Team Management

What is a Non-Compete Agreement? Do You Need One for Your Business?

Feli Oliveros  

As a business owner, you’ve poured countless resources into your company to make it successful. 

But as your organization grows, some of your employees will inevitably move on for other opportunities. And when key staff members leave, what happens to the insider knowledge they have on your company? How can you protect yourself from potential information leaks?

In instances like these, a non-compete agreement can help. Keep reading to find out how.

What is a non-compete agreement?

A non-compete agreement (NCA)—also known as a non-compete clause (NCC), non-compete covenant, covenant not to compete (CNC), or restrictive covenant—is a legally binding contract that prevents an employee from competing against a business, both during their employment and for a certain length of time after their work relationship comes to an end. 

By restricting employees from working for a competitor or starting a similar business in the same niche, an NCA helps protect your company’s most valuable or sensitive information—think customer or client lists, methods or practices, strategies, ideas, future products, and more. 

For example, a niche marketing agency may have concerns about their employees starting a side hustle of their own, siphoning clients and proprietary marketing practices from them in the process. To stop this from happening, they may require all account managers and salespeople to sign a non-compete during the onboarding process. 

Although non-compete agreements are often used in employment contracts, they can also be used in contracts with consultants and independent contractors as well. In fact, it’s estimated that about 37 percent of workers have worked under an NCA at one point in their careers. 

What information do you need to create a non-compete agreement?

  • The date that the agreement will begin
  • The parties involved in the contract, as well as their names and signatures
  • The reason why the agreement is needed
  • Specific things the employee cannot do under the contract
  • How long the agreement is in effect
  • The geographic area covered by the agreement
  • How the employee will be compensated for signing the contract

If you were taken aback by the last point, you’re not alone. 

But remember, when you ask your employees to sign an NCA, you’re essentially asking them not to take future work in their chosen field for the welfare of your company. This means you’ll need to give them something in exchange for their consent. 

When you present a non-compete agreement to a job candidate, it’s implied that you’ll offer them a position at your company upon signing. That leverage doesn’t exist if you ask any of your current employees to sign a similar contract. As a result, you may find that other incentives—such as a pay raise or promotion—are necessary to secure their signature.  

How effective are non-compete agreements?

Non-competes are typically considered binding if they present clear and reasonable limitations, especially when it comes to the lifespan, geographical reach, and commercial reach of the contract. 

  • Time-based restrictions: Companies can only set reasonable timelines (usually no longer than two years) and they cannot permanently restrict employees from furthering their career in their field or industry.
  • Geographic restrictions: In most cases, a non-compete agreement is limited to a clearly-defined geographic area—say, for example, the city or county in which the company does business.
  • Commercial restrictions: This aspect of an NCA defines what’s considered a competitor to your company. You may restrict former employees from finding work with a select list of direct competitors or expand it to a broader swath of the industry. 

Keep this in mind, though: If the limitations of your NCA are too restrictive, an employee can bring you to court for it and the state may choose not to enforce your contract. So, it’s best not to get overly ambitious with the terms of your contract and keep things reasonable. 

What’s the best way to know if the terms you set are acceptable? Well, let’s first take a look at an example of terms that are too restrictive. 

Let’s say a personal finance company creating a budgeting app doesn’t want their developers taking their code to one of their competitors. They decide to draw up a contract preventing their programmers from working for any finance or technology company in the country for the next 15 years. 

Because this agreement could seriously hurt the career prospects of their development team (and would likely push some of them out of the industry completely), this contract would be considered overly restrictive. 

In contrast, a set of reasonable terms may prohibit the same company’s developers from creating a similar app in the same state for a year. 

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Non-compete laws by state

However, even the most meticulous and well thought-out agreements are subject to state laws on the matter. Each state enforces non-competes differently—while some don’t enforce them at all. 

Some states have decided that NCAs can only be used for certain fields, for example, or have placed a cap on how long these contracts can last. 

Other states—such as California, North Dakota, and Oklahoma—do not enforce non-compete agreements, no matter how reasonable they are. They also won’t support employers in court, even if the business is located in a state that allows these contracts. In California specifically, an employee can sue their employer if they are pressured to sign a non-compete.

As a general rule, most states don’t like the idea of non-competes, but some enforce them if they have reasonable terms. Before you draw up an agreement for your own employees, check if your state has any specific restrictions on NCAs. If your company has any employees working from a different state, you’ll want to check for that state’s limitations too.

Pros and cons of using a non-compete agreement for your company

Pros 

  • You protect your company’s trade secrets, business practices, and other proprietary information.
  • You help keep your clients or customers from switching over to your competitors. 
  • You reduce employee turnover by deterring candidates who don’t plan on staying with your company for very long. 
  • You may be more inclined to invest in more resources and training for your employees since they’re less likely to work for rival companies. 

Cons

  • You’ll need to keep in mind the legal limitations of your state as well as those of other states if you have employees working remotely. 
  • You’re responsible for the hefty legal fees involved if you take an employee to court (or the other way around).
  • You may cause former employees to leave their field and take their expertise and knowledge with them, especially if they specialize in a niche industry or line of work. 
  • You don’t actually need non-competes if the employee in question doesn’t have access to trade secrets or other important information. 

Five things to keep in mind when creating your non-compete agreement

1. Don’t be overly restrictive

Consider only creating specific contracts for important positions that have access to considerable insider information, instead of drawing up general agreements that apply to everyone at your company. 

Start by thinking about what information you need to keep under wraps, then decide what terms and restrictions will help you do that. 

2. Keep your terms fair and reasonable for both parties

The best contracts don’t just protect your interests—they’re fair to your employees as well. Transparency is the best policy, so you’ll want to be upfront with your employees and your competitors about your non-compete agreements. 

Let job candidates know about the terms of your contract and explain what they mean before they sign. When employees move on to greener pastures, remind them about the restrictions they’ll need to follow and offer them a copy of their contract if needed. 

3. Add a severability clause to your contract

A severability clause states that the terms in a contract are independent of each other, so if one of them turns out to be illegal or otherwise unenforceable, the rest of the contract still stands. 

You now know that the effectiveness of non-compete agreements differ between states. As you can imagine, this provision then becomes especially important for employment agreements and other contracts where the non-compete is only one of many clauses. Without a severability clause in one of these larger and more encompassing contracts, the entire agreement could become null and void if the non-compete is found to be unenforceable. 

If you decide to move forward with an NCA for your employees, you might need this clause sooner than you think. In an executive order he signed earlier this month, President Biden pushed for a ban or limit on employment-related non-compete agreements. Even though legislation hasn’t been passed yet, it’s worth remembering that the laws governing these practices can change at any moment. You’ll want to protect your company by staying up-to-date and compliant.

4. Consider other legal options

Non-compete agreements aren’t the only way to contractually prevent employees from running off with precious information, but they’re certainly one of the most restrictive methods. If you’re concerned about the legal consequences of entering into an NCA with your employees, there are other options available to you.

Look to options like proprietary information and inventions assignment (PIIA) agreements, non-disclosure agreements, and non-solicitation agreements as a complement to or a replacement for non-competes.

  • PIIAs prevent employees from making off with proprietary information owned by or developed at the company, even if they were the ones who created or discovered it.
  • Non-disclosures prohibit employees from revealing confidential or otherwise valuable information about your company to others.
  • Non-solicitations forbid former employees from hiring or recruiting others at your company.

5. Ask your lawyer to review the agreement

Have your lawyer review your contracts to make sure they’re equitable, enforceable, faithful to state legislation, and harmless to your employees’ career prospects. Employees challenge non-competes in court more often than you think, so you’ll want to make sure they’re sound and legal. 

Your employees and job candidates may be wary of signing away their rights in a non-compete agreement, and for good reason. That’s why it’s important to make sure your contract includes the restrictions your business needs to remain competitive—and nothing more. 

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Feli Oliveros
Feli Oliveros Feli Oliveros is a freelance finance and business writer with experience covering personal and small business finance. In 2015 she graduated from UCLA, where she earned her bachelor’s degree in English and minored in Anthropology.
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