Death By NDA? How An Innocent Contract Can Stifle Entrepreneurship

VictorBlog9.17.14By Victor Hwang, CEO & Co-Founder of T2 Venture Creation, from Forbes

We sign them all the time. They usually seem harmless. They’re often considered just a matter of custom. However, they can be far more harmful to entrepreneurial ecosystems than they appear on the surface.

I’m talking about nondisclosure agreements—NDAs. They are a common tool of business between parties who want to share sensitive information. I was recently quoted in The New York Times about NDAs, and I got a number of responses about it. Here’s the quote:

“Each time an N.D.A. is signed, it stalls the conversation for a week because of the legal work involved, Mr. Hwang said, and over time, that can give a competitor the opportunity to enter a market first. “In the life of a start-up company,” he said, “you might have to sign 30 to 50 N.D.A.s. That’s a week each time and a year of holdups. The risk of going slow is bigger than the risk of being copied.”

Let me provide some nuance missing from this extract. Yes, NDAs have an important purpose. But there’s a big difference between Silicon Valley and most other places when it comes to how and when NDAs are used. In the Valley, startups rarely sign them when beginning a relationship with someone, like a possible employee, partner, investor, or consultant. NDAs can come later, after a working relationship has started, when things need to get deeper.

In other geographies, however, it’s often different. My firm does a lot of work in ecosystems across the U.S. and the world. We find that NDAs are usually the norm for everything. Startups sometimes won’t give you the time of day without an NDA already signed, sealed, and delivered before a conversation even starts.

Why the difference? What does it mean for entrepreneurial ecosystems? I’ve discovered that the use of NDAs can be a useful thermometer for the health of an ecosystem. Allow me to explain.

Contracts 101

Contracts are not just contracts. As every first-year law student learns, they are tools for overcoming distrust. They can outline what is expected from each party when the future is uncertain. They can allocate responsibilities and costs.

Disputes may arise, that’s life. Someone doesn’t deliver what they promised to deliver. Someone doesn’t pay what they agreed to pay. Contracts can hold parties accountable. Timing, methods, costs, who, where, when—contracts are useful tools for aligning expectations, allocating risk, and most importantly building trust.

But NDAs are a special sort of contract. By their very existence, they implicitly announce that a handshake is not good enough. They basically say, “I don’t trust you.”

This matters because distrust is the silent killer of innovation. When parties ask for NDAs too early, it can stifle relationships before they are born. Or they can slow down relationships for extra days, weeks, even months. They can add suspicion and sow the seeds of disharmony later.

In the aggregate, over the life of a startup, lots of NDAs can build up and create an aggregate drag. Startups don’t usually die from hammer blows; they die deaths of a thousand cuts. Think about it. If you have to sign 50 NDAs in the early life of a startup, and each one takes a week to sign, you have just lost 350 days in the life of your company. And speed is the lifeblood of startups.

The restrained use of NDAs by startups is one of those little advantages that makes the Valley the Valley. The norm emerged not as a way for venture capitalists or corporations to take advantage of startups (although that does happen sometimes), but rather as a way for startups to move faster. In order to succeed, entrepreneurs must rally a series of hundreds of prospective partners, employees, customers, suppliers, investors, providers, etc. For startups, apathy is often the worst enemy. When the task is so great, and speed so crucial, it’s more efficient when handshakes can substitute for formally written contracts.

Most ideas aren’t that original anyway. It’s the execution of the ideas that makes the difference. As Michael Dell of Dell Computers once said: “Ideas are a commodity. Execution of them is not.” Worrying needlessly about giving away your idea can make you look like a paranoid amateur.

Furthermore, NDAs are not that easy to enforce anyways. W. Scott Blackmer, an IT lawyer, writes about NDAs: “Litigation over NDAs can be costly, public, and ultimately unsatisfactory to the party claiming a breach, especially if it is hard to prove the intended scope of the agreement and the actual source of the information.”

This is not to say that NDAs don’t have their place. As relationships progress and some basic trust has been established, an NDA might be appropriate, particularly when technical details and proprietary secrets come into play. When discussions begin to revolve seriously around how to bring ideas to implementation, pulling that NDA out of the drawer might be a good move.

The free flow of ideas

One of the reasons places like Silicon Valley thrive is because people serendipitously bump into each other and share their ideas freely. You feel it everywhere you go in the Valley. People are yapping all the time, like dogs at a kennel.

And it’s not just the Valley anymore. Other places are catching on as well. This is the goal behind Zappos CEO Tony Hsieh’s reinvention of downtown Las Vegas into an environment ripe for such interactions.

There’s plenty of historical evidence for this notion as well. Stanford economist and social theorist Thomas Sowell points out that Europe’s geography (particularly the presence of several large, slow rivers and natural harbors) facilitated the sharing of information, thus promoting Europe’s technological leap ahead of the rest of the world during the 18 and 19 centuries.

Too many NDAs slow the flow of ideas across an ecosystem. An environment of distrust and paranoia stifles communication. This in turn slows innovation. And this in turn slows economic activity. Thus, individual actions can shape entire economies. Ecosystems are the sum of the countless daily interactions that occur across a vast invisible web of individuals connecting, sharing, and building together.

In short, the more there is trust, the less we need contracts, the faster the ecosystem goes.

Victor W. Hwang is CEO of T2 Venture Creation, a Silicon Valley firm that builds ecosystems to take great ideas to scale, and primary co-author of The Rainforest: The Secret to Building the Next Silicon Valley.

Read Victor’s other articles in Forbes.

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