united-states, software, funding, venture-capitalDoes VC due diligence always involve revealing all trade secrets and code?
Are there circumstances under which a startup could get VC money while keeping its technology secret, even from the investors? Has it ever happened?
What if I can demo the technology without revealing its secrets, like showing compression with the world’s best Weissman score?
From https://news.ycombinator.com/item?id=866299 :
Due Dilligence is a VERY invasive process, depending on the quality of the people that the VC hires. My own specialty, technical due dilligence usually takes the form of a several hour long grilling of the CTO of a company with anybody they wish to call on, subsequently they get a long list of follow up questions via email. I will want to see your code, meet your developers, look at your documentation, inspect your physical security if you store private information and so on.
On the other hand, there are many reliable sources that state that VCs (understandably) never sign NDAs, and can not be trusted with secrets, regardless.
Not all IP can be protected with patents. As Elon Musk said, “If we published patents, it would be farcical, because the Chinese would just use them as a recipe book.”
NDAs are typically off limits to VCs for liability purposes (theirs, that is). "First impressions can be overcome, but they're strong. Don't send an NDA to a VC." (Keith Gillard)
"...keep your core secrets to yourself; forget about an NDA and protect yourself by telling the VCs only enough to get the hook sunk in the soft part of their mouths." (Joseph Bartlett)
Most of the time, VCs seem to be interested more in the management team, the potential market size, the potential market share, potential competition, barriers to entry, etc. ... all the 'MBA'-type concerns than the actual technology nitty-gritty details.
I have worked with multiple startups, and the pitches usually brushed over the details of the technology, and referenced patents or published patent applications, with a quick 'businessman's view' of the technology.
From Keith Gillard, General Partner, Pangaea Ventures Ltd.:
The truth is, you don't need to disclose confidential information to effectively tell your story. Leave the truly sensitive data or trade secret details out. You don't need to confess to us your entire cost basis in the initial communication.
From Joseph W. Bartlett , Special Counsel, McCarter & English, LLP
In the first phase, when the parties are simply flirting with each other, the target or the issuer will disclose only enough confidential information to whet the appetite of the counterparty to the transaction. The best way to keep information confidential is to not disclose it in the first instance
VCs will go through increasing rounds of due diligence. As they become serious enough to start demanding truly critical confidential information, forms of reasonable protection are available - much of this should be done beforehand in the form of patents filed and copyrighted (admittedly more difficult in software startups post Alice - but not out of the question)
Keith Gillard again:
To be honest, we do actually have a form of NDA we will enter into during late stage due diligence. It's a specific IP release that allows a company to disclose unpublished or unfiled patents, so that we may review them just prior to making our investment. Obviously we only get to that stage with a very few companies each year (see my "Why We Say No" blog). And of course there are confidentiality clauses in our contracts with our portfolio companies and our investors. But generally speaking, we don't do NDAs. [emphasis added]
Joseph Bartlett again:
On the other side of the coin, if the deal doesn't happen, one must be careful not to have been "contaminated" by information, meaning accepting disclosure of information you already own ... and plan to use in your business.
Again:
... there may be two NDAs or at least a segmented NDA covering two tranches of information. The party at risk will lift the curtain only so far initially, and then wait until the definitive agreement has been signed before exposing the entire tranche of information the other party needs. This entails a risk, of course ...
Accordingly, one solution is to make disclosures in escrow [ i.e. to an independent expert who validates to the VC the company's claims] [emphasis and notes added]
And finally, it can't be reiterated enough:
FILE YOUR PATENTS! The whole world is first-to-file now. Nobody cares if you can prove you were first-to-invent. Once you have your IP in order, come back and don't ask us to sign an NDA. (Keith Gillard)
It's true, not everything can be done through patents, however, if your business process or software is so revolutionary that a VC can't have access to it without ruining you, then there is a good chance that a good patent practitioner can help you get some level of patent protection.
While it is rare that you have true trade secrets that you will never disclose to investors (as opposed to sensitive technology that you will only reveal after some form of NDA or other suitable agreement is entered into at a late-stage of engagement with VCs), various VCs indicate that there are times that they will invest without knowing trade secrets ... but you'd better be able to persuade them to invest without it - both through technological advantages and management team ability to deliver.
From Brad Feld, managing director at Foundry Group (invests in software and Internet companies around the US):
If you think you have something super secret that no one else should know, just don’t tell me about it. Oh – and check your assumption in that case – especially since the value is in creating the thing, not simply having the idea. [emphasis added]
And from Andre Gharakhanian, Founding Partner, Silicon Legal :
In the end, most experienced entrepreneurs will tell you that one cannot simply rely upon the provisions of an NDA. Instead, you need to take a calculated and measured approach when it comes to disclosure. Disclose only what needs to be disclosed to get your point across and hold onto "crown jewel" trade secrets whose disclosure will hurt the company.
The best argument for keeping trade secrets secret from investors comes from Justin Camp in Venture Capital Due Diligence: A Guide to Making Smart Investment Choices and Increasing Your Portfolio Returns (Wiley, 2002). On page 123, he discusses due diligence with respect to trade secrets. Investors should check to make sure trade secrets are carefully protected - among other things:
Allowing access to the company's trade secrets only to those for whom access is absolutely necessary.
and
Requiring all business partners, investors, and any other parties for whom access to the company's trade secrets is absolutely necessary, to sign NDAs or confidentiality agreements.
In other words - the VCs should be ensuring that even they don't get access to trade secrets unless they absolutely need them.
I can tell you first hand it is possible to get VC investment while keeping technology secret, but details I have are difficult to share.
Basically I was involved in two businesses, each backed by unrelated VCs (thus, more than one data point!), one in the US, one outside.
In both cases they asked for no detail of the technology beyond abstract descriptions, etc. They asked for financial details, but little or no trade “secret”.
In one case the company is doing well, and the VC is happy. In the other, well, the contrary.
Interesting fact: I just come out of a meeting where the VC asked quite early to sign an NDA…
When you’re looking to partner with a venture capitalist, the last thing you want to do is ask them to sign an NDA.
People ask me why all of the time, and my answer is always the same.
If a firm invests in your company, you will be working with that firm for a long time. Do you really want to go into a long relationship (with people who can sometimes oust you) by saying “Look, I’ve got something great. I want your money. And by the way, I don’t trust you, so sign here.”
In saying that, your stance is fundamentally flawed because they get lots of supposedly “great” and “revolutionary” pitches/ideas. The only difference between your and the next guy’s idea is that you’re asking them to review and sign an NDA, to give someone money, who by the way, doesn’t trust them.
Not the way to go about starting a long relationship involving lots of money and (sometimes) power play.
If you have awesome technology, great! Tell them all about it. Show them what it does. Sell them on it. Give them the financials. Just keep the good stuff that you don’t want them to know private, and if they ask about it, let them know their investment will secure that information.
And then if they invest, you’re off to the races.
And then if they don’t, you’re still of to the races. You need to line up pitch after pitch, to keep momentum. The only thing NDA’s do in the pitching world is kill momentum.
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