have great difficulty grasping something with such a clear value proposition...without seeing the ad system in actual operation.

This is in spite of the fact that our own US Dept of Labor already runs a very visible, very successful system (over 500,000 users/month)--GovBenefits.gov--with a number of the same operational factors as paid match.

Thankfully, (though I'd of course like to see it in use sooner rather than later) because I will have strong IP protection once the patent issues, I'm not under the same kind of time pressure most new "no IP protection available" companies are to get to market.

Hope this approach (common in the biotech field) can help others desiring--and able--to follow the same path I am.

[Rick Segal]

Hi Steve,
Thanks for the comments. I've seen a couple of people take this approach. It can be a very smart thing to do.

best,

[Jim Pollock]

Good article, Rick. As the director of a tech incubator in Boulder, CO I am in a similar situation and plead the same: no NDAs, but no need to show me the sauce bottle. Virtually all of the mentorship/advising we do is around basic business 101 block and tackle. Not digging into their technology.

However, Brad above brings up an interesting situation in "the pure execution play". I occasionaly run into such companies and they want me to sign an NDA before disclosing the play, 'cause, that IS the sauce. In order to understand the the business model, they have to give up the execution and the market they've identified. That takes away the "don't talk about what's under the hood yet" point.

Thus far, I've just told 'em I don't do NDA's at this level and either they can trust me and continue or not and stop there.

Any thoughts you have on this specific need for disclosure?

Thanks!!!

Jim

[Andy Beard]

Rick, many thanks for your answer.

One of the hurdles I have to face is that my "secret sauce" is the business process and the way certain technologies can be integrated.

I might actually be in a similar position to Steve in some ways because I am also not a coder, and my "play" is also in the monetization arena.

I am in the process of preparing an Investment Memorandum for a group of Angel investors in the UK who have agreed to forward my proposal to their membership for consideration.

As a check, I provided the latest draft to a colleague I trust in a similar line of work, and his response to the first "vague" document was "Andy, that doesn't tell me anything".

I forwarded him a second version, that was what I intend to be sent out. It is less vague, but there are obvious holes in the information.

Those holes unfortunately are the ones that might be the key way of demonstrating future success, and that showed in the feedback I received.

I am not in a position to start the patent application process. I am trying to find a way I can fill in the holes in my presentation materials.

In the investment memorandum I have stressed that 30,000 of the 100,000 in funding I am looking for is intended for the patent process, and that my ideal investor would fulfil the role of CTO.

I am technically competent enough to define the ways various components are glued together, and how many of them work, but someone with higher technical skills and experience in the patent process needs to be the one producing the documents.

[Rick Segal]

Andy,
Send me an email and let's see if I can't help you a bit on this paper and some navigation.

rick at jlaventures dot com