Thursday, July 29, 2010

Why Investors Dont Sign NDAs

While it is important to protect intellectual property, having investors sign non-disclosure agreements (NDAs) is never a good idea. Investors do not sign NDAs. Well, at least those who you’d want to work with don’t. Brad Feld, co-founder of the early-stage VC firm Foundry Group, mentioned in his article Perfect Your Pitch in that this is one of the 8 mistakes entrepreneurs make in trying to secure venture capital. As a venture capitalist, here’s how he expressed his sentiments on NDAs:

“Asking the venture capitalist to sign a nondisclosure agreement, or NDA: This is a stupid idea perpetuated by lawyers. Most venture capitalists will not sign an NDA, so all you're doing is putting up a barrier to get their attention and demonstrating your naivety.”

What he is saying here is that NDAs can actually hurt your chances of getting funded. Not only are you putting up a hindrance, but you are also showing your cluelessness.

Here are a few reasons why investors don’t sign NDAs:

1. Trust issues

First of all, you’re sending out the wrong signals. You’re implying to investors that you don’t trust them. That you’re afraid that they might rip you off. Once they learn the recipe to your secret sauce, they’ll drop you in a heartbeat and start the business without you. After all, they have the money. All they need now is an idea. Right?

Wrong! Investors are not too keen on stealing ideas. They come across great ideas all the time. Most likely, they are currently looking at 5 other ideas like yours. Yes, your ideas are not as unique as you think. The fact that you thought about it means that others have already come up with the same idea. Maybe some are even better than yours or already have a working prototype.

Investors see entrepreneurs who find it hard to trust other people—especially investors—as a red flag. Not only does it reveal the entrepreneur’s personality, but it also points to partnership problems in the future. Something they want to stay as far away from as possible.

2. Time and resource factor

Investors are very busy people. Yes, they are. They don’t sit around all day counting their money. They have board meetings to go to, funds to manage, deals to review, and conferences to attend. They neither have the time nor the proclivity to go through each and every NDA. They can’t spend their entire day reading NDAs. They can’t. And they won’t. Reviewing NDAs will never be on top of their to-do list.

They won’t even have their lawyers do it. Why? Is it because they don’t want such an imposition on their lawyers? Absolutely not! What does having lawyers review hundreds of NDAs amount to? Huge fees! And what will they get out of it? Nothing!

Startup lawyer Ryan Roberts illustrates this point in his post in The Startup Lawyer:

“If VCs maintained the practice of signing NDAs for each submission they received, only two groups would benefit: lawyers and paper companies. Lawyers would benefit because they would get to draft, edit, and negotiate each NDA. Additionally, the VCs would have to retain a team of lawyers to keep track of all the NDAs they’ve signed with the fund-seeking entrepreneurs that have come before you. Therefore, NDAs would increase a VC’s transaction costs and potentially prevent a VC from even hearing your pitch. Both reduce the already slim chances you will get funding.”

3. Legal issues

NDAs are legal documents. And it is not advisable for anyone to be party to too many legal documents. Keeping track of them alone is already a nightmare. Furthermore, signing NDAs constrains investors. It means they can’t look at other projects that offer the same technology as yours. Not even those which are remotely similar. This will ultimately limit the investors’ deal flow. Something they don’t want to happen.

It also hinders them from investing in projects that are similar to yours. Doing so makes them susceptible to legal action. Something they also don’t want to happen.

Guy Kawasaki, a Silicon Valley venture capitalist, sums it all up quite nicely in his blog “The No-Bull-Shiitake Investor Wishlist“ on the Open Forum by American Express:

“[D]on’t ask any potential investor to sign a nondisclosure agreement (NDA), because asking them to do so will make you look clueless. Venture capitalists and angel investors are often looking at three or four similar deals, so if they sign an NDA from one company and then fund another, they expose themselves to legal action. If you find an investor who is willing to sign and just to hear your idea, you probably don’t want his or her money.

I’ve never heard of a venture capitalist or angel investor ripping off an idea—frankly, few ideas are worth stealing. Even if your idea is worth stealing, the hard part is implementing the idea, not coming up with it. Finally, continuing the dating analogy, you probably won’t get very many dates if the first thing out of your mouth is “Will you sign a prenuptial?”

Investors are not in the business of ripping off people. If investors are not interested in stealing your ideas, then what are they interested in?

The ability to execute

What investors are more interested in is the execution of ideas. They look more closely to the people behind the ideas. The management and their ability to implement the idea are mainly considered in determining whether a project is fundable or not.

Execution is actually the primary investment criterion. Seventy percent (70%) of the decision is based on management and only thirty percent (30%) for the idea. So execution weighs more heavily than the idea itself.

The ability to sell/network

If you’re so concerned about protecting your proprietary information, then you should be able to pitch your idea to investors without divulging the recipe to your secret sauce. Ideas are a dime a dozen. Those which are worth stealing are hard to come by. They are few and far between. If your idea is really worth stealing, enticing investors without giving away your secret is your only option.

Investors don’t look at deals so they can steal ideas. They look at deals to see which are fundable. Indeed, investors are looking for the next Google, Apple, or Microsoft. But without execution, your idea is just an idea. That and $5 will buy you a cup of coffee at Starbucks. Ultimately, your ability to sell ideas, to network, and to execute is what investors find the most attractive. A definite indication that your project is worth investing.

Thursday, July 22, 2010

Quality of Deal Source, Why It is Important to Investors

To sell your product, you must understand the market. To get funding, you must understand the investors.

You probably have a stellar idea and a solid business plan, but you can't seem to get investors interested in you. You've already sent out hundreds of proposals, scoured websites and submitted business plans, and even have deals shopped. Still, nothing.

It's disheartening, but take courage. It's really a matter of knowing what to do and what not to do.

First, you have to know that the scattershot approach is really an exercise in futility. Like shooting blindly in the dark. You won't get results.

Investors work within certain parameters and in order to get to them, you must know where and how they operate. Here are a few important things you should know about investors:

Investors are very busy people.

Believe it or not, they don't sit around all day wondering what to do with their money. They have a lot of things to attend to: sit on boards, work on existing pipelines, attend conferences, manage funds, etc. They have around 10 meetings in a day. Though not all of them are with entrepreneurs. And those that are rarely result in funding (less than 1%).

Investors don't read every business plan that comes along their way. They are constantly inundated with deals so they have to screen them. The deal screening process is very similar to the “American Idol.” There are thousands of hopeful applicants but in the end only one will be proclaimed as the “American Idol.” In the same breath, investors receive hundreds of deals a month. It’s foolhardy to go through each one of them so they try to get rid as much as possible to save time and effort. They select a few which they feel have merit and fit their investment criteria. And out of the few only one will ultimately get funded.

Investors look only to trusted sources for deals.

Many entrepreneurs make the mistake of going to an investor’s website to submit an executive summary, proposal or business plan. What they don’t realize is that submitting proposals using this method has the worst hit rate.

An effective way investors screen projects is determining their source. Investors tend to favor deals referred by trusted sources or those who are in their network.

Investors listen to people whom they trust. The operating word here is “trust”. If someone they trust refers a deal, then they will most likely take a look at it. Getting any ideas?

Trusted sources tend to bring less problematic referrals. They will not risk their reputation by referring a bad deal. Furthermore, with their knowledge and experience, they help make the deal process more efficient.

Some investors put their money in certain sectors of the industry.

You don’t have to submit a proposal to every investor you see. Some investors only finance IT-related projects. If you’re looking to expand your restaurant chain, submitting a proposal to such investors is pointless. They’d drop you without batting an eyelash.

“Be thoughtful in approaching potential investors. Biotech investors, for example, don’t want to hear about a clothing manufacturer. A scattershot approach is likely to turn them off. Industry associations, local trade groups or, in some states, business-incubator centers can help point to potential angels” (How to Get Funding from Angel Investors,

Now that you have gotten to know a little more about investors, what can you do to get results?

Network, network, and network.

Getting your proposal to the investor’s hand is all about networking, networking, and networking. Believe it or not, this antebellum method of building relationship through networking and referral is the best technique to get investors.

Habile entrepreneurs are good networkers. Investors are looking for such; if you can network your way to an investor; it means you have networking ability to find clients in the future. Doing research and building relationships through networking with people who are familiar with the investor is paramount.

To put it quite simply, the best way to get to an investor is through someone they know and trust.

On my next blog, I will talk more about who these trusted sources and network are; and how to network effectively.

Jerome Gentolia is Co-Founder for Tech Launch Solutions and ComeUnite Network.