When should startups use non-disclosure agreements (NDAs)?
When you are committing to a startup venture, you and your co-founders will understandably want to protect your “secret sauce”—the information that makes your product or service unique, whether it’s intellectual property, know-how, or trade secrets. Especially when the company is young and growing, your co-founding team will likely want to gain every protection you can to ensure that no one else can implement your idea before you do.
While it’s true that ideas are often less valuable than the execution founders put behind them, innovation is still at the heart of any successful startup. A sensible first step toward protecting your ideas is to form a legal entity and turn this intellectual property into an asset of a company (rather than individuals). However, there are certain situations where using a non-disclosure agreement (NDA) can go a long way in helping to keep a company’s confidential information outside of public knowledge.
What is an NDA?
An NDA, or non-disclosure agreement, is a legally binding arrangement between two parties where one or both parties will classify confidential information and prohibit the other party from disclosing shared information. The party in the agreement that is disclosing confidential information is conveniently called the “Disclosing Party” and the party receiving confidential information is called the “Receiving Party.” Additionally, the NDA can either be a mutual or unilateral confidential obligation. A unilateral NDA is an agreement where the Receiving Party is the only party that is receiving confidential information from the Disclosing Party. A mutual NDA, in contrast, is an agreement where both the parties are a Receiving and Disclosing party regarding the exchange of confidential information.
The most crucial part of the agreement is making sure that it clearly describes all the information that the Receiving Party must keep confidential. The Receiving Party needs to know exactly what information they can not disclose. Generally, the Disclosing Party will do this by creating a broad description of what they consider confidential information as well as by marking any shared materials conspicuously as “confidential.” Clearly marking materials is particularly useful when the NDA is between the company and a third party, like a contractor or partner. The markings help the Disclosing Party prove that the Receiving Party was aware that the disclosed material was confidential should a dispute arise in the future.
An NDA is only as good as the protection it offers your confidential information. In the case of a breach, there are several remedies to the harmed party, all of which must be reasonable to be able to enforce—for example, for an NDA to be enforceable between an employer and an employee, it must be reasonably linked to a legitimate business purpose. For an interesting review of the enforceability of NDAs, see Issues Enforcing Nondisclosure Agreements by Neda Dadpey. The two most common remedies are an injunction (a court order to stop disclosing confidential information) and monetary damages. Which remedy a plaintiff seeks or a court grants depends on the nature of the breach and the harm caused to the affected party.
In addition to the description of the information (and boilerplate language), the other key part of an NDA is the timeframe for the agreement. This informs the Receiving Party how long they must keep the covered information confidential. The term is a function of the negotiation between the two parties. The durations used for non-disclosure agreements are most commonly 2, 3, or 5 years, but they can also be indefinite.
What are good uses for NDAs?
- Co-founders: All co-founders should sign an NDA. Co-founders typically have a high degree of mutual trust and respect at the outset of their venture, but over time things can change and relationships can sour. It is important to the company that the individuals that have the most access to confidential information be unable to disclose any of that information should they leave the company. If a company expects employees to sign NDAs, it makes sense for the co-founders to do the same.
- Employees: NDAs help ensure that anyone you are bringing into your company will not be disclosing sensitive information. This will most likely be covered in the employment agreement, but the NDA may also have a term that exceeds the term of the individual’s employment. Finally, presenting an NDA to your employee may be a useful tool for setting the expectations and company culture surrounding confidential information.
- Independent contractors: Non-employees who do work for your company are a clear case in which you should require an NDA before providing any sensitive information. Independent contractors, especially any working on your product or service, will constantly come in contact with confidential information. You should make it clear to the contractor that they must keep your company’s information confidential.
- Partners: Depending on your relationship with a strategic partner, it may be a good idea to have an NDA be a part of the relationship. You should set expectations around how a partner could potentially talk about your products and not disclose confidential clients. For example, if employees of a larger company work alongside a startup to develop the product for a possible future acquisition or vendor relationship, both the startup and the larger corporation would want to ensure that any confidential information shared would not be disclosed.
What are not good uses for NDAs?
- Investors: Investors are generally not willing to sign NDAs and asking a potential investor to sign one may send a negative signal. The sheer number of companies that approach investors asking for fundraising would make reviewing and complying with NDAs from every company completely impractical for the investor. Even without NDAs, it would not be in the investor's best interests to disclose or steal a company’s ideas: they need to maintain their reputation and credibility so they will continue to receive investment opportunities. With that said, each startup should do their own due diligence on their investors to make sure they are reputable.
- Lawyers and accountants: Lawyers and other professional service providers make their living by keeping their client’s information confidential. Most professional service providers are also ethically bound to keep their client’s confidences, so asking them to sign an NDA would be redundant. For lawyers, make sure that you actually establish an attorney-client relationship (i.e. sign an engagement letter with your attorney) before disclosing any confidential information.
Using Sample or Stock NDA Forms
There are plenty of free form documents available on the internet that founders can use for NDAs. However, not all NDAs are created equally. It’s crucial that a founder understands the information that they want to keep confidential and what goals they are trying to accomplish with the NDA before they attempt to fill out one of these “off the rack” documents. To simplify this process, all Gust Launch founders get access to workflows to easily create one-way and two-way NDA agreements.
Founders should note that there are several types of contracts that deal in some form with confidentiality. NDAs deal specifically with the contractual obligation to not disclose confidential information. Other agreements that can include confidentiality in some form are proprietary information and inventions agreements and employment agreements. These agreements are different from NDAs because the non-disclosure of confidential information is only a piece of what each other agreement is accomplishing, whereas the primary purpose of the NDA is to protect sensitive, confidential information. If a founder has any questions about what form to use in a particular situation, they should contact their attorney to ensure they are appropriately protecting themselves.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.