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Unit Economics

A Point of View on Lawyers, Stealth Mode, Patents, and Secrecy

When you start your venture, you embark on a creative, complex, and difficult process. Your natural inclination might be to conceal as much as possible—much like a poker player does his cards—for fear others will take advantage of you. Alternatively, you might construct a moat around your idea with NDAs, patents, and all forms of IP agreements.

This is unequivocally the incorrect strategy. If you are doing this, please think again. In many cases, this type of protection is expensive, time-consuming, and damaging to your venture. More, it often makes entrepreneurs seem naive and ill-informed.

If you are building a great company, you need to spend your time and resources on what is most important: your team, your strategy and execution, and your product. Unneeded legal expenses are friction. Don’t do it unless you have a compelling reason. Stay lean. Focus on execution, and target your resources towards building your company. Go fast and let nothing slow you down.

It’s important to recognize that there are probably hundreds of people in this world who have a similar idea to yours. What differentiates you from them is your ability to execute your idea. In VC, ideas are cheap, execution is everything. An age-old adage says that the top ten things to evaluate when considering an investment in a venture are: team, team, team, team, team, team, team, team, idea, plan.

Think about it. The product or service you are creating is nothing more than the instantiation of the brilliance and creativity of your team.

Regardless of the quality of an idea, a mediocre team develops a mediocre product which leads to a mediocre company.

Limit Your Non-Disclosure Agreements

What about non-disclosure agreements (NDAs)? NDAs are legal documents that allow your startup to maintain confidential, proprietary, or sensitive information. As you develop information that’s important for you to keep private, NDAs are valuable tools. But be careful what information you try to protect.

For example, if you’re just going to present your venture concept to a VC, be aware that VCs almost never sign non-disclosure agreements (NDAs) in the initial phases of their diligence. This is because they are often exposed to many teams with similar ideas. And if they sign an NDA with your company and invest in a similar company to yours, you might (falsely) believe that they shared your information with the other company. And subsequently, you might attempt to sue them. In addition, signing an NDA might hamper the VC’s ability to perform diligence on your company. If they like your idea, their first reaction might be to reach out to other industry experts. The NDA will prevent that.

So if you have information that you absolutely don’t want to disclose, don’t disclose it - at least at your initial meetings. VCs will understand and appreciate that. You can broadly explain your idea without sharing specific confidential information that needs an NDA. VCs are going to make a decision not just on your idea but also on your team and your ability to execute.

In addition, if you are attempting to recruit team members and ask for an NDA, this is a real barrier. Just telling them the venture idea is not a good reason to ask for an NDA. You should be able to explain at least the broad strokes of the idea without asking for an NDA. If there’s in-depth technology to be explained, then an NDA might be justified in a later discussion.

Do You Really Want to be in Stealth Mode?

If you think your venture should be in “stealth mode,” you might think twice. Or three times. Yes, you might not want to alert competitors that you are developing your venture or your product. But you are limiting conversations with future team members, as well as with VCs. You are also losing out on vital early feedback on the usefulness of what you are creating. For every company that successfully emerges from stealth mode, there are ten that emerge only to discover they've built something that no one wants.

Are Patents Important? It Depends …

What about patents? Many companies spend a great deal of funds on patents and believe patents enable them to build their venture and limit their competition. It is true that patents offer value to a company. They are concrete assets and sometimes can be highly valuable.

But it’s important to know that patents are not going to protect you from another company entering your market space and potentially infringing on your patents. You are a startup, and startup companies usually do not have the funds or the human resources to sue another company for patent infringement. Venture capitalists do not want their money spent on legal fees. They want it spent on building the company and the product and the team.

As an example, suppose Google decides it wants to launch a product that you think you have a patent on. Are you going to sue them? Of course not. They have enormous resources to defend themselves and can tie you up forever. They can counter sue of course. They can also attack the patents themselves, claiming prior art or a million other reasons that it’s not valid. No board would ever allow you to spend your resources on this suit. And this type of suit would normally take $Ms and years of legal battles.

What patents do for you though, is provide some defense against attack by others. If you don’t patent, others might. And in the patent world in the US, it’s no longer first to invent who gets the patent. It’s first to file. So if another company likes your technology and decides to patent it, you can be in grave difficulty. They can, and often will, sue you for infringement.

Secrecy on Equity Value

As long as we’re discussing confidentiality and secrecy, there’s another type of secrecy within the startup community. Many startups have a culture of secrecy as relates to the value of the equity they distribute. I think this is a serious mistake. The management might offer equity in their company, such as 50,000 options for example, and then refuse to tell the employees the value of these options or what percentage this tranche makes of the company.

It’s hard for me to understand this type of secrecy. Though the value of options can be complicated by dilution of future rounds, 409a valuations, common vs. preferred stock, and more, team members have a right to understand at least what percentage of the company they are getting at the time they get it. Otherwise isn’t it just a meaningless number? In addition, companies like Pitchbook or Crunchbase can tell you the number of outstanding shares, for example. Trying to conceal that type of information will only backfire by eroding relationships and trust.

Do you agree? Do you have examples or counter-examples?

I’d like to hear from you.

Norman Winarsky

Norman Winarsky

Oct 6, 2022  - 147 views

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