As the founder of your startup, you have the right to protect the interest of your business. One of the risks you want to safeguard your business against is key employees with proprietary knowledge of your start-up leaving your company and joining a competitor or even setting up a competing venture.
From an investor’s point of view, they might also want the insurance that the founder doesn’t leave somewhere along the line and set up another business in competition with their investment.
Contents
- What is a non-compete?
- What type of interest can you protect through non-competes?
- Enforceability
- Typical situations where non-competes are relevant
- Components of a non-competes
- How enforceable are non-competes?
- Conclusion
One way to protect your startup from unfair competition is to include non-compete clauses in your employment contracts. You could also have a non-compete in the shareholders agreement that you sign with your investors. This gives them peace of mind that you are protecting the interests of their investments and subjecting yourself to non-compete obligations.
To successfully grow your startup, you will invest significant time and money to develop your team. By signing a non-compete agreement, the employee undertakes to not compete with your business if they leave your employment. So non-competes help you protect your business, trade secrets, intellectual property and ultimately, your investors’ investment.
Whilst most jurisdictions recognise some form of a non-compete clause, the validity and enforcement of non-competes are some of the most argued-about aspects of employment law.
Before you sign or include a non-compete in your contract, you must fully understand what a non-compete is, the requirements for enforceability in your jurisdiction, and what type of interests you can protect with a non-compete.
What is a non-compete?
In legal terms, a non-compete is an agreement or a contract between an employer (which, in the case of the start-up, will probably be the founding team) and an employee preventing the employee from competing with the business during and after the employment has ended.
It could be direct or indirect competition and includes leaving the current employer to work for a competitor, starting their own business in competition with the previous employer, or sharing trade secrets with a competitor. It could also prevent the ex-employee from recruiting your employees to follow them to a new employer or start-up. Likewise, it can prevent an ex-employee from poaching your customers.
Non-competes are particularly important when hiring key employees who will have access to confidential and proprietary information about your startup.
The non-compete could be a separate agreement or a clause in the employment contract. It should be signed at the beginning of the employment relationship.
Without a non-compete, ex-employees could legally use proprietary information or trade secrets to further their careers or give a competitor an advantage.
What type of interest can you protect through non-competes?
For a non-compete to be enforceable, it needs to protect a legitimate business interest of the employer. What is regarded as a legitimate business interest depends on the company, the industry, and the specific circumstances. There is no “one size fits all” non-compete.
Legitimate business interests include the following:
- Trade secrets
A non-compete can prevent an ex-employee from using or sharing your ideas, processes, systems, software, or intellectual property. It prevents ex-employees from sharing this information with competitors or using it to start their own businesses. Trade secrets can include complicated algorithms, specialised product information, or marketing strategies.
- Confidential information and client relationships
In certain types of businesses, such as sales or professional services, it is imperative to protect client lists and client information. If an employee leaves your company, you want to prevent them from taking the clients they acquired through your marketing and business services. It could also apply to prospective clients that you were lining up.
- Training skills and methods
As a founder, you may invest a lot of time and money in training your employees. You want to prevent an ex-employee from using that training to the competitor’s advantage.
Enforceability
Ultimately, the scope of your non-compete depends on the nature of your business. To be enforceable, you must prove it protects a legitimate business interest. You should also ensure the restrictions are limited and reasonable. It is better to go for. A shorter non-compete period and a smaller geography to ensure enforceability. For example, a 10 year non-compete that covers the whole world is highly unlikely to be enforceable. Whereas a 12-24 month non-compete that covers one or a handful of countries where your start-up operates has a much higher chance of enforceability. It’s about balancing the protection of your legitimate business interest with the unfair hampering of an individual to make a living.
Typical situations where non-competes are relevant
- Start-ups or highly specialised businesses
Protecting your business ideas, systems, algorithms, product design, etc., can be crucial in a start-up or highly specialised business situation. You must protect your start-up or business against employees with access to critical information joining a competitor or starting their own business competing with yours. Investors also want assurance that their investment is protected from such an event.
- Selling the business
When you sell your business, the buyer might ask you to sign a non-compete to protect their investment. No one wants to buy a business only for the previous owner to start a similar business in competition with them or take all the business ideas and customers with them to a competitor.
- Client-specific businesses
Suppose you have a business where your employees build up client relationships with specific clients. In that case, you need a carefully drafted non-compete preventing that employee from taking those clients to a competitor or a new business competing with you.
Components of a non-competes
Although the specific wording depends on your business and what interests you want to protect, all non-competes should include certain key elements:
- Scope
The wording of the clause or agreement must be specific, clear, and unambiguous. It must indicate a particular activity the employee is not allowed to engage in. For example, not sharing specific trade secrets, not poaching clients, or sharing client information, not working for a particular competitor, not developing a similar product, or providing a similar service, etc. It could also include specifying an industry in which the employee may not work. It may include a specific business even if the new job does not involve disclosing trade secrets.
- Duration
For the non-compete to be valid, it must specify a time limit. Typically, the time limit will be two years or less. Lengthy non-competes will rarely stand up in court. The time limit must be realistic and reasonable.
What is reasonable will depend on the industry and the type of employment. It cannot prevent employees from progressing with their careers.
- Geography
A valid non-compete should define the geographical area where ex-employees are prevented from working or starting their own business. It could be specified as a radius around the startup or mention specific cities, towns, or offices of an individual competitor in a country, etc.
An extensive geographical area is less likely to be enforced in court, but it depends on the specific circumstances. Generally, the area must not be such that it imposes an unfair or unreasonable restriction on the employee.
- Define the competition
Although it is not necessary to specify each competitor, you must define the competition. You need to define the type of business or industry the employee is prevented from working for or in, i.e., companies or industries competing with your start-up.
- Damages and compensation
Employers should specify what damages and compensation they would be entitled to if the employee breaches the non-compete.
How enforceable are non-competes?
The non-compete must comply with the laws of your jurisdiction to be enforceable. Some labour law jurisdictions have specific requirements, and you should familiarise yourself with the rules where you register your start-up.
Besides specific laws, there are certain pitfalls that you should avoid if you want to rely on your non-competes. Courts have ruled against agreements regarded as unfair or unreasonable towards the employee.
So, what is good practice to ensure enforceability when drawing up non-competes?
When the courts consider reasonableness, they will look at the following:
- Is the duration reasonable?
- Is the geographical area not too large?
- Is the competition well-defined and reasonable?
- Is it still possible for the employee to find other employment or start a business?
- Is there a balance between protecting the employer’s legitimate business interest and what the employee is prevented from doing?
In summary, to enhance the enforceability of your non-competes, you should:
- clarify what legitimate business interests you are trying to protect;
- use specific language when drafting the non-compete; and
- ensure that the provisions are reasonable.
Best practice includes limiting the geographical area and the duration to only what is reasonably necessary to protect your interests, but also not stand in the way of the employee to pursue their career path.
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Conclusion
Non-competes are particularly relevant when an employee has access to and can use knowledge or client relations to compete with your business. Although most jurisdictions recognise non-competes, enforceability is not always guaranteed. Non-competes should be drafted to protect legitimate business interests in a fair and reasonable way.
To have non-competes that won’t stand up in court is a costly waste of time. The drafting of non-competes should be left to professionals with experience in this field.
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