Everything Entrepreneurs Need to Know about Non-Disclosure Agreements

Do you think you need a non-disclosure agreement (NDA) to protect your business ideas? Do you or a business partner want one in place before you team up? You may find that not everyone is excited about or willing to sign an NDA. To understand why, you need to understand how NDAs work along with what happens if someone violates an NDA.

What Is a Non-Disclosure Agreement?

A non-disclosure agreement is an agreement to prevent others from using your confidential information to their benefit. The agreement will contain language to the effect that proprietary information or trade secrets cannot be shared with others, used to create a competing product or service, or otherwise used to the signer's benefit.

Some NDAs will have a time limit while others are in effect indefinitely. The NDA may also state which damages a person who breaches the NDA is liable for and how any disputes over the NDA should be settled (for example, in court or arbitration and in which city or state).

What Are Non-Disclosure Agreements Good For?

If you have worked hard to create an idea, you probably do not want someone to steal it. You have likely heard at least one story about a founder of a large, publicly-traded tech company who allegedly stole an idea or code from a co-founder and cut that person out of their share of the company.

The entire purpose of an NDA is to protect your ideas and work so you can start your business without someone taking what you have done, finishing it without you, and claiming all of the profits for themselves. When you talk to potential business partners, investors, employees, or contractors, they will naturally want to know more about your business to decide if they want to do business with you. An NDA gives you a way to have these conversations without the risk that you are giving away your secrets to a potential competitor.

Why Entrepreneurs Want People to Sign Their Non-Disclosure Agreements

Entrepreneurs obviously want the benefits of a non-disclosure agreement, but it goes deeper than that. To an entrepreneur, their business is their baby that they have put everything into. This makes entrepreneurs highly protective of their business and their ideas.

For an entrepreneur who spends a huge portion of their life going over the small details of their business, any piece of information can be used to compete with them. Therefore, an entrepreneur may want an NDA in place before having any sort of detailed conversation about their ideas and operations.

Why Accountants, Lawyers, and Other Professionals Do Not Sign Non-Disclosure Agreements

Nearly all entrepreneurs will reach a stage where their business needs professional advice. But what they find is that professionals, such as lawyers, almost universally refuse to sign non-disclosure agreements. This is not because your CPA or attorney is waiting to steal your idea; most would not even have the expertise to steal and recreate your idea if they wanted to.

The real reason professionals will not sign your NDA is to avoid liability. If a CPA does your tax return and then later does the tax return for someone who has replicated your business idea, then there is a risk to the CPA of having to defend a claim that they breached the NDA even if they did nothing of the sort. While you might be reasonable enough to not bring such a claim, many overprotective entrepreneurs are not so reasonable, especially if the competition has put them out of business.

Your ideas are your own creation, and you may have even found a truly unique secret sauce. However, when an attorney or other professional is dealing with dozens or hundreds of clients, it is almost certain that at least a few of those clients have had very similar ideas. The reward of signing one extra client just is not worth the risk of having a conflict over an NDA.

Why Investors Usually Do Not Sign Non-Disclosure Agreements

Venture capitalists and other investors also refuse to sign non-disclosure agreements for reasons similar to business advisers. However, the risks for them are slightly different.

An accountant might only have your financial statements and know little about the technical side of what you do. During an investment pitch, potential investors will want to learn as much as possible about your idea and how you plan to grow. In the right hands, the information they ask for could easily be used to create a direct competitor.

The problem for investors is that there is always going to be similarities from one pitch to the next. This is especially true for investors who are known for specializing in certain niches and who attract a high volume of pitches in the same field. With guaranteed overlap between pitches, investors cannot reasonably protect themselves from an allegation that they violated an NDA and stole a rejected pitch. Their solution to this problem is to simply refuse to sign NDAs knowing that even if they miss one winner, the rest of their portfolio will make up for it.

In some cases, it may be possible to ask a venture capitalist to sign a limited non-disclosure agreement. To achieve this, you would first need to show why you are presenting an opportunity that is compelling enough to consider it. You would also likely need to ensure that the non-disclosure agreement is extremely limited in scope. This might be by covering only specific pieces of information or by limiting how the venture capitalist can use the information in a limited way that allows them to continue to talk to other founders.

What Are the Alternatives to a Non-Disclosure Agreement?

Just because someone will not sign a non-disclosure agreement does not mean your ideas are unprotected. In fact, there are many alternatives to an NDA.

  • Professional confidentiality rules – Need to talk to an accountant, attorney, or other licensed professional? Most professions have strict confidentiality rules that bar their members from using client information for their own gain. Violations of these rules can result in severe penalties up to permanently losing their license.
  • Professional reputation – Even when there are no actual professional rules of conduct, most people still need to protect their reputation. Venture capitalists make their money by investing in many businesses and hoping for a few home runs. If they get a reputation for cutting out their founders, they would end up with no one pitching to them.
  • Lack of expertise – If you are a programmer talking to an accountant, they probably lack the ability to duplicate your app. This will hold true for many of the people you talk to. While it is true that they can find a programmer on their own, the time you have spent getting as far as you have is worth something. If they were interested in investing in what you are doing, why not pay you instead of someone else?
  • Patents – Patents protect your inventions and processes. Once you have filed a provisional patent application, you own the exclusive rights as long as your idea is unique. If someone tried to steal and replicate your idea, you could sue them for patent infringement.
  • Trademarks – Trademarks are a form of intellectual property rights that protect your business's identity. This includes things like your company name and logo. While a trademark does not go to your actual idea, sometimes a catchy, memorable name is most of the marketing battle.
  • Copyright – Copyright covers written works, video, software, and other intangible creations. Copyright can apply to code, but it becomes complicated when the code uses previous code that is not your original work. While copyright protections might be the weakest NDA alternative in respect to protecting ideas, a smart copyright can create just enough of a roadblock to safeguard what you have created.
  • Limited disclosure – One of the reasons the Manhattan Project to build the atomic bomb was able to succeed was that information was compartmentalized on a need-to-know basis. Even if a spy had been selected to work on the project, they would not have known enough to know what the project's real goal was, and the small pieces of information they had would have been useless. You can take the same approach when you talk to people. Proprietary information comes in various categories such as code, client lists, and technical data. If you only share certain aspects of your confidential data, the people you work with will be able to help you without being able to steal your entire company.

Do You Really Need a Non-Disclosure Agreement?

To decide if you really need a non-disclosure agreement, ask yourself the following questions:

  • What is the reputation of the person I am dealing with?
  • What incentives do they have to protect or misuse my ideas?
  • How important is the information I am going to share?
  • What else would they need to create a direct competitor?
  • Are there any available alternatives to an NDA, and do they provide enough protection?
  • If this person will not sign an NDA, is there a greater chance that not working with them will help or hurt my business?

How to Create a Non-Disclosure Agreement That Gets the Job Done

If you have decided the risks of not using a non-disclosure agreement are too great, it is time to make sure you get your NDA right. Follow these general guidelines:

Keep It as Narrow as Possible

A very broad NDA is easy to write and gives you the greatest protection, but that also means the other person has to worry more about accidentally violating it or not being able to do business with others. To avoid these types of concerns, limit the NDA to specific topics, such as your client list, rather than using broad terms like 'all information.'

Tailor the NDA to Who You Are Working With

You should not have one NDA that you use for all situations. Instead, change your NDA based on who you are working with. For example, employees and independent contractors each have a different relationship with you and have access to different information. Your NDA should reflect those differences.

Be Reasonable about the Terms

In addition to potentially scaring people away, an NDA that is unreasonably strict may not even hold up in court. Common reasons judges invalidate NDAs include:

  • being too broad,
  • being too vague, 
  • imposing unreasonable restrictions on employees, or 
  • violating specific statutory limitations on NDAs or contracts in general.

Instead of asking for everything, think about what you really need. Do you have the secret formula for a world-famous soft drink, or do you just need a year to make sure you are first to market?

Don't Forget Dispute Resolution Provisions

A non-disclosure agreement should include which state's laws govern the agreement, how to resolve disputes (court or arbitration), and who pays for attorneys' fees (the loser or each party pays their own). This is especially important when you are dealing with someone who has much deeper pockets than you to avoid being prevented from exercising your legal rights due to overwhelming legal costs.

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