Confidentiality Clauses: Boilerplate or Binding?

The Confidentiality clause (often referred to interchangeably with a Non-Disclosure Agreement or NDA) is a contractual obligation that prevents parties involved in a potential investment from disclosing or misusing sensitive information shared during the negotiation and due diligence process.

Imagine you’re sharing your secret recipe with a potential investor. This clause is like a promise they make not to share that recipe with anyone else or use it for their own competing bakery.

Some Terminology:

Proprietary Information: Refers to information owned by the company that gives it a competitive edge (e.g., trade secrets, unique processes, customer lists).
Sensitive Information: Any data that, if revealed, could harm the company or its competitive position.
Due Diligence: The process where potential investors thoroughly investigate your company’s financials, operations, legal standing, and more, before making an investment.

Why it Matters?

This clause is vital for both founders and investors, although their motivations might differ slightly.

For Founders: It safeguards your invaluable intellectual property, business plans, financial projections, customer details, and strategic information. Without it, there’s a risk of your proprietary data being misused, disclosed to competitors, or impacting future fundraising efforts. It builds a foundation of trust, allowing you to share critical information necessary for investors to make an informed decision.
For Investors: It assures them that their involvement in the transaction will not be prematurely disclosed, which could affect their reputation or other dealings. It also protects their own strategic interests and ensures that the information they receive is used solely for the purpose of evaluating the investment.

Common Variations

The exact wording and scope of confidentiality clauses can vary, and founders should pay close attention to these details:

Definition of “Confidential Information”:
- “Everything” Definition: Broadly states that virtually all information exchanged is confidential. This offers maximum protection for the disclosing party.
- “Trade Secrets” Definition: Limits confidential information to only those aspects that meet the legal definition of trade secrets. This is less protective for the founder.
- “Written Information Only” Definition: Restricts confidentiality to only written disclosures. This can be problematic as oral discussions about plans might not be covered. Founders should aim for a broad definition that covers both written and oral communications.
Permitted Use of Information: Clauses typically specify that the information can only be used for evaluating the investment opportunity. Investors should be prohibited from using the information for any other purpose, especially for investing in competing businesses.
Exclusions from Confidential Information: Most clauses include carve-outs for information that:
- Is already publicly known without a breach of the agreement.
- Was already in the receiving party’s possession prior to disclosure.
- Is independently developed by the receiving party.
- Is required to be disclosed by a court order or law.
Duration of Obligations: Confidentiality obligations are generally time-limited, typically lasting between one to three years after the conclusion of the transaction or termination of discussions. Some agreements might seek a longer duration, or even perpetual confidentiality for trade secrets. Founders should aim for a reasonable duration.
Scope of Disclosure to Third Parties: This specifies who the receiving party (investor) can share the confidential information with. Typically, it includes their employees, legal counsel, financial advisors, and sometimes limited partners, all of whom should also be bound by confidentiality. Founders should ensure this is tightly controlled and limited to a “need-to-know” basis.

Here’s a simplified example of how a confidentiality clause might read:

“The Parties agree that all non-public, proprietary, or sensitive information disclosed by the Company or its representatives (the “Confidential Information”) during the course of the proposed investment shall be treated as strictly confidential and used solely for the purpose of evaluating the transaction. This Confidential Information shall not be disclosed to any third party, except to the receiving party’s directors, officers, employees, and professional advisors who have a need to know such information and are bound by similar confidentiality obligations. This obligation shall survive for a period of [X] years from the date of disclosure, except for information that (a) is or becomes publicly available through no fault of the receiving party, or (b) was already known to the receiving party prior to its disclosure by the Company.”

Evolv’s Recommendations:

Define “Confidential Information” Broadly: Ensure the definition covers all types of information you are sharing, including business plans, financial data, intellectual property, customer lists, and even the existence and terms of the negotiations themselves. Do not accept clauses that limit it to “written only” or solely “trade secrets.”
Limit Permitted Use: The clause should explicitly state that the information can only be used for evaluating the investment. Prevent investors from using your insights for other investments, especially in competing ventures.
Be Wary of Overly Short Durations: While perpetual confidentiality might be unrealistic for all information, especially for core trade secrets, ensure the duration is long enough to protect your interests, typically 2-5 years for general confidential information.
Control Third-Party Disclosures: Ensure that any third parties who receive your confidential information (e.g., the investor’s limited partners or other advisors) are also bound by confidentiality obligations. The clause should clarify that the investor is responsible for any breaches by these third parties.
Seek Reciprocity: While often unilateral (protecting the company’s information), sometimes investors also share confidential information. In such cases, a mutual confidentiality agreement is appropriate.
Understand the Binding Nature: The confidentiality clause is typically one of the few binding provisions in an otherwise non-binding term sheet. This means you are legally obligated to adhere to it from the moment you sign.
Consult Legal Counsel: Always have experienced legal counsel review your term sheet. They can identify potentially unfair clauses, negotiate better terms, and ensure your interests are adequately protected. Don’t rely on boilerplate language without professional review.

Understanding and carefully negotiating the Confidentiality clause is a crucial first step in protecting your startup’s sensitive information throughout the fundraising process.