Thinking About Non-Competes

Now here’s a good test of the venture blogging community. Our friend and co-investor on a number of deals, Bijan Sabet, has started a meme, "Eliminate Non Competes", and I think we should discuss it online. Here’s the entire FeedBurner VC network, I’d love to see posts from all these bloggers on the subject. We could tag them all in delicious or technorati, or both, and then we’d have a full blown blog discussion. I’ll do my part. Here’s my thoughts and I’ll tag this post with on technorati and delicious.

I’ve been involved in doing venture deals for 20 years and the non-compete has always been a standard deal term in our term sheets (except for california deals where non-competes are not enforceable). My friend Morty always said "just because you always get it in a deal doesn’t mean it makes sense". So I’ll approach this one with Morty in mind. I’ll try to think about why non-competes are good for the companies we invest in (and us).

I don’t buy Bijan’s argument that Massachusetts’ strong enforcement of non-competes is the reason his state is trailing California in new company creation. I think California’s emergence as the center of the startup ecosystem has to do with a lot of things and non-competes would be way down on the list.

I do buy his argument that if they aren’t going to be enforced then why have them in our agreements. Its silly to have a provision in an agreement that nobody has any intention of using.

But I’ve had several experiences in my career that a non-compete was helpful to our portfolio company and our investment. One that sticks out in my memory is a situation about four years ago when the VP Sales of one of our portfolio companies was recruited to become VP Sales at a publicly traded competitor of ours that was bigger, stronger, and eager to put our company out of business. We stopped that employee from being able to take that job by enforcing the non-compete and the big company walked away from the offer. This story has a funny ending. A few years later, our company ended up buying the larger competitor.

It’s not a good thing when one of your key employees, particularly one that knows your entire customer base or your entire code base, or worse knows your entire employee population and who is a superstar and who is not, leaves to join a direct competitor.  It’s in the company’s interest to stop that from happening. So I am in favor of non-competes for senior members of a management team and key employees.

That said, I think non-competes need to be paid for. You can’t ask someone to sit on the beach for six months or a year and not pay them. If someone is fired or leaves for "good reason" and wants to work for a named competitor, they should be required to ask your permission to do so. If your company refuses that permission, then it needs to pay the employee to sit on the sidelines for that period of time at the same rate they were paid when they worked for your company. If an employee just quits and then wants to work for a competitor, that should not be allowed for at least six months and ideally a year.

In addition, "competitor" needs to be tightly defined. Let’s look at our portfolio. Simply Hired is a competitor of Indeed. Mint is a competitor of Wesabe. Facebook is not a competitor of Etsy just because they both have communities at their core. It takes work to define what a competitor is and is not and many lawyers are overly broad in their definitions because it’s hard to define something tightly. But we should all work to do that. Because it’s not right to stop someone from working for another company unless its a direct competitor and I mean direct.

So let me summarize my positions. I am not excited about the prospect of eliminating non-competes from our deal terms. I think non-competes are very much in the interests of our portfolio companies. But the non-competes need to be tightly defined and the term of the non-compete needs to be paid for by the portfolio company if the employee was forced out of the company. The non-competes should certainly apply to all senior management team members and all key employees (like star engineers and such).

It takes a lot of work to build a company. You should not risk all that knowledge and talent being able to walk out the door and set up shop across the street. Those are my thoughts. What are yours?

UPDATE:

Ask The VC weighs in

Dan Primack of PE Hub is following the discussion