Covering Your Assets – Why Use Non-Compete Agreements?

Too often, we encounter small business owners who have expressed reluctance to use non-compete and other restrictive covenant agreements.  In addition to expressing concern over the cost of engaging legal counsel to draft an agreement, many believe that their business is too small to worry about non-competes or similar restrictive covenants.

The term “non-compete agreement” technically refers to a contract that precludes a person from engaging in certain acts of competition for a prescribed period of time within a prescribed geographic area.  The term, however, is often used broadly to refer to any contract by which someone has any type of competitive restrictions, including non-solicit, non-recruit, non-disclosure and confidentiality agreements.  The reasons small business owners might want to use one or more of these covenants are diverse, but often compelling.  Some of the more common considerations include:

  1. Enhance the value of the company – If a sale transaction is considered or there’s a need for external cash, it’s important to preserve company value. One way to accomplish that is to require employees to sign restrictive covenants.  When someone purchases or invests in a business, that investor will want assurance that the value of the investment is protected.  If key employees, with access to customers and relationships, are able to leave employment following a merger or acquisition, the value of the corporation may be adversely impacted.  Protect the worth of your company and its assets by using appropriately tailored non-compete agreements.
  1. Qualify for trade secret protection – Generally speaking, any valuable business information that is kept secret from competitors is subject to trade secret protection. To state the obvious, information must in fact be kept secret to be considered a trade secret.  When determining whether information should be entitled to trade secret protection, courts look at many factors, including the extent to which the owner took reasonable steps to preserve secrecy.  A widely recognized precaution includes requiring employees to agree not to use or disclose confidential or proprietary information.  In addition, if customer information is considered a trade secret, a covenant not to solicit customers may be of value.
  1. Protect customer relationships – Small businesses tend to place client relationships in the hands of only a few employees. Without appropriate agreements in place, client relationships can walk out the door, alongside outgoing employees.  All small business owners know that it takes time to build (forget re-build) client confidence.  Clients are the lifeblood of any business, but this is particularly true for small businesses.  A small business simply cannot afford to lose clients and having the appropriate agreements in place will go a long way to protect those relationships.
  1. Enhance client confidence – Clients entrust personal and/or business information to those who provide service and support, and they want to know that the information they share will be protected. Requiring employees to sign restrictions on use and disclosure of confidential information is a good way to provide clients with assurance that their data is safe in your care.
  1. Protect your investment – Training resources help to attract talented employees and are a worthwhile endeavor. However, small business owners rarely take the steps needed to prevent competitors from swooping in to hire employees in whom investments have been made.
  1. Clarify expectations – Employees rarely fully appreciate the extent to which employers expect them to leave behind the information to which they were entrusted. Ensure that your employees understand that the relationships you paid them to cultivate and maintain belong to you.  The best time to clarify expectations with employees is before a dispute arises and generally through a restrictive covenant agreement.
  1. Potential litigation – When your business is on the line, you may have little choice but to protect your interests through legal action. Although no contract can eliminate the expense associated with litigation, carefully drafted and appropriately scoped agreements can help to minimize costs.
  1. Deter competitors – Restrictive covenants will not generally be enforced if they serve no purpose other than to restrict competition. If your business, however, has a legitimate purpose for requiring employees to sign a restrictive covenant agreement, such as a need to protect confidential information or customer relationships, it is important to send a message to competitors that you are prepared to protect your interests.

Smart Tip: Critically consider your company’s interests and evaluate any risk your business has, if it does not have in place restrictive covenants.