Why more startups are sharing ideas without getting legal protection

07/02/2014 5:58 PM

07/02/2014 5:58 PM

In 2011, Andy Moeck was looking for investors for Moeo, a Los Angeles startup he was building that makes mobile gaming apps based on real-time sporting events. A friend introduced Moeck to a partner at the Silicon Valley venture capital firm Kleiner Perkins Caufield Byers, and at their first meeting, Moeck asked the partner to sign a nondisclosure agreement.

Such agreements, known as NDAs, are designed to prevent an idea or technology from being stolen and copied. Moeck was especially concerned because the venture capital firm was already backing Zynga, another gaming company.

“We knew they didn’t have a mobile or sports strategy,” he said of Zynga. “I didn’t want to pitch Kleiner about what we were doing and have them go back and say to Zynga, ‘This is how Moeo does it.’”

But the Kleiner Perkins investor refused to sign an NDA, leaving Moeck to decide whether to proceed with his pitch.

It is a common quandary, and not just in Silicon Valley. Ten years ago, it was not unusual for entrepreneurs to request and potential investors to sign nondisclosure agreements. But today the agreements are largely considered a thing of the past. In fact, some investors say they walk away from a founder who even suggests signing one.

This cultural shift, which began in the late 1990s and accelerated during the early 2000s, began in Silicon Valley, said Victor W. Hwang, chief executive of T2 Venture Creation, an investment firm in Portola Valley, California.

“One of the most advantageous things an entrepreneur can do is talk about their company to anyone who will listen,” Hwang said.

Not everyone agrees.

Thom Ruhe, vice president of entrepreneurship at the Kauffman Foundation, said the declining use of NDAs “is certainly not in the interests of entrepreneurs. It favors the VC.” Although it is rare that an investor steals an idea, Ruhe said, it does happen.

“But in the skewed echo chamber of the Valley, and the sycophantical networks that aspire to be just like them,” he said, “they’ve made the easier and less morally defensible position - no NDAs - the coin of the realm.”

Even if a startup manages to get an agreement signed, it can be tough to enforce, said Aaron I. Messing, a lawyer with OlenderFeldman in Summit, New Jersey.

“It’s very hard to prove that you kept information confidential, and it was only disclosed under an NDA,” said Messing, who represents both founders and investors. “And it can be expensive.”

In 2011, Ben Goodwin started using a co-packer to package a probiotic drink for his company, which is based in Santa Cruz, California, and now called Obi Probiotic Soda. The co-packer took some of Goodwin’s ideas and went on to make his own probiotic drink.

“I couldn’t sue him,” Goodwin said. “It was going to come down to a ‘he said, she said.’ I have to prove that he definitely took it from me and that I am experiencing damages and losses as a byproduct of his actions. And that means I would need the legal and financial resources to pursue that route, which isn’t really practical for a small business.”

Investors say signing such agreements is impractical for them, too. “VC firms and angels are looking at so many more deals today, that they could freeze themselves out of a given area by signing an NDA with one person,” said Peter C. Wendell, a faculty member at Stanford Graduate School of Business and the founder and a managing director of Sierra Ventures, a tech-oriented venture firm in Silicon Valley.

Each time an NDA is signed, it stalls the conversation for a week because of the legal work involved, Hwang said, and over time, that can give a competitor the opportunity to enter a market first.

“In the life of a startup company,” he said, “you might have to sign 30 to 50 NDAs. That’s a week each time and a year of holdups. The risk of going slow is bigger than the risk of being copied.”

When Moeck was told that Kleiner Perkins does not sign NDAs, he decided to pitch his startup anyway.

“I felt OK about it because the investor was referred by a trusted friend and Kleiner is a very well-known firm,” he said.

Moeck also felt that even if Zynga did learn what he was doing, the company had become too big to execute quickly.

“I thought, regardless of what Zynga heard or thought, we had the better chance of being successful in our category,” he said.

He was also hoping that disclosure might open doors. “Although we didn’t want Zynga to copy us,” he said, “we did want them to be aware of what we were doing in case there was an opportunity to partner with them.”

In the end, Kleiner did not offer financing to Moeo, although the company did manage to raise $500,000 from angels. It continues to ask investors to sign NDAs, but has yet to persuade any to do so.

Below are some guidelines to consider. They apply when engaging not just investors, but also manufacturers, partners and even customers.

Do not ask unless you have something to protect. Chris Schultz, an entrepreneur and partner in the angel investment fund Voodoo Ventures in New Orleans, said, “Everyone thinks their idea is extremely unique, but the idea is really 1 percent of the value. The value is in the execution.”

Paul A. Jones, co-chairman of the Venture Best practice group at the law firm Michael Best & Friedrich in Milwaukee, said there is no reason to share proprietary information during an initial, 20-minute pitch anyway. “And I’ve never known a reputable investor to steal an idea and create a company around it,” he said.

Know your audience. Before making a pitch, research the background of whoever you are pitching.

“Think through who you are sharing your ideas with,” said Patrick Riley, head of Global Accelerator Network, a group of 50 startup accelerators worldwide. “Unless the investor is very well-known, have a reference or two. People will say they are investors when they aren’t, so ask what other deals they have done, and then call those companies to ask about the deal. Do they trust this investor?”

Messing advised making sure an investor does not have potential conflicts or overlapping investments. Reputable investors, he said, “have much to lose by stealing your idea.”

Consider filing for a provisional patent. C. Andrew Keisner, a lawyer with Davis & Gilbert in New York City who regularly counsels investors and startups, said the reluctance to sign NDAs is one factor driving startups toward patent protection.

“If you’re far enough along that you’ve developed an app or a prototype, there is a big advantage to filing a provisional application,” he said.

That is what Brian Nickerson and his co-founders at Chippmunk, a coupon search engine, did. Before talking to investors and closing a $750,000 investment round last December, the Los Angeles company filed a provisional patent application for its search algorithm.

Proceed gradually. When discussing a startup, founders should walk a fine line, conveying sufficient information about what is unique and proprietary, but not disclosing information that would let someone replicate the business. For example, said Messing, the lawyer, an entrepreneur could disclose “what an algorithm can do, but not the algorithm itself.”

Wendell of Sierra Ventures said founders should reveal information as if they are peeling an onion. “It’s a gradual process, as the entrepreneur increasingly engages the investment firm. You need to make a few peels for it to be clear that this is an interesting opportunity and a good fit.”

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