NDAs: When To Use Them in Business, When Not to Bother

NDAs: When To Use Them in Business, When Not to Bother

The NDA is possibly the most overrated type of legal document that companies will ever use, but still a critical tool to use when you need to. This article will answer the when do you need to? question.

NDAs: The Basics

Every company at some point will encounter a non-disclosure agreement (NDA, a.k.a. “confidentiality agreement”). Sometimes another company asks you to sign their NDA; sometimes you and and your attorney design your own “paper” to ask other companies to sign. It could be a stand-alone document or one clause in a much longer contract. Whatever the form, the NDA typically prevents the person signing it from doing two things. First, disclosing certain information, documents or materials to other people: A gives B sensitive information, and B promises not to share it with C.

Second, NDAs usually bar using the sensitive materials for the recipient’s own purposes. For example, if A gives B a list of A’s sales prospects, B should promise not to pursue those prospects itself. The parties promise to use the protected information for the purposes of doing a deal together and for no other internal purpose.

What makes NDAs overrated?

NDAs are overrated in two respects. First, they offer less real-world protection than people think. Having an NDA is one thing; suing over a violation of one is another. Lawsuits over NDA breaches are expensive. And unless you have strong evidence that another company not only breached the NDA but that breach harmed you financially (this second point is far harder to prove than the first), it’s unlikely you’ll ever actually sue over one.

Second, companies often use NDAs in situations where they are unnecessary, meaning the costs of negotiating and signing them outweigh any true need for secrecy. This is the case where people over-estimate the rarity or value of a mere idea that they have. If the idea for a business or product is all that you have, think twice before asking somebody to sign an NDA to protect it. If the other party understands your industry at all (which is usually the case, if you’re planning to work with them), chances are good that they have already thought of or heard of that same idea before, and are not interested in developing it themselves.

When should your business use NDAs?

NDAs are common and usually advisable in the following situations.

  • Agreements with your employees and independent contractors.

Your business should always use written contracts with its employees and contractors (freelancers). In addition to confirming the person’s compensation, whether they receive benefits and so on, it’s perfectly acceptable to include a clause in which they promise to safeguard your company secrets. In fact, sometimes it’s critically important that they do — because at some point you’ll sign B2B contracts in which you must promise that your employees have signed them. It’s best to have your personnel sign these contracts at the time of their hire, because it can be hard to enforce their NDAs later unless you pay them separately to sign them after they’ve begun work.

You can also ask job candidates to sign NDAs to cover sensitive information you’ll share with them during an interview process (for example, technical interviews in software companies).

  • Preliminary NDAs with potential business partners.

Before two companies collaborate, they often spend extended time learning about each other in depth. They may hold a series of meetings with both companies’ software engineers, salespeople and finance teams, for example, as they explore whether a deal would make sense for both of them. To allow for candid conversations, it makes sense for both companies to promise to keep each other’s secrets secure. Often this preliminary NDA will terminate immediately if the two parties ultimately sign a deal, as that contract (see below) would include a different NDA clause replacing the first.

  • NDAs in B2B contracts.

When two companies agree to do business together, it often makes sense for the contract to include an NDA. This could be an agreement between you and your suppliers, resellers, end customers, marketing firms or any other type of B2B agreement. In each case, the purpose is the same: you need to share some sensitive information in order to do the work, so define how you both will protect it.

  • Discussions with investors or potential investors

Not all companies will pursue outside investment from angel investors, venture capital firms or other professional investors. But some will. While there’s rarely a need for an NDA in early conversations with investors (see below), at some point in negotiations it can make sense.

When should you not use NDAs?

  • Initial meetings with angel investors and venture capital firms.

Our startup clients often ask us if they should ask potential investors to sign NDAs. Their reasoning is understandable: before I share my secret business ideas with this person, shouldn’t I ask them to keep it confidential? But our advice is almost always no – please, don’t even ask them to. Here’s why.

Investors don’t steal ideas. They try to identify startups that are positioned well to execute great ideas and then fund those companies. That’s what they do. You want them to feel free to discuss your startup with other investors. As a startup, the fundraising process is long and iterative: create your pitch deck, pitch, get feedback, revise deck, pitch again, feedback, revise, many times. Most investors who see your deck or hear about your idea will never invest. That’s fine; it doesn’t mean they can’t be helpful to you. Investors often talk to each other. The VC who passes on you today may introduce you tomorrow to an angel investor who better understands your particular industry or business model. That’s exactly what you want – the warm intro to another investor. Bear in mind too that ideas are cheap. Whatever your business idea is, somebody (probably many people) have had the same idea. If they’re not building a company around that idea, it’s because they couldn’t figure out how to execute, they lost interest, they ran out of cash, and so on. The idea won’t be what gets you funded, so there’s no great need to protect it with an NDA in these early investor meetings.

And this is why investors generally view it as a “rookie mistake” to even ask them to sign an NDA. They won’t sign it, and cannot possibly sign it; they’re in the business of talking to large numbers of entrepreneurs and other investors, and if they signed NDAs with each, they couldn’t do their jobs.

With that said: if the first meeting with a potential investor leads to a second, and then a term sheet, and then due diligence – by all means, at some point, use an NDA. That would be when you reach the point where the investors asks for genuine trade secrets – your detailed financials, lists of your customers, copies of your customer contracts, etc.

  • Any other time you don’t really need to.

Signing an NDA has a downside for everybody who signs it. Companies usually run NDAs by their lawyers before signing them, so just signing one is expensive. And by signing one, you’re agreeing to painful legal consequences if you violate it later, although most most violations of NDAs are inadvertent and harmless. So don’t sign NDAs, and don’t ask others to sign them, unless you really need to. Just as you wouldn’t ask a business partner to do anything else expensive unless you had a strong business need for the request.

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Adam Nyhan

Adam Nyhan represents clients in Maine, Silicon Valley and globally in software, privacy, trademark and business law matters. He is also the co-founder of a Software-as-a-Service startup and a former in-house attorney at a software firm in New York City.