Friday, March 21, 2008

Non-Compete Agreements....Again

What is it about the weather that has everyone ranting all over the blogosphere? Let’s start with Bijan Sabet’s call for the end of non-compete clauses. Bijan has been touting this since at least late last year, and I thought VCs on both sides had nicely dissected the issue back then. But it seems Bijan is a man with a mission, bringing the matter up again in a recent guest post for GigaOm. It’s not mission I’d sign up for.

The crux of Bijan’s argument is that non-compete agreements are a significant barrier to innovation; enforcement of these agreements prevents new ideas from making it to market, which is one reason why New England lags in innovation behind California (where statutes prohibit the use of non-compete agreements). Here are my thoughts:

As a lawyer, my main job is to protect the assets of each client’s business.
The non-compete covenants given by key employees are, in fact, assets that are reflected on the balance sheet as goodwill. (This is even recognized under California law, which permits non-compete agreements in connection with a sale of a business so that shareholders may capture all of the business’ goodwill.) Abandoning a company asset for no consideration in the name of the broader public good strikes me as corporate waste and a breach of the obligation to preserve shareholder value.

The power of the non–compete is essential in the start-up phase of most businesses. It provides the incentive for founders to work out their differences and to continue to develop and launch their product vision, even before the value of the aggregate know-how and intellectual property that the start-up is based on is fully understood.

In later stages, non-compete agreements encourage businesses to develop employee retention initiatives. Why spend corporate resources on developing human capital if employees can walk across the shop and open competing businesses? I often hear this from larger corporations, who see their California employees as “free riders” on the benefits and incentive plans created for the rest if their staff.

I should note that Bijan differentiates between non-compete agreements, confidentiality agreements and agreements not to solicit customers, all of which employees typically sign. The latter two, he says, are fair game and should remain. In my view, however, breaking up this three-pronged asset protection scheme creates more problems than it solves. The non-compete agreement is the easiest for a company to enforce, since a breach can be established from public knowledge. By contrast, proving that confidential information has been disclosed, or that customers have been compromised, requires access to third party records and information. Removing the non-compete from the equation imperils a company’s entire intellectual property scheme.

No question, Massachusetts lawyers make a terrific living tracking down and trying to stop former employees from breaching these agreements, and Massachusetts courts have been fairly obliging. (Some of our own clients have been the recipients of lawsuits from their Boston-based employers.) And it’s also no question that many start-ups are heavy- handed in their approach to non-compete agreements. For example, having all employees sign non-competes is unnecessary, and even harmful. Litigators will tell you that it is more difficult to enforce an agreement against a CTO if you failed to do the same when a secretary also crossed the street to work for a competitor. Where possible, we advocate having only key employees agree to restrictions. Adjusting how you protect your assets is a more sensible approach than doing away with it altogether.

One last point: In most jurisdictions, the enforceability of a non-compete is a function of its reasonableness. Many later stage companies – RIM is a good example – provide for the possibility that employees may moonlight and develop new ideas after hours. This approach is not typically followed in agreements signed by founders, but it should be considered as any engineering and tech teams are scaled. The scope and range of non-compete provisions need to be considered and reviewed as a company scales, so that the whole structure doesn't fail because of a one-size fits all approach.

Happy Easter, all.

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