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Non Disclosure Agreements are Critical for Your Startup

Written by Patrick Henry

Non Disclosure Agreements

A Discussion about NDAs with Jeremy Glaser Esq., Co-Chair of the Venture Capital and Emerging Companies Practice at Mintz Levin

In this interview with Jeremy Glaser from Mintz Levin, we discuss the key elements of various forms of Non Disclosure Agreements (NDA).  We go on to discuss when you should use what types of NDAs.  Investors, including Venture Capitalists and Angel Investors  typically will not sign NDA.  Is this an issue?  Find out!

Patrick:     Hi, this is Patrick Henry, the CEO of QuestFusion, with the Real Deal…What Matters. I’m here today with Jeremy Glaser who is an attorney at the Mintz Levin Law Firm.

Jeremy also serves as the co-chair of the firm’s venture capital and emerging companies practice. Jeremy has experience representing both venture capitalists as well as entrepreneurs and startups. He has experience on both sides of the fence.

We’ve had Jeremy as a guest on the show before. You should definitely check out his initial interview that he did with us. It explains a little bit more about his background.

Jeremy has so many awards and recognitions that it’s hard to name them all. Most recently, he was named the San Diego Venture Capital Law Lawyer of the Year. Congratulations on that, Jeremy.

Jeremy:     Thank you.

Patrick:     Jeremy has also served as a past president and board member for the San Diego Venture Group. He is a member of the American Bar Association. Welcome, Jeremy.

Jeremy:     Thanks, Patrick.

Patrick:     Today we’re going to be discussing non-disclosure agreements, or NDAs, as they’re commonly referred to. We will discuss the different types of NDAs and what the key components are that you need to include in NDAs as a startup or as an entrepreneur.

                  Jeremy, can you describe in layman’s terms the different types of NDAs?

Jeremy:     Let’s just start with why you need an NDA. Most companies are developing some new product or new technology. That’s their secret sauce. The last thing that you want to do is be out there talking to people about it. Then they can say, “That’s a great idea,” and go off and start their own business.

The purpose of the NDA or non-disclosure agreement is that when you meet with someone, you have them agree in writing that what you’re sharing with them is going to be confidential. You’re specifically agreeing that they’re only going to use that information for purposes of the specific relationship or conversation that you’re having.

They agree in writing that they are not going to go off and start a new business using your idea, go share your information with someone else or write an article about it and publish it. It protects your idea.

It’s really important that you have a form that you use when you go out to meet with people. I will talk about some instances where you can get NDAs and some instances where you can’t.

Basically, there are really two flavors. There’s what we call a mutual NDA and a one way NDA. They’re what they sound like.

The one way is if I sit down with you Patrick and have a great idea I want to share with you. I make you sign a one way. It says that I’m going to give you information. You’re going to keep it confidential.

A mutual one would be used if you and I were negotiating a deal. You might be providing some service to me. I might be providing some service back to you. We both have secrets that we want to keep. That’s what we call a mutual NDA.

Patrick:     Rarely have I seen anyone willing to sign a one way.

Jeremy:     That’s because everyone always thinks they have some secrets to sell.

Patrick:     In my experience, when you have a confidentiality provision and a proprietary invention with something about the technology, are those things always included in all NDAs? What are the components?

Let’s talk about a mutual NDA. We’re sharing information with each other. We want to do it in a confidential way. What are the rules associated with that?

Typically, there is a term or length of time that the information is in existence. What are some of the other provisions that you commonly see in NDAs? Does Mintz have a form NDA that they have for startups and things like that?

Jeremy:     The answer is, yes, we do. We have forms for both mutual NDAs and one way NDAs. We actually have a fixed fee program that we provide the startups. We give that NDA for free.

                  Granted, the form is thorough, and it’s great. Someone can use it. There are always things that you need to be aware of as you’re negotiating off of any document. The form is just a starting place.

There are a couple of things that you mentioned. One thing that you need to be focusing on when you’re negotiating an NDA is what is confidential. The scope of what has to be kept confidential is really important.

There might be a lot of information being shared that’s not private. It may already be in the public domain. Maybe you actually knew the information before you met me.

The definition of what we’re going to consider confidential, and therefore what can’t be used, is important. Otherwise, you could find yourself potentially being exposed to a lawsuit by some third party or the party who you have the NDA with.

You had every right to use that information, but you didn’t make that clear in the agreement. You now bound yourself to keep something confidential that, really, you shouldn’t have had to.

The definition of confidential information is a really important part of the NDA. It should be carefully reviewed. Make sure it fits the specific circumstance.

You mentioned the term. You certainly don’t want the NDA to last forever. At some point, theoretically, the information becomes so old and cold that it really doesn’t have to be kept confidential anymore.

That’s not always the case. There is some information that may be valuable forever. You could certainly provide that this person agrees to keep this information confidential and not use it forever. That’s unusual. You would typically have an NDA have some sort of a set term. It might be a couple of years or three to five years at most. Then your agreement would go away.

There are so many other aspects that one can negotiate. There is one thing that I always want to warn people about, especially in the technology space. Particularly when working with a large company, you can sometimes end up in this situation.

I don’t mean to say that they’re tricky, but they try to protect themselves. They will draft the agreement in such a way that there are things that are derived from the conversation. For example, I share an idea with them. They don’t use that idea, but they walk away with the knowledge in their heads.

Patrick:     That’s residual knowledge.

Jeremy:     Exactly. They will sometimes carve that out. That could be very dangerous to a startup company. You could have ended up giving away something very valuable without knowing it.

Now the big company can run off and use it. The way that the NDA was drafted, you have no way to stop them, even though it was derived or residual as they talk.

Patrick:     You’ve obviously had to deal with this before. They can be bullies.

Jeremy:     Yes, they can. The bigger the company, sometimes the more bullies.

Patrick:     They’re less flexible. They have a lot of intellectual property. They want to make sure that they’re protected. They also feel like they should be able to do anything that they want to do. As an entrepreneur, you have to be very careful in those situations with things that are really intellectual property.

I think, a lot of times, entrepreneurs get wrapped around the axle on what really is something that you need to have as confidential. As an example, typically a venture capitalist or even most angel investors will not sign non-disclosure agreements.

Jeremy:     Exactly. They will not.

Patrick:     You need to find a way to share information about your business and raising money in a way that you don’t have to get people to sign and NDA. They’re not going to sign it.

Jeremy:     That’s exactly right.

Patrick:     What’s your experience in coaching entrepreneurs about those kinds of things?

Jeremy:     It comes up all the time. You’re exactly right. A venture capitalist and most angel investors will not sign NDAs. The reason is obvious.

They’re seeing so many deals. If they’re signing NDAs on deals, they don’t know if the next deal that they’re going to see might be of interest to them. They invest in it, but they’ve signed an NDA with you and decided not to invest in your deal.

Now you’re suing them, claiming that they violated it. They can’t be put in that position. It’s just not going to happen that you’re going to get an NDA signed in that situation.

It’s obviously built upon a lot of trust. It’s the same advice that I’ve given to companies when they’re considering a transaction with a third party or an M&A deal.

You need to sort of leak out the information. You don’t just walk into the meeting and give them everything. You need to make sure that there’s real interest and that it’s serious interest.

Over time, and as you get comfortable with the relationship, you can obviously share more and more of the information that you view as really important and crucial to your business.

You’re right. I always tell entrepreneurs that I want them to put together an executive summary and a pitch deck that is non-confidential. There’s nothing in there that you would be worried about if it ended up in the hands of a direct competitor of your business.

If there’s something in there that you don’t want a direct competitor to see, then you have to take it out. There will be a time later when you’re much further down the road with that investor that you can then share that kind of confidential information.

That time is once you’ve gotten a term sheet, or you’re pretty darn close to getting a term sheet. At that point your interests are so aligned that they obviously have no interest in sharing the information. It would hurt their investment at that point.

Patrick:     That’s where they’re in a deeper diligence phase, but you need to have layers of information that basically can provide stuff. Let’s say that I have my slide deck. I market confidential and proprietary information at QuestFusion.

Does that protect me, or do I need to get a signed agreement from someone to make it confidential?

Jeremy:     I think you always should mark things confidential. In the absence of an agreement from someone that they were going to keep it confidential, you can’t sue that person and claim that they violated your confidentiality. They could look at it and say, “There’s nothing confidential in there. I knew all that before. I haven’t learned anything from what you said to me.”

                  It’s good just in case it ends up in someone’s hands. People will probably be a little more thoughtful about how they are going to treat it. In the absence of an agreement around confidentiality, you’re not going to be successful in going after someone that uses that information.

Patrick:     How important is it to outline how confidential information is exchanged? I’ve seen in my history where you have a meeting. You have to follow up afterward and say, “These are the specific things that we talked about that are confidential.”

                  Is that essential? If you don’t have that, are you exposing yourself to a lot of risk? How does that work?

Jeremy:     It really depends upon the terms of the agreement. I think that this is where people can get too comfortable. They think that a form NDA is okay. They pull something off of the internet and use that without understanding its implications. Then they don’t live by it.

                  The classic examples would be as just described. Someone pulls an NDA off of the internet. They sign it. They think that they are protected now because they signed an NDA.

The NDA that they signed says that, in order for something to be confidential, it has to be marked confidential. You have to identify it as confidential prior to or immediately after the disclosure.

Then they disclose all kinds of things in the meeting, none of which is marked confidential. The follow up doesn’t happen. Now they’ve lost the protection. The agreement that they signed said that, in order for it to fall into the definition of confidential information, you needed to go through those steps.

You don’t need to have that. You can say, “We broadly define these areas and type of information that we share as confidential.” It really is a give and take in a negotiation.

That whole marking concept is obviously very protective for the person who is getting the information. My argument to you would be that I really want to know what you think is confidential so that I know what I have to protect.

We are talking about so much stuff. Some of it I know. Some of it I don’t know. Some of it might be in public domain. Some of it may not be. I can’t possibly determine what that is.

Patrick, you know because it’s your information. It’s your obligation to make sure that you clearly identify what’s confidential when you deliver it to me or promptly thereafter. That’s a legitimate argument, but it creates a procedure that can really blow up in your face if you don’t follow it carefully.

Patrick:     What if you have one of these conversations, then you get the follow up action? They have a bunch of stuff marked confidential. You know that stuff is in the public domain. It used to be hard without the internet. With the internet, it’s really easy.

                  I do have these conversations. This is so secret. If you have the internet, then it’s all over the place. How do you challenge that but challenge it in a way where you don’t disrupt the relationship? At the same time, you don’t want to be beholden to something that someone thinks is confidential, but it’s really not.

Jeremy:     You start with the agreement and the definition. Most NDAs, confidentiality agreements, have a specific exception. It says, “If the information is in the public domain prior to the time of disclosure, and you can prove that with written evidence, then it’s not considered confidential information.” It goes into the definition.

Patrick:     It’s pretty easy.

Jeremy:     Yes, as long as that carve-out is in there. There’s a number of standard carve-outs that are important to have. They are important to understand, read and make sure that they work in the context of your specific relationship.

Patrick:     Does this basic form NDA that you have on MintzEdge cover things with customers, partners and employees? Do you need to tailor it for different audiences?

Jeremy:     That’s a very good question. There are really two broad universes. There’s the NDA that is used for customers. This is what I would call the business relationships.

Patrick:     Commercial business type stuff.

Jeremy:     Exactly. Then there’s a whole separate confidentiality agreement that’s for employees and consultants. We actually use a different name for it. We call it a proprietary information and inventions agreement.

That is a very different agreement. That’s something that every company should have at the time that they form their company. Make every employee, consultant and whoever works with the company sign.

Patrick:     I’ve definitely been in situations where companies haven’t managed that process well. You get into an M&A discussion. Now we have to round up these five guys and four consultants that never signed anything and try to get people to sign stuff after the fact. It’s crazy.

Jeremy:     It can be a big deal. It can really matter, especially if you develop it. If they were involved in the process of inventing any of the technology and not signed that document, then you have some real issues about ownership and whether you have clear title.

                  That’s a hugely important document to get signed by every person that is an employee or consultant. In fact, I talked about how we have these forms and this MintzEdge package.

Part of the MintzEdge package for companies and part of our fixed fee program is that they get a form proprietary information and inventions agreement. They have that from the very beginning. All of their employees and consultants are signing the appropriate document

Patrick:     Within those two universes or basic form agreements that you have, do you have the data on how frequently people use them as is versus needing some level of customization?

Jeremy:     The employee proprietary information and inventions agreement is pretty much used as is. The only exception is there’s a specific section in there where an employee can list inventions that they invented prior to their working for the company. They want them excluded. That’s the customization for that.

That’s usually not negotiated. Those inventions are listed. The employer will look at them and make sure that they agree. Rarely are you really changing the language of that specific agreement.

On the flip side, the more commercial business terms NDA is typically where you’re getting negotiations. Early startups are moving fast. The forms are sort of adequate to protect them.

You still have to make sure that you know what’s in there, so you know that you are complying with whatever requirements are in the form that you’ve elected to use.

It works without a negotiation. I always urge people to make sure that they understand it and don’t just sign it away without really understanding what it says and what it requires of people.

Patrick:     What about the bigger company that is like the David and Goliath? Not really David and Goliath because actually the little guy won in that situation.

                  Let’s use a more typical situation where the bigger company says, “You have to sign our NDA. It’s our farm. It’s our thing.” As a startup, how do you deal with that and make sure that you’re not getting in a situation that is going to compromise you a lot?

Jeremy:     I know it’s hard because no one wants to spend the dollars on legal fees. I tell every startup that you should never sign a form NDA put in front of you by a large corporation. There’s “got ya’s” in there.

Patrick:     You’ll regret it later.

Jeremy:     It could hurt you later. It could mean that you lost some protection of some important information. It could mean that you’ve allowed a competitor to get into your space who wouldn’t have been there otherwise sharing that information.

                  It’s really worth it. It’s not an expensive review to have an attorney look over the NDA and at least point out to you the issues where you have exposure.

You can go back to the other company and at least try. Even if they won’t make changes, at least then you’re aware of where the risks are.

Patrick:     You might share information differently than you would otherwise by thinking, “I’ve got all of this protection.”

Jeremy:     Exactly.

Patrick:     We haven’t talked about this. Is there a third form of NDA related to M&A transactions where you’re exchanging data room information? Can you talk a little bit about that and what that’s all about?

Jeremy:     When you’re going into M&A negotiations, clearly there’s going to be a form of NDA that will be put together up front for the initial companies that you are talking to about your business.

Patrick:     Yes, there’s a step one and a step two. In step one, what’s included in that?

Jeremy:     The initial one isn’t really different from the business commercial terms NDA. What it does is that it’s specifically tailored around the M&A discussions.

We go back to what is considered confidential. It really is driven by that definition of the kind of information that is going to be shared. That’s really where the tailoring and the M&A NDA comes from as opposed to a more standard business type of NDA.

The reality is that they’re quite similar. They have periods of time where the information cannot be shared. They have some specific exceptions where things are outside of the definition.

In the M&A context, usually there’s much more sophistication going on at the time of the exchange. That’s where you’re more likely going to see the kind of marking things that we were talking about. People are in a process that is much more formalized rather than an ongoing business conversation.

Those NDAs will tend to be a little bit tighter and more formal. They have more process built in. In the business NDA, we try not to do that. We realize that most companies are not going to be following procedures as they’re having multiple conversations with lots of different potential customers or suppliers.

Patrick:     I’ve seen non-solicitation baked in a lot of times in these M&A types of NDAs. That means that the company that you’re potentially selling your company to can’t recruit your employees if you’re exposing your employees’ names, what they do and those kinds of things.

                  Is that pretty common? Do you see a lot of push back on that in M&A transaction?

Jeremy:     Yes. You bring up a really good point. Very often you’ll see snuck into these, not only a no solicitation of employees, but what we call a lock up. Big companies will put in an NDA that you’re agreeing to effectively take your company off of the market. That is obviously unacceptable. You would never agree to it. You’d be amazed at how often they try to hide it.

Patrick:     They try to sneak it in there.

Jeremy:     They think that someone is so excited about the potential of being sold that they’re going to get this free look period on the company. Be very careful and thoughtful if you’re ever being given the NDA by the potential acquirer as opposed to you providing your format to the people who are looking at the company.

                  In this context, and even in the context of the typical customer relationship, you often won’t have the no solicitation of employee provision. The theory is that, in both of those situations, you are being exposed to the employees of the other company.

Patrick:     Sometimes it’s a mutual non-solicitation type of thing.

Jeremy:     Correct. Again, those are negotiated. Things like how long. There are some very specific exceptions that you need to build in.

The most obvious one is that you don’t ever want to be in a situation where you can’t hire someone who has quit their job and is out looking. You should be able to hire that person.

You need to build in exceptions like that. You can get a lot more creative on some of the exceptions on the solicitation of employees.

It’s a bit of a broken record, but it is important to actually understand the context of the NDA that you’re putting in place. Review it carefully. Have an attorney preferably, or someone who is very familiar with NDAs, review it as well.

At least you can know where the pitfalls and risks are. Then you can hopefully go in and tighten some of these things down to make it work for your particular business.

Patrick:     Hypothetically, let’s say that we’ve signed a mutual non-solicitation agreement. You have some engineer working for you, and he hates working for you. He says, “Hey, Patrick. I really want to come work for you.” You and I have this agreement in place. Am I able to hire that person because they’ve contacted me?

Jeremy:     It depends again on the language in the agreement. Some no solicitations are actually no hires. You agree that, for a year, you won’t hire anyone.

Patrick:     I won’t hire anyone from that company.

Jeremy:     Right. You have to be really careful. The language matters.

Patrick:     I think a lot of times entrepreneurs get very paranoid about people stealing their ideas. In my experience, you need to protect how you do stuff. You need to be able to explain that in a way that doesn’t include confidential information.

                  Do you really see venture capitalists ripping off ideas from companies? Is this a legitimate concern by entrepreneurs?

Jeremy:     It’s certainly not with venture capitalists. Think about it. What venture capitalist is going to stay in business if they have a reputation of taking companies’ ideas and running off and starting new companies? You’re going to destroy your business.

                  I can honestly say that in 30 years I’ve never seen any venture capital firm do this. However, I have seen companies do it. It’s quite important to have that NDA in place when you’re engaged in negotiations. It’s especially important when you’re a small company and you try to show your technology to a potential strategic investor or potential customer.

Unfortunately, I’ve seen situations where large companies with a lot of resources have seen a technology and said, “It’s not patented,” and off they go. Even though there might be a case to go sue them, the cost is so prohibitive to go after them on it.

I can think of one situation where my client folded up shop and went out of business because the company took their idea and ran off with it. There was really nothing that they could do because they couldn’t afford to sue them. It was a terrible situation.

Patrick:     I think this has been a really good comprehensive discussion. There’s one thing in my kind of experience where you still have to be careful. It used to be Korea. Now it’s primarily China.

It may be cultural. Even if you have a non-disclosure agreement or employees over there that signed a proprietary invention, you still have to be very careful on how you protect your intellectual property.

You may have the right agreements in place. Think about your ability to pursue people in that environment or to sue a customer or supplier. I think that you must use good judgment associated with the exchange of confidential information. The way I would put it is that agreements alone are necessary but not sufficient.

Jeremy:     Patrick, I totally agree. I tell all my clients that all an agreement does is give you the right to sue a person if they violate it. Then the question is, how much money is it going to take? How much time is it going to take? Can you get a remedy based on where the person lives?

                  I always start with trust. If the trust isn’t there at the beginning of the relationship, then there’s no agreement that is going to protect you.

Patrick:     Absolutely. All it does is that, if you have people that you’re dealing with who are trustworthy and you have that type of relationship, then it outlines how things are done in the event that something goes wrong.

Jeremy:     Exactly.

Patrick:     It’s the same way with the employment agreement. I’m not requesting you to do an employment agreement with me because I don’t trust you. It’s just defining how we deal with things in the event that something goes sideways. I think NDAs are in that same genre.

Jeremy:     I agree. I will say that they do give you at least that option to go after someone who, for whatever reason, becomes a bad actor and runs off with your information.

That being said, I know that patents, trade secrets, trademarks and copyright will be in a whole separate conversation you’ll be having with others. There’s a lot of intellectual property rights that are very important to have in addition to an NDA.

Patrick:      This has been very informative as always. Thank you very much, Jeremy. This is Patrick Henry for QuestFusion with the Real Deal…What Matters.

Mintz Levin has many resources for startups available at MintzEDGE.  Check it out!

If you like this interview and found the information valuable, please let us know!

This is Patrick Henry, CEO of QuestFusion, with The Real Deal…What Matters.

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