By Maurie Cashman
Non-Compete Agreements have become commonplace in todayâ€™s economy. Last week we discussed Stock Appreciation Rights as a method of incenting employees and motivating them to grow the value of your company. This week I want to talk about an agreement that often goes along with incentive plans and has come heavily into vogue during the recent recession, the Non-Compete Agreement.
â€œAnyone who conducts an argument by appealing to authority is not using his intelligence; he is just using his memory.”
–Leonardo da Vinci, Italian artist
WHAT IS A NON-COMPETE AGREEMENT?
A non-compete clause (often NCC), or covenant not to compete (CNC), is a term used in contract law under which one party (usually an employee) agrees not to enter into or start a similar profession or trade in competition against another party (usually the employer). Generally these agreements are used with key employees to prevent them from taking the knowledge they have gained about processes, customers, employees and suppliers and using them in the employ of a competing company to the detriment of the competitive position of the employer.
WHEN IS A NON-COMPETE AGREEMENT APPROPRIATE
A non-compete agreement is absolutely appropriate and critical to have in place with your key employees. These are the employees that, were they to leave tomorrow, would create a serious negative impact on the business. The non-compete is a risk management tool that protects the intellectual assets of the business from walking away.
There are two critical factors at play with a non-compete agreement in an ownership transition planning scenario.
Critical That The Key Employees Are Prevented From Leaving.
Employees are your most important asset.
I recently was involved in a transaction in which my client had decided to sell the business to a third party. The buyer had made it clear from our first conversation that he considered one employee as absolutely critical to the deal and that they would not close without him. They considered him to be indispensable to the business.
My client did not have a non-compete agreement in place with the employees. The buyer was requiring the employees to sign employment agreements, including non-competes with the new company. One day before closing all of the employees showed up to sign except one â€“ the key man. He was sick and did not understand the importance of the day apparently. We managed to find him and got him to sign the agreements but not before the buyer had threatened to abandon the deal.
Employees Can Compete
Employees are capable of setting up shop on their own or helping someone else to compete with you as the new owner. I was once offered the opportunity to come to work for a company for a few months to â€œget a feel for itâ€ with the idea that if I liked it I could buy it. I quickly turned it down. The owner found someone else interested and after 4 months he left the company, built a building across the street and began selling exactly the same products as the seller. The seller went out of business within a year.
You Make an Investment in Your Key Employees
Hiring and training new employees is not cheap. I want to distinguish this from the investment made in key employees however. Employers often make perks available to key employees that are not available to others, such as incentive plans, stock ownership, enhanced training and evaluation and access to key financial information. In this case it is important that this information is protected and that employees cannot go to a competitor while still holding stock in the Company. Sounds out there but it happens.
WHEN NON-COMPETE AGREEMENTS ARE INAPROPRIATE
When There is No Competition Occurring
A situation I was recently involved with was with an employee who accepted a position with another company, not realizing that he had signed a non-compete agreement when he was 22 years old. The employer sent both him and the hiring company a certified letter threatening a lawsuit should the employee go to the new employer. Fortunately, the deal was able to be walked back with minimal damage but it could have been a devastating situation to a young personâ€™s career.
This employee had no access to sensitive information and the new company was not a direct competitor. However, the Non-compete was used as leverage to keep the employee in place by threatening the employee and the new company with a lawsuit. In this case, the golden rule applies â€“ he who has the gold rules. The hiring company was understandably not going to court over this and the employee could not afford the lengthy proceedings that would no doubt ensue. Not good for employee morale.
When the Employee is Not Key and Does Not Pose a Threat
This situation applies to the example above but also is the reason that it is notoriously difficult to enforce non-compete agreements. It makes absolutely no sense to have everyone including the mail-room and the cleaning staff sign non-compete agreements. They will never possess sensitive information and therefore will never pose a threat.
Non-Competes May Damage Your Business
There are two way that a non-compete may damage your business.
First, if you try to enforce a non-compete agreement and lose. These agreements are notoriously difficult to enforce. The fact is: you cannot unreasonably prevent an individual from earning a living. Therefore, the courts routinely throw out non-compete agreements that are not limited very specifically to the knowledge being protected, the geographical area in which it is to be enforced and the length of time it can be enforced. Should you try to enforce a non-compete and lose, all of your other non-competes are at risk due to the precedent set.
Second, it may impact your ability to hire entry level talent. You should absolutely put non-competes in place with key employees in exchange for the perks discussed above that go along with that key status. That seems to me to be the appropriate time to sign a non-compete agreement.
In my opinion, companies have used the recession to turn the tables on employees by forcing them to sign non-competes in exchange for employment of any kind. I predict that the tables may turn on this as the labor market tightens up in the future. A rapidly growing company may benefit by waiting to sign non-competes until such time as the employee is key to the business.
I was confronted with this early in my career. I was offered a position by each of two competitors. One was offering more money but wanted a non-compete agreement. One offered slightly less but without the non-compete. I took the lower offer.
Non-Compete Agreements are an important component in the ownership transition planning process. However, they need to be carefully thought through when implementing.