NDAs with investors and potential partners

This post was prompted by a Hacker News discussion.

Is it even worth asking a potential investor for an NDA?

Potential investors in a company might be reluctant to sign an NDA. Venture capitalists in particular often flatly refuse to do so. If you’re dealing with folks like that, you might either have to take your chances that they won’t “steal” your idea or see them walk away.

As a practical matter, though, going without an NDA with a potential investor might not be a bad bet, because:

• You can try to be very, very selective about what you disclose without an NDA, so that you’re not giving away the “secret sauce” of your idea.
• Investors and others generally do have one or two other things on their minds. They generally see lots of entrepreneurs who are convinced they’ve got a world-beating idea. You’ll probably be lucky to get these investors to pay attention for two minutes. Ask yourself how likely it is that they’ll want to take your particular idea and spend time and money building a business around it without you.
• Contracts aren’t the only thing that discourage bad behavior. If an investor stole someone’s idea, and if word got around, then that investor might later find it hard to get other people to talk to him.
• You have to decide what risks you want to take. Your business might fail because an investor steals your idea and beats you to market. Or it might fail because you can’t raise the money you need to get started.

It’s sort of like having to take a trip across the country. You have to decide whether to fly or drive. Sure, there’s a risk you could die in a plane crash flying from one side of the country to the other. But if you were to drive the same route, your risk of dying in a car crash has been estimated as being something like 65 times greater than flying.

As the old saying goes, you pays your money and you takes your choice.

Potential BigCo “partners” might be a very different story

Suppose that one day you’re contacted by a big company. The BigCo people say that they want to “partner” with you, and hint that they might want to acquire you. It might be that their real interest is in finding out your secret sauce. This Hacker News commenter tells of how that happened to his (or her) startup company: A big company reached out to the startup and invited them to do a demo. The BigCo people asked, “how exactly do you do X?” The startup people told them. The BigCo people then showed the startup folks the door, with one of the BigCo higher-ups saying, “the race is on, better hurry!”

That sort of situation can be averted by an NDA — although it might take a long time and a lot of legal fees to enforce the NDA, especially if BigCo is convinced it hasn’t done anything wrong. On the other hand, sometimes it can pay off, because a jury might well punish a company that it found violated an NDA. See, e.g., the 1996 case of Celeritas Technologies v. Rockwell International, where a federal-court jury in Los Angeles awarded a startup more than $57 million, and the judge then added $900,000 in attorneys’ fees, because the jury found that Rockwell had breached an NDA. (Disclosure: I was on Rockwell’s trial team in that case.)

Be sure to comply with marking requirements

Many NDAs include requirements that confidential information must be disclosed or summarized in a writing that’s marked “Confidential” or “Subject to Nondisclosure Agreement” or something like that, on pain of losing protection. Disclosing parties will want to be sure to comply with any such requirement, because not doing so could be fatal. For example, in the Convolve v. Compaq case, the computer manufacturer Compaq (now part of Hewlett-Packard) defeated a claim of misappropriation of trade secrets concerning hard-disk technology because the owner of the putative trade-secret information didn’t follow up its oral disclosures with written summaries as required by the parties’ non-disclosure agreement. See Convolve, Inc. v. Compaq Computer Corp., No. 2012-1074, slip op. at 14, 21 (Fed. Cir. July 1, 2013) (affirming summary judgment).

Include a “show-how fee” in the NDA?

4. Suggestion: Even for non-secret information, an NDA might be negotiated to include the equivalent of a break-up fee. That is, even if it turns out that the secret technology wasn’t a secret after all, but the receiving party didn’t know the technology, then the receiving party might be required to pay the disclosing party something as payment for “show-how” (as distinct from know-how), in return for having taught the receiving party about the information.