Fear and Loathing of Non-Disclosure Agreements

Today I was reminded how perception plays a far larger role in whether or not someone will sign an NDA, rather than the actual content.

Without going into specific details, I have found most people can be grouped into one of two broad categories when it comes to NDAs. The first wants “lots of protection” (typically a nervous entrepreneur or company management) and the second simply wants something “simple and basic” (typically sales people or investors). I have two basic NDA templates: the one I use most often is a single page (2 columns in 8 point font) and the other is five pages long (single column in 12 point font). For the most part, experience has taught me that matching the appropriate version to the expectations of the recipient can really move things along.

As you probably have guessed by now, the irony is that content of both templates are EXACTLY the same. I do not do this to be unscrupulous, as each provides adequate protection for each party and are always tailored to fit the purpose, but rather to free everyone to focus on the actual deal by getting past an irrational hurdle.

I use the term “irrational” because I find that too many business people (including the very intelligent and successful) have formed pre-conceptions about NDAs despite rarely actually ever reading what one says. Some are the downright misguided.

Like any contract, an NDA is simply written understanding of what the relationship is between two parties. Having or not having one has little to do with “trust” and more to do with avoiding the future misunderstandings that all-to-frequently arise when you rely on a verbal agreement alone. Don’t believe me? Try playing Broken Telephone by passing a piece of paper with the original message written on it instead of whispering it orally: the outcome will be very different from the traditional variant of the game.

I have found that spending a quick 3-5 minutes to run through an NDA can easily to dispel some of the misplaced angst that seems to surround them. In a future post I’ll run though what I like to see in a non-disclosure agreement and why each point is not really that controversial important for me.

Great Expectations? The Future of VC in Canada

An article appearing in the Financial Post earlier this week about new venture capital initiatives in Quebec and Ontario got me thinking about current expectations for future performance of venture capital in Canada.

After reading much of the press this past year surrounding the new $300 million Tandem Expansion fund launched here in Quebec and some thoughts on growing fund sizes South of the Border, I did some very quick, back-of-the-envelope, fuzzy calculations to gauge how high the bar is currently being set.

Not being familiar with the terms or structure of the new fund, I have assumed:

  • the new $300M fund will aim for a return of at least 20% over 7 years;
  • the management fee is 2% (I suspect it is actually lower given recent comments on fees by Jacques Bernier, managing partner of Teralys Capital, an investor in the new fund) with a carry of 20%; and
  • the fund will have an average 30% equity stake on exits.

In order to return 20% to LPs in seven years, the managers would have to turn that $300 million into just under $1.4 billion, after annual management fees and carry are factored in. If the fund holds a 30% stake on each exit, then they will need to create nearly $4.7 billion in market value.

While I don’t have any recent numbers on value creation by later-stage Canadian VC firms to contextualize my fuzzy math, those are some quite impressive numbers.

Investors as Source of Risk: Sometimes it is Better to Just Get out of the Way

At its most basic level, the business of investing is about managing risk. In order to reflect the risk in the terms of a deal, most investors know the basics risks to look at (e.g. market, management, operational risks, etc.) and engage in intensive due diligence processes to discover what the extent of those risks are.

One source of risk that is rarely considered in the investment process, however, is sometimes readily discoverable if investors simply look in the mirror.

Fred Destin at Atlas Ventures has put together an interesting post on the topic of investors behaving badly after the money goes in, but an investor can also unintentionally notch up the risk BEFORE investing a single cent.

I once had the opportunity to see this happen first hand. Briefly, the company had an exceptional management team, proven technology, good track record, full order book and a slew of potential customers in their pipeline. A large round of financing was needed to scale the company rapidly to seize a market opportunity that would have given any first mover a significant sustainable competitive advantage. In other words, the company had to move quickly and needed the financing to do it. After much negotiation and due diligence, we were ready to close with the material issues having been reasonably addressed in the terms of the deal…

…then some of us decided that even bigger belts might look good with our already hefty suspenders.

Initially, this was not necessarily a bad thing. But as weeks turned into months, the value-add of the negotiation process began to decline exponentially. As some insisted on debating what colour costumes the angels dancing on the pin should be wearing, the company’s window of opportunity was shrinking. The absurdity of the situation was brought home when a particularly combative member of the investor syndicate suggested now not doing the deal because company management had failed to achieve their projections for that year – projections that had been based on the assumption that the financing would have been in place several months earlier on the initial expected closing date (in fact the performance numbers showed the management were still making remarkable progress despite funding capital expenditures from a relative dribble of internally generated cash).

Although the deal eventually closed, and on terms that made some sense, the business plan ended up being riskier than it had been at the start of the process. It had nothing to do with the entrepreneurs involved, however, and everything to do with some investors trying just a little too hard to justify their existence.