Restrictive Covenants: What New Companies Should Know
Most new companies have a new technology or a new way of doing business distinguishes them from their competitors. To protect this competitive edge, companies want to prevent employees and founders from taking know-how or customer relationships and helping or starting a competitor. Many startups try to limit the risk of this happening through using restrictive covenants, but many startups do not understand their mechanics or limitations.
There are several types of restrictive covenants, but the most common are non-compete provisions, non-solicit provisions, and non-disclosure provisions. A non-compete provision means that an individual cannot leave your company and then work for another company competing against yours. A non-solicit provision means that an individual cannot go to another company and try to convince your customers to abandon you in favor of the new company (a non-solicit can also be used to prevent someone who leaves your company from recruiting others to join the new company). A non-disclosure provision prevents an individual from telling a different company about your business processes or trade secrets.
To be enforceable, restrictive covenants must be reasonable on several levels. They must be reasonable as to time, as no court will enforce a restrictive covenant that says it lasts forever. They must be reasonable as to scope, whether that be geographic or in the description of what industry your company is in. A restrictive covenant is also more likely to be enforced if it is protecting a legitimate business interest, such as confidential information or business relationships.
Most restrictive covenants are governed by state law. This creates uncertainty, especially if your company hires remote employees. While your business may be located in North Carolina, you may have employees in New York, Texas, or California. To protect your company to the maximum extent possible, you need to specify in the employment agreement that the agreement is governed by the law of the state where your business is located. That way you will at least have more familiarity with the applicable laws. Even this is no guarantee that the restrictive covenants in an employment agreement will be enforceable (for example, California is famously hostile to restrictive covenants).
As a general rule, use restrictive covenants only for high-level employees and founders. Several states have enacted legislation prohibiting restrictive covenants for low-level employees, such as those working on a factory line or assembling sandwiches at restaurants. These laws were in response to a perception that companies were being excessive in requiring employees to sign non-compete agreements, so do not make it easy for an adversary to lump your company together with others who have received this unfavorable media coverage. Use restrictive covenants for those who head departments or manage sales accounts—the individuals who have knowledge about the magic that makes the company successful. The more reasonable a restrictive covenant looks and feels at first glance, the more likely it is to be enforced.
If you are a new company considering implementing restrictive covenants, email us at email@example.com and we will walk you through the details of your situation and work towards a successful outcome.