One of the questions that entrepreneurs ask me the most is, "When I approach a venture capitalist, how can I protect my idea?"

Unfortunately, there are no easy answers. Many first-time startups try to persuade venture capital firms to sign a non-disclosure agreement (NDA), a legal document that prevents outsiders from discussing a company's business plan or its presentation. But the overwhelming majority of venture capitalists will not sign NDAs. In fact, Promod Haque of Norwest Venture Partners says that entrepreneurs who push NDAs on VCs look "amateurish."
There are reasons why VCs won't sign NDAs. As Tod Francis of Trinity Ventures told me, if a venture firm signed an NDA for every business plan it accepted, it would have to hire a team of lawyers to track the origin of the ideas that it funded. More important, perhaps, VCs could not invest in certain deals because they were bound by a loosely worded NDA they had signed earlier. (I know of one recent high-profile deal in which this occurred. Not surprisingly, the VC firm in question did not wish to be identified.)
Venture capitalists say entrepreneurs should look carefully at a venture firm's reputation. But it is no secret that even highly respected VCs sometimes share "hot" business plans with others. Eric Greenberg, chairman and cofounder of Scient (Nasdaq: SCNT) and cofounder of Viant (Nasdaq: VIAN), says first-time entrepreneurs are the most vulnerable. "There is a strong code of trust for entrepreneurs who are known and respected by VCs," Mr. Greenberg says. "But it is difficult to determine what that code is when the VC and the entrepreneur don't know each other."
 

PROTECT YOURSELF

In order to make sure that a VC firm is not using a startup's business plan for market research, Mr. Haque recommends that entrepreneurs do their homework. Entrepreneurs should pore through a VC firm's Web site to determine if it has a similar investment. If the startup sees no conflicts, it should only send VCs an executive summary, not a full business plan. This suits most VCs just fine.
Stan Fung of Zero Stage Capital says that 95 percent of a company's success is determined by its team anyway, not a unique product idea.
When entrepreneurs first meet with VCs, Mr. Fung recommends that entrepreneurs ask VCs if they have any similar investments that may not have been posted on their Web site. Mr. Haque, Mr. Greenberg, and Mr. Fung all recommend that entrepreneurs only discuss their idea in minimal detail. Startups should be especially careful about leaving materials behind or providing elaborate detail. "Don't spill your guts," Mr. Haque states.
Mr. Greenberg points out that certain types of businesses are more defensible than others. In his opinion, service businesses like Scient, which rely mainly on human capital, are much more difficult to replicate than product-based businesses, such as networking equipment. Nevertheless, he says entrepreneurs have to accept the fact that they are running a risk when they bring their idea to a venture capitalist.
Many entrepreneurs will end up exposing their ideas to people whom they don't know. But that doesn't mean they can't be smart about how they do it.

Source: Alex Grove, Redherring, Aug 11, 1999