Is Your Startup’s NDA enforceable?

“All that plowin’ just to watch the crop wash away.” Not an expression any startup founder wants to hear. You’ve come up with a great business idea. You’ve worked hard to build a product and developed proprietary technology. You’ve even taken the trouble to sign an NDA. However, you’ve discovered that the NDA is not worth the paper it’s printed on and you’re left trying to shut the barn door after the mule’s already out.

Let’s find out why. Here are five pitfalls I often see and how you can avoid them:

1. Parties and Affiliates. This is so basic that it’s often overlooked. Most companies assume you’ve done here once you’ve listed the parties’ names, where they’re incorporated, their addresses, and maybe their company numbers or EINs. Many early-stage companies forget to cover affiliates, assuming that other companies are small like them. More advanced businesses, however, have webs of affiliates and portfolio companies, some of which may be competing directly with your startup. If you want to avoid having these affiliates use your trade secrets, you need to make sure that affiliates are explicitly covered in the definition of the “Parties.” This can also help you when your company has its own subsidiaries.
2. Defining “Confidential Information.” Most companies use NDAs from templates with exhaustive lists of general items considered confidential information (think, “any non-public information in written, graphic, machine readable or other tangible form”). This is both overbroad and excessively narrow: so broad that it may not be enforceable and so narrow that important words are missing. If your startup relies on an algorithm, the word “algorithm” should appear. If you’ve gone through the effort of building a network of clients, “client list” should get a nod. Before signing an NDA, startup founders should write out a list of the 5-10 most important non-public competitive advantages and make sure that they are all covered explicitly and in sufficient detail.
3. Non-Use and Non-Circumvention. Many founders assume that an NDA is what it says it is, namely an agreement not to disclose confidential information. Much more important, however, is the agreement not to use that information. Your partner could probably make a lot more money building on your secrets than telling the whole world about them. Good NDAs cover non-use in detail; bad NDAs give the topic short shrift or lump it in with non-disclosure. You want to be explicit about what is prohibited, including circumvention of the NDA’s controls and use in your partner’s or its affiliates’ own products.
4. Time Periods. There is a tendency to go either too long or too short, but startup founders want to find the Goldilocks time period. VCs and other funders often want short durations (e.g., one year). Partners with their own proprietary technologies often seek longer durations (e.g., 3-5 years). As a founder, you want a time period that adequately protects your technology but doesn’t obligate you (or your future employees) to protect the other party’s secrets long after the initial discussions. You also want to make sure that there is a carveout for protecting your confidential information so long as it remains a trade secret (think, the Coca-Cola formula). Be aware that courts may not enforce excessively long terms.
5. Enforcement. Many companies overlook governing law and dispute resolution, assuming that litigation is unlikely. This is a mistake. Even if litigation is low-probability, the threat of it informs the parties’ behavior. If you know that you will be embarrassed, have to spend hundreds of thousands of dollars, and have your business disrupted, you’ll act differently. Some companies want to arbitrate NDAs, but this reduces the reputational deterrent. Others agree to litigation in unfamiliar jurisdictions, which has obvious drawbacks. The ideal governing law/dispute resolution clause is highly fact specific (see Dan Harris on China NDAs). However, you want to think it through before signing up. Jurisdiction/governing law clauses are very much open for negotiation.

When it comes to NDAs, you don’t want to find yourself mending fences after the herd’s already gone. The above items give you an idea of what you need to consider as you approach discussions and sharing of confidential information. There are a ton of other NDA-related items to cover—including IPR, warranties, and compliance—I’ll cover those in future posts. These aren’t the only issues that come up with NDAs, but tackle them first and you’ll be miles ahead.

Disclaimer: This blog is for informational purposes only and does not constitute legal advice. Reading or interacting with this content does not create an attorney–client relationship. You should consult a qualified attorney for advice regarding your specific situation. Mehaffy, PLLC disclaims all liability for actions taken or not taken based on this blog.