Using Non-Compete Clauses to Protect the Value of Business Assets

On Tuesday, we discussed how a Buy Sell Agreement keeps the value of a client’s business, frequently their most valuable asset, from evaporating following the owner’s death. While many business owners prepare for physical disasters though the use of insurance and some prepare for ownership transitions with Buy Sell Agreements, most fail to protect their business from a trusted employee who leaves to start a competing business.

Well-drafted, up to date, Non-Compete Agreements (or Non-Compete Clauses in Employment Agreements) can protect the business owner from losing valuable trained employees to competing ventures, but such documents must be narrowly tailored in order to be effective. While the courts enforce contractual agreements, there is a reluctance to enforce agreements when the employer does not compensate the employee in some manner for accepting the Non-Compete Agreement or where the restriction on competition is unreasonably broad.

Fortunately, acceptable compensation for assenting to a Non-Compete Clause/Agreement includes promotion to a new position or access to new information regarding the operation of a particular business. This allows the business owner to implement a Non-Compete Agreement with a small group of key employees whom the owner sees as potential successors without the worry that one of them will then leave to start a competing business.

In addition to requiring compensation to enforce a Non-Compete Agreement, the agreement must not be so broad as to restrict the employee from making a living. The breadth of restriction applies both to geography and to length of time. This means that an agreement that bars working in a similar business within thirty miles of an existing employer for two years is likely enforceable, while an agreement barring employment in a whole industry for ten years will likely be overturned. It is important that the agreement balance the scope of restriction against the time the business needs to recover from the employee’s departure. When considering whether to enforce a Non-Compete Clause courts also examine whether the clause serves a legitimate business purpose or appears to be purely punitive to limit the employee's ability to make a living.

Unfortunately, all too frequently employers only come to us after an employee leaves a business. The owner will want to stop the employee from using key business information, such as processes, client lists, or technological developments to compete in the absence of a Non-Compete Agreement. While Michigan law will protect the "trade secrets" of a business to a certain extent, only properly drafted documents before a problem arises will maximize that protection.

Our clients work hard to build valuable assets they hope will provide for them and their loved ones far into the future. It is important for us as advisors to work with our clients to protect their investment in the company during their ownership as well as establish a plan that provides the client, or their loved ones, with a smooth transition to new owners to best maintain the value of the business. 

Matt Ferrara