Can You Keep a Secret?
Much has been written about why institutional venture capitalists won’t sign non-disclosure agreements (NDAs), also known as confidential disclosure agreement (CDAs), and with rare exceptions, it’s pretty much all true. And while we still occasionally receive requests from entrepreneurs with a wink and a “you can’t blame me for trying,” the fact is, you shouldn’t be trying. In today’s informed world, there is really no excuse for asking a VC to sign an NDA.
However, corporate venture capital firms may occasionally sign NDAs. When would it be appropriate for a startup to expect to sign an NDA with a corporation? When the two companies have products or services that may potentially be directly competitive, or when those same entities are considering a commercial relationship that simply cannot happen without sharing sensitive information.
If you are an entrepreneur, you should expect that the corporation will insist on using its own form of non-disclosure agreement. Below are the top five terms you should review carefully, and potentially negotiate.
1. What is the business purpose of signing the NDA?
The NDA should describe the business purpose of the relationship. An overview of the main types of commercial relationships between a startup and a corporation can be found here. The description of the purpose should detail what type of confidential information is being shared by which party, and why. For example, if the purpose of sharing confidential information is to evaluate a reseller agreement, the beginning of the agreement should say so, in plain English.
Many large corporations use boilerplate NDAs for routine business cases, particularly for co-developing products. Typically, these NDAs indicate that the corporation may disclose inventions, formulae, and other trade secrets that in practice, may not be relevant to the type of information that will be exchanged with, or by, a startup. The corporations include this language to protect themselves, but typically their lawyers will be open to editing the description of the purpose, if their business unit counterparts can explain what information is actually being shared.
Why is this important? Every time you sign an NDA, you assume responsibility to keep information secret, and you may be able to limit your liability (if you are receiving secrets), or strengthen your protections (if you are disclosing secrets), by being specific about your business purpose. In law, the best practice is to ensure that all legally binding documents clearly represent the actual intended business relationship. Clear documents limit potential legal liability for both sides by reducing ambiguity, as well as administrative overhead in keeping track of your actual obligations with regard to NDAs you’ve signed.
2. Is the NDA unilateral or bi-lateral?
This refers back to the purpose of the NDA, and specifies which party is disclosing information. Some lawyers will suggest that all your disclosure agreements should be two-way, on the theory that at some point in the relationship, each party may be divulging secrets. This is simply lazy lawyering. If you aren’t able to describe the business purpose and type of information being disclosed by each side, then you need to go back to step one. If it turns out that only one side needs to disclose confidential information to accomplish the specific business objective, then the NDA should be unilateral, or one-way. You can always amend the agreement in the future if you begin discussing a new business purpose that requires both sides to disclose confidential information. From a “legal hygiene” perspective, it is better to eliminate any potential ambiguity in case there is ever a dispute.
3. How is confidential information designated as such?
To reduce the burden of determining which information might be covered under the agreement, the NDA should require that confidential information is clearly marked. It is typical to accept written and verbal indications. In many standard agreements, verbal indications shall be reduced to writing (including email notice) within 30 days of disclosure.
Unless you are a mind-reader, you should eliminate any language from an NDA that indicates that confidential information includes anything “that reasonably ought to be understood to be confidential” or any similar concepts that create ambiguity about what is confidential and what is not.
4. Are all four standard exclusions articulated?
The following exclusions to what “constitutes confidential information” should be in every NDA you sign. These are industry standard terms.
- Information you possessed prior to the agreement
- Information that is, or subsequently becomes publicly available, without your breach of any obligation under the agreement
- Information that became known to you from a source other than the corporation, other than by breach of an obligation of confidentiality owed to the corporation
- Information disclosed pursuant to a court order
It is typical to provide a notice right to the discloser in the event of a court order requiring the recipient to reveal confidential information, such that the discloser can take action to prevent the public disclosure.
You should ask to insert any of the standard exceptions that may be missing from your NDA, so you can limit your potential legal liability by carving out any information that is not truly confidential.
5. Is there a time limit on confidentiality?
There should be a time limit of two to three (2–3) years on the obligation to keep information confidential. This is different than the term of the agreement, which could be any amount of time, or even an unlimited period until terminated by either party. In some agreements, this time limit may be described as a “tail” that begins after the agreement is terminated, but usually the clock starts at the time of each disclosure. Generally speaking, confidential information with regard to plans in the technology industry does not have a useful “shelf life” exceeding three years, as startups move so quickly that your information is often obsolete within that time frame. In some industries, the obligation is even shorter.
Over time, you may sign many NDAs with prospective business partners, and the lack of a time limit could create an unlimited administrative burden to track your obligations. In addition, if you engage in discussions with competitors in the same industry, a time-based limitation on your obligations to keep secrets will reduce potential liability in the event that you have discussions with one company and eventually wind up working with another corporation in the same industry.
What if the corporation is reluctant to agree to a time limit? It would harm your reputation if you disclosed information your corporate partners believe to be confidential, so you should make every effort to keep all confidential information secret for as long as need be. That said, there are certain types of information that should be even more strongly safeguarded: these are the types of written documents that would be embarrassing if they were leaked to industry publications or to newspapers, for example. To alleviate these types of concerns, you should agree to a provision to return or destroy physical documents at the end of the term in every NDA. This may make it easier for the corporation to agree to a time limit.
Finally, you should check to see if there are any unusual terms in the agreement. The majority of an NDA appears to be standard boilerplate, with provisions for damages, legal venue (where any legal proceedings will occur, generally at the preference of the corporation to maximize their convenience), and so on. If you see any unusual provisions that create additional obligations for your firm that are outside of the scope of the business purpose of the NDA, be sure to ask questions.
If you focus on the overall business goals of the relationship while discussing these terms, it won’t feel like an adversarial negotiation. You will simply be clarifying your purpose and highlighting the needs of each side, so you can prevent misunderstandings as you explore potential mutually beneficial opportunities.
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Scott Lenet is President of Touchdown Ventures, a Registered Investment Adviser that provides “Venture Capital as a Service” to help corporations launch and manage their investment programs. Touchdown’s Los Angeles-based Associate Selina Troesch contributed to this article.
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