On why VCs don't sign NDAs
And how to protect yourself without one
Founders often gripe that VCs expect founders to tell them a startup’s deepest, darkest secrets, but then won’t legally commit to treating this sensitive information as confidential.
This concern is not without merit - after all, many venture capital firms have an Entrepreneur-in-Residence program, which brings experienced founders into the VC firm to search for their next great idea.
The topic is a hot button issue - my tweet on the subject generated quite the level of commentary, with many strong opinions and NSFW language.
Nevertheless, ….. and here, I really can’t say it better than Paul Graham himself:
An idea for a startup, however, is only a beginning.
A lot of would-be startup founders think the key to the whole process is the initial idea, and from that point all you have to do is execute. Venture capitalists know better.
If you go to VC firms with a brilliant idea that you'll tell them about if they sign a nondisclosure agreement, most will tell you to get lost. That shows how much a mere idea is worth. The market price is less than the inconvenience of signing an NDA.
Source: How to Start a Startup by Paul Graham
Ideas are dime a dozen, VCs want to invest in great moats and the best in class execution. It’s a fallacy of first time founders to believe that it’s the quality of an idea that’s the most valuable contribution to a startup’s success.
If you’d like a slightly more succinct summary, here’s experienced founder Julie Fredrickson on the topic:
Drivers of resistance to NDAs
In a little more details (and a little more politely), here are some of the reasons that VCs don’t sign NDAs.
Investment volumes
VCs invest in about 1% of the investments they see.
The sheer volume of pitches means that naturally, any one firm is going to see a lot of competing investment opportunities, and multiple companies working on similar ideas.
Signing an NDA with any one company would create an unwelcome liability overhang, for no commensurate benefit. Any startup, disgruntled at not being chosen as the one single investment that the VC made in that problem space, would be motivated to file suit, claiming that the VC firm learned about the idea exclusively from the plaintiff’s pitch.
Legal and time costs
Given the sheer volume of opportunities considered by a VC firm, reviewing that many NDAs is not practical for an investor - not just in terms of the cost of the legal fees but also the sheer drag on time.
Even if the VC don’t invest in a competitor, any legal contract inherently exposes the firm to a risk of spurious lawsuit, and is best avoided.
Quality filter, execution over ideas
Most VCs fundamentally believe that if your business is so fragile that sharing top line financials or a product demo with a VC materially harms you, it’s probably not that strong a business to begin with.
Asking a VC to sign an NDA shows them that you don’t believe in your own ability to out-execute competitors, and don’t have a natural moat to your business above and beyond IP.
Information imbalance
If a VC can only invest in one team pursuing a given problem, then they want to make sure they’re investing in the best team pursuing that problem.
If the VC can’t learn about you and your business, they can’t tell whether you’re the best team to solve this problem, and will likely default to assuming there’s another team out there that might be stronger. Why would they sign an NDA with you that precludes them from engaging with that other team?
Culture check
The main reason that VCs won’t entertain signing an NDA before meeting you, however, is that it gives them a clear signal that you haven’t done your research and don’t understand the industry culture. Asking for special considerations above and beyond industry norms makes you seem insufferable to work with, and no good investor wants to be stuck with that for the 7-12 years of a VC-founder relationship.
Protecting yourself without an NDA
So, if getting an NDA is out of the question, how can you protect yourself?
Consider what you disclose
Don’t give away valuable IP at the first meeting. Let the level of disclosure match the depth of the trust - from both sides.
Most VCs don’t need to see your codebase in the first meeting - they’re just trying to get a feel for who you are as a founder, why you chose this problem to solve, and what are the key drivers of success in the business you’re building.
You can leave sensitive information like customer lists, detailed financials, or patents in progress, to the end of your fundraising process, when it’s clear that these are the last outstanding due diligence queries.
Don’t talk to firms with competing investments
Before reaching out to a potential investor (or responding to an inbound request from a VC firm, should you be so lucky) - check out their portfolio page. Don’t talk to venture capitalists that are already invested in a competitor to you.
And for what it’s worth, good investors won’t seek to take such a meeting anyway. In fact, most VCs will actively avoid getting into conversations with potential competitors to their existing investors.
Check if the firm has an EIR program and who is currently in it
If you feel that one of the firm’s Entrepreneurs-in-Residence has experience in an adjacent space and would be interested in building something akin to what you’re pitching the VC, then reconsider talking to that firm.
Talk to reputable, good quality firms
Good firms build their reputation over decades of repeated founder interactions. They’re unlikely to want to throw away their good name by treating a founder poorly - after all, acting without integrity today just kills their supply of great founders who want to partner with them tomorrow.
Pick VC firms that have great reputations, and ask for references if you can - from other founders, from other VCs, and from the VC’s own investors (Limited Partners).
Technology is a tightly networked industry - if a venture capitalist starts mistreating founders, you will hear about it very quickly, not just from other players in the ecosystem, but also from the tech press!
I hope you’ve found this explanation of why VCs don’t sign NDAs, and what you can do instead, insightful and actionable.
A huge thank you to Julie Fredrickson, Hari Raghavan, Yoni Rechtman, Nia Johnson, and the ever-helpful Alexander Tang for all of their (very funny) input for this guide. Please let me know if there’s something I’ve missed, as well as what other questions you’d like me to answer in future posts!