By Emmanuel Roth Soares
Coordinator of the venture capital and innovation team at MdME Lawyers
One of the most important agreements that startups frequently use are non-disclosure agreements – commonly referred to as an “NDA”. An NDA is an agreement between two parties where one (or sometimes both) agrees to keep confidential any sensitive information which is shared by the other party.
NDAs can take the form of a separate legal agreement. However, non-disclosure, confidentiality or other similarly designated clauses are often included in other types of agreements (such as employment contracts or term sheets) and serve the same purpose – preventing information shared from being disclosed to third parties.
For most startups, their most valuable assets need to be kept confidential for the business to have an advantage in the market. This can be information on a new type of product or service, a new IP or patent, research results, or a novel business model. It can also be information on partners, investors, or suppliers, or even details on how the business is operated or when a new product or services intends to launch. In the cutthroat world of business and tech, allowing such information to leak out to the public (or potential competitors) could make the difference between success and failure.
That said, the reality is that in the course of doing business, it is often necessary to share sensitive information with other parties –from employees to business partners, suppliers, and even potential investors. In these cases, an NDA is used to legally require these parties to keep the information confidential and not share it with anyone else.
The following are some of the most important use-cases for startups:
Co-Founders and Employees
Your partners and employees will be the persons with most in-depth knowledge of the business model, IP and trade secrets of your company. While working together, you will likely have full trust in your fellow partners and employees, but it’s still important to have NDAs in place to protect each other and the company when someone decides to leave the company.
For this reason, NDA clauses are usually included in founder agreements or employment contracts. These are often paired with non-compete and non-solicitation clauses. This means that when leaving the company, the exiting founder/employee has agreed to not start a directly competing business or attempt to convince other employees of the company to leave as well.
Contractors and Suppliers
Contractors and suppliers of a business will often need to come into contact with sensitive information in the course of providing their services. These parties do not have the same level of responsibility and loyalty towards the company as a co-founder or employee, so it’s important that NDA clauses are included in any contracts with these entities.
During the fundraising process, potential investors will naturally want to know how the business operates and what its valuable IP and trade secrets are, in order to assess the value of the business and their interest in investing. However, negotiations with most investors will fall through; leaving the investor in possession of any sensitive information it received regarding the business. For this reason, in the course of discussing a potential investment, investors should be asked to sign an NDA before any particularly confidential information is provided.
It’s important to keep in mind that, in the case where the investor is a current or potential competitor (this applies to large corporate investors as well), simply signing an NDA may not be enough to protect the interests of the startup, as any knowledge obtained during the negotiations may directly benefit the receiving party even if its not shared with anyone else.
The balance between being open to investors and protecting one’s confidential information is sometimes a fine line to walk. A good rule of thumb is to agree to comprehensive due diligence into confidential aspects of the business only after a term sheet is signed. This means that you are only sharing confidential information in cases of a serious investment proposal with a higher likelihood of completion.
A Few Things to Note
It’s important to recognize that NDAs can only legally protect certain types of information. The receiving party can only be required to respect proprietary information that is created and owned by the startup, such as a unique concept, design, code or asset. Information or ideas which are considered common or public knowledge are typically not protected by an NDA. For example, you cannot claim ownership of a general business idea, but you can require the other party not to share the details of your specific and unique implementation of that business idea.
Finally, while NDAs are binding legal agreements, at the end of the day, if the terms of the NDA are breached by the other party, you may need to enforce the NDA through long and costly legal procedures, such as by claiming damages in court. Therefore, NDAs serve more as a dissuasive mechanism rather than watertight protection, and you should consider carefully the risks involved in sharing sensitive information and the best way to do so in each particular circumstance.
This is the fifth in a series of articles offering practical legal tips for young entrepreneurs, to be published by the author in cooperation with the Macao Young Entrepreneur Incubation Centre, where he provides mentorship and consultation for its members.
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