Every business owner should have a solid understanding of the fundamental legal statutes and rules of law that pertain to their business. Non-competition agreements are often overlooked in this respect or business owners may simply have the wrong information about how they actually work – giving them misplaced confidence. I want to give you the real facts.
All too often, I’ve found that businesses have been handed a template non-competition agreement by their attorney when first setting up their company. The intention is that every employee in the future, from the CEO to their factory workers, sign that same agreement. While there are broad sweeping rules of non-competition, the specifics tend to vary state to state. Read this blog for a step-by-step guide that will help you maximize the value of your employee documents.
The main objective of non-competition agreements is to protect your competitive advantage. Having your employees or founders sign this document prevents them from sharing your business’s critical information with your competitors. There is a balance to be struck however; the government recognizes the rights of your employees to also earn a living. From the government’s perspective, the needs of the individual employee outweigh the employer’s need to protect themselves.
Scope, and how you can limit it
When considering having an employee sign a non-competition agreement, the first step that needs to be taken is limiting the scope to guard your interests, and at the same time enabling the employee’s right to perform the activities they are trained for.
Here are some ways to limit your non-competition agreements:
- Geographic limitations
- Temporal limitations
- Limiting the list of prevented activities
Geography in the context of a non-competition agreement specifies the physical boundaries where work can be undertaken, e.g. city, state or country. This will most likely apply to medical offices, restaurants or other service providers. An example of this may be a doctor with their own practice who brings on another young doctor whom they plan to sell the practice to in the future. In this instance, you don’t want this younger doctor developing relationships with your patients and then establishing their own practice rather than purchasing yours as agreed. Here, a non-compete may be limited to a finite distance from the physical location of your practice. This gives the younger doctor the opportunity to work within a reasonable distance of that practice, but not so close that every patient will jump ship to the new practice.
In an online environment however, physical boundaries are far less consequential. Many companies form non-competition agreements to stop work within the United States or a 25 mile radius of their customers. In simple terms, this denies a US citizen the right to carry out work for which they have been trained within the US – making for a much less enforceable agreement. In other words, geographic limitation may be suitable for local business but not so much in the digital realm.
In terms of temporal limitations, avoid any length of time lasting more than one year. Occasionally, where an employee is receiving an annual salary in the range of $500,000 or more, preventing them from working for one year may be possible. On the flip-side, denying their right to work for five years would place undue hardship upon them. Likewise, ordering an employee on minimum wage to cease work for an entire year would be very unreasonable, regardless of whether they have critical knowledge of your business which could be easily passed on to a competitor. Thus, temporal limitations should take into consideration the salary of the employee and the burden that length of time places on them.
Limiting the activities or job in a non-competition agreement should take into account the type of activities and not the job in its entirety. Enforcing a clause that prevents a programmer from coding in C++ for one year in the United States isn’t very fair. Yet, enforcing a clause which prevents that programmer from contributing to a project that improves the user interface in a video game might be – the programmer could use their skills in other areas such as a natural user interface for a word processing application. This still gives the programmer the ability to earn a living and/or apply for jobs within their profession.
Who needs to sign?
The second rule to take into account when having an employee sign a non-competition agreement is determining when it is necessary. An employee simply may not perform activities or have access to business critical information. Obviously there is no need for these employees to sign a non-competition agreement. A mistake that most new businesses make is that they draft non-competition agreements aimed at the founders but then apply that same agreement to all of their employees, no matter their role. Ultimately it may save on legal costs, and in the case of a very small organization, it does hold some weight. Nevertheless, should the company continue to grow, not everyone should have to sign the same agreement. The more selectively you apply non-competition agreements, the more enforceable they are. A single enforceable non-compete agreement is much better than 1000 unenforceable ones. Choose only key employees for whom you require a non-compete and protect your competitive advantage.
Finally, if you are contemplating having an employee sign a non-competition agreement, ask yourself, are you willing to pay more for the non-compete? Non-competition agreements are generally an employment matter. Therefore, consideration for non-competition agreements is equal to the work the employee is tasked with creating (e.g. salary). Although, if non-competition is not essential to employment, then it is more enforceable. Rather than analyzing the concept of non-competition as “you work for me, sign here.” Approach it as “if you sign this, you will get increased salary in return.” For example, if you hire a CEO at a salary of $300,000, the non-competition agreement can be combined with their paperwork. Alternatively, you could offer $300,000 plus a $70,000 signing bonus for completing the non-competition agreement – making the non-competition agreement an individual document the CEO chose to sign. Otherwise, you can offer them $270,000 for employment and $100,000 each year for complying with the individual non-competition agreement. If this is found to be unenforceable, you should at least get the $100,000 back, right?
There is no guarantee that your non-compete agreements will be enforceable, but by being astute in deciding who signs them, placing temporal, geographic and activity restrictions, and framing the non-competition agreement as a standalone document, with individual consideration, you can increase the chances that the non-competition agreement will be enforceable.
Your company is probably only going to care about the employee’s new job when it is essential to the operation of your business – so take care to plan ahead and make use of the three rules mentioned above to improve the possibility that an employee’s non-competition agreement will measure up to the scrutiny it will face and protect your competitive advantage.
If you know of a friend or colleague who may have use for this information, please forward this on to them!