What you need to know about NDAs – Part One
NDAs are not standard. They are straightforward, but they are not standard.
I once had a client who had a standard operating procedure of asking me to look over the NDAs proposed to him by others. He set up this arrangement with me when his business got into a painful, costly trade secrets dispute (which he won). He owned and managed a patent-rich ODM business. Each new project required him to disclose trade secrets and know how. That was the precursor before either side could see if they could work together. He faced a classic risk-reward dilemma. No disclosure: no business. Naive disclosure: hurt business. Proper disclosure: business and reward. The brutal experience of litigation resulted in him looking at precaution as a priority.
Trade secrets are the most common, most valuable, under-appreciated, poorly protected intellectual property out there. If things go wrong with trade secrets, they go badly wrong. Market position is lost. Litigation is fought. Businesses go under. People go bankrupt.
That experience showed me the many stripes and colours of NDAs out there. Many are fair. Some misguided. Some grossly unfair. But they are not standard.
So here are my thoughts on questions I am frequently asked about NDAs.
1. What is a Non-Disclosure Agreement?
An NDA requires persons who receive confidential information to keep it secret (until the information becomes public), only use it for the purpose for which it was disclosed, and give confidential documents back when finished or on request.
An NDA can be mutual, or one-way. In a mutual NDA, each party is both disclosing and receiving confidential information, and protections apply mutually between them. In a one-way NDA, only one party’s confidential information is disclosed and protected.
2. What is confidential information?
Confidential information is non-public information that is marked confidential or secret, or is clearly intended to be kept confidential or secret because of the circumstances. Circumstances that could indicate information is confidential include restricted access to information, or policies restricting use of information to a limited group. Confidential information generally will have commercial value or importance.
Confidential information excludes information in the public domain, or information that the recipient receives from a third party without any confidentiality restriction.
Confidential information can be intangible information that is not physically recorded. Typically, confidential information will be specific non-public information contained in documents, and can include things such as customer and price lists, budgets and strategy plans, or product specifications.
3. Is a trade secret different to confidential information?
A trade secret is a sub-set of confidential information. It is the gold standard of confidential information that is commercially valuable and gives an advantage over competitors. The Courts give a higher standard of protection to trade secrets. An example of a trade secret is the secret formula to make Coca-Cola.
4. Is know how different to confidential information?
Know how is the practical knowledge of how to perform a task, process or skill. It derives from the hands-on experience of performing a task, and is not recorded in paper but is rather stored in the memory of the person. Know how can only be protected by contract, and (unlike confidential information and trade secrets) no protection arises generally under law. That being said, there is an overlap, in whole or in part, between confidential information and know how.
5. Is intellectual property different to confidential information?
Confidential information is a form of intellectual property. Intellectual property refers to intangible property creations of the mind that are used in business. This includes many forms of confidential information.
6. When does a Founder need an NDA when speaking to Investors?
There are two situations when a Founder can expect an Investor to sign an NDA:
- If the Founder has already started on basic product design or platform development, then some of that work may qualify for protection by way of intellectual property (IP) rights. Some IP rights (like patents, designs and trademarks) can only be obtained after an application has been filed and approved. One of the key requirements is novelty. If the Founder discloses or commercially uses a work before filing for a patent or design application, then he may lose the ability to obtain valid protection for that work. This is particularly important in the field of patents, which is a form of IP right that protects the rights of creators of novel inventions (and can include software developments). It is unlikely that an Investor will want to inspect the trade secrets of the business in detail (as in, diligence the source code, for instance). If this is required, then an NDA is not only desirable – it is essential. From an IP perspective, it would be better to file for IP protection before disclosure.
- Investor engagements at a more mature stage – perhaps Series A, more likely later – warrant an NDA. At that stage, the Investor will undertake more extensive due diligence for a potential investment, and this may include some sensitive disclosures. Then, an NDA is a normal, reasonable request.
7. Why will an Investor refuse to sign an NDA?
An Investor will look at a significant number of investment opportunities. He will pass on the vast majority of them. Once he passes, he will move to the next, and then the next, rarely reflecting on the rejections, focusing on the future. He has little interest in taking secrets and applying them in his business or passing them on to portfolio companies. There is an obvious reputation risk if he did such a thing. More fundamentally, his core business is to look for a return on investment, not to build a product or platform.
There is also a nasty legal complication for the investor. If each investment proposal comes with an NDA attached, then each NDA must be negotiated. Also, the investor must comply with that web of NDA’s even if the investment proposal is rejected. Many businesses start from a similar business concept or model, and aim for success with a tweak. How many proposals are along the lines of “This is Uber for the [fill in the blank] market”? An investor may struggle to demonstrate compliance with NDAs when it receives investment proposals for basically the same business opportunity from separate founders. It’s a claim waiting to happen.
There are more investment opportunities than there are investments. An Investor can pass on viable opportunities, and still make good sound investments. If it is difficult for the Investor to say yes – such as needing to consider an NDA – he might say no and move to the next opportunity as a matter of convenience.
Want to lean more? Part two of this article will cover more frequently asked questions about NDAs, including: how long confidentiality protection should last for, whether an NDA prohibits all disclosures of confidential information, whether NDAs are enforceable, issues you should look out for in an NDA, and tips on practical and administrative matters of an NDA. Stay tuned!