Many founders in their fundraising journey are surprised to find out that, when starting conversations with investors, signing Non-Disclosure Agreements (NDAs) isn’t common practice, especially when it comes to raising early-stage growth capital. This is not to say that NDAs are never signed by investors, but that they are less likely to feature in the fundraising process.
In order to understand why this is the case, let’s first discuss the role of the investor. An investor’s job, primarily, is to learn about a market they have an interest in so they can find and analyse investment opportunities. The only way to do this, given the limited public information on early-stage private companies, is to speak directly with the stakeholders in that industry: companies (new and incumbent), customers, advisors/consultants, legislators, and anyone else who has a say or an opinion in said market. So it is fair to say that if you are speaking with an investor, it is highly likely that they are also in conversations with your competitors. So, understandably, it makes sense for founders to want to have some form of protection against commercial secrets being leaked.
That is where an NDA would normally come in. The purpose of an NDA is to stop the disclosure of information to a third party; it can be one-sided (i.e. protects one party) or two-sided (i.e. protects both parties). Each party tends to have a template that they share with the other party, who then goes over the agreement and suggests any changes before it is signed. This revision process tends to take some time – which is one of the first reasons why investors don’t usually like to sign NDAs.
By the time internal counsel (or the company’s external lawyers) and the investor’s lawyers have reviewed the NDA and agreed on its contents, the actual conversation between the company and the investor may have ceased. It is no exaggeration to say that investors receive hundreds of investment decks a week, so it follows that it is impractical for them to review and sign hundreds of NDAs in a week.
Another practical reason for this practice is that in the worst case scenario of information being leaked, the company and its lawyers must consider the burden of proof and their ability to prove that information was leaked by the second party and damage was done as a result. Whatsmore, if the case ends up in court, the information that was deemed confidential might ultimately have to be revealed during evidence collection and court hearings.
Investors know that what goes around, comes around.
One final, more philosophical but not less important, reason for this phenomenon is the self-regulating nature of the system which relies on trust. Founders trust that investors won’t divulge confidential information about companies, and investors trust that founders will keep investment conversations private; if any one of these parties breaks “the rules”, they are penalised by way of damaging their reputation. This is key since an investor’s main asset is their reputation. If they squander it by giving away information that is confidential, sooner or later the market will know about it and cease reaching out for new investment opportunities. Investors understand this and know that what goes around, comes around. If data leakage became a norm in the industry, their portfolio companies would likely suffer from it.
In any case, founders can protect themselves from the risk of data leakage by choosing carefully what is disclosed in their investment materials. If, for example, they run a B2B company, they might want to mention who their clients are (first making sure clients consent to this), but not disclose the details of the contracts until they are in advanced negotiations/final due diligence with an investor. For a B2C company, for example, they might want to disclose a key metric, say churn rate, but not the breakdown of the causes for churn – which, again, would normally be disclosed once investors show real appetite for a potential deal.
Finally, founders should take comfort in the fact that most information disclosed during investment negotiations, by itself, is of little value if not executed well. And that, ultimately, the reward for disclosing the right information to investors, in order to put your best case forward and raise growth capital, is greater than the potential risk of a data leak.
The information and opinions we provide do not address your individual requirements and are for informational purposes only. They do not constitute any form of legal advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances and is not intended to be relied upon by you in making (or refraining from making) any specific decisions.
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