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A non-compete agreement is a contract in which one party agrees not to start a business in the same field as another party.

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What is a Non-Compete Agreement? 

A non-compete agreement (NCA) (or a non-compete clause) prevents another party from starting or working for a similar business or new employer that could compete with yours or threaten its market share. In some cases, restrictive covenants may only apply to a certain geographic radius or region (referred to as geographic scope) and may only last a certain amount of time. These documents may be referred to as non-competition agreements or noncompete contracts and are often used along with a nondisclosure agreement.

Recent data suggests that around 20% of the United States workforce are bound by non-competes, including 14% of those earning less than $40,000 per year.

The Essential Guide to Non-Compete Agreements

By FormSwift Editorial Team
May 16, 2018

This guide covers everything you need to know about non-compete agreements (NCAs) or clauses. We explain what they are, when you need one as an employer, the legal guidelines for NCAs, whether an employee or contractor should sign one, the pros and cons of NCAs on the economy as a whole, and more. After reading this guide, you’ll have all the knowledge to confidently move forward.

What is a CNC? 

CNCs typically refer to three different types of NCAs. Those are:

  1. Traditional non-compete: An employee cannot work for a direct competitor within a specific geographic area identified in the agreement for a set period of time and/or in a particular division.
  2. Non-solicitation agreements: Prohibits employees from contacting the customers, employees, or suppliers of the former employer.
  3. Confidentiality agreements or non-disclosures: Prohibits employees from utilizing and divulging sensitive information, intellectual property, and client lists of their former employer.

What to keep in mind

Before you expose an employee or contractor  to the intricate workings of your business, it’s a good idea to have them sign an NCA or to include one it the work contract. It's much easier to do this before the employment relationship begins because they do not apply to past actions or exposure to information; they take effect on the present date or a future date and continue for a specific amount of time into the future. For maximum protection, you should make executing this document a priority.

  • Don’t Be Shy about Using Templates
    • There are plenty of reputable websites that offer free templates that you can download and fill out. This method simplifies several steps for you because the organization and formalization of the document are already taken care of. All you need to do is prepare and enter the information required by the template before the employee signs.
  • Include All Details
    • Vague language doesn’t protect anything. Unless you outline the details of what your employee or contractor needs to do or not do, your non-compete agreement or clause is basically useless. Be sure to provide details on limitations, such as the duration of the agreement, identifying direct competition, and the geographical area to which it applies (you can’t say the agreement is for the entire world, forever).
  • Compensation
    • Compensation is usually called “consideration” in the agreement. This is whatever you pay your employee or contractor to adhere to the agreement. In the case of a new employee, the compensation could be a job offer. In others, it can mean money. Be sure that you evaluate how much your captive market is worth to you and structure your agreement accordingly.

Who Needs a Full Non-Compete or Clause?

Here’s a simple question to help you determine whether a business should offer a full non-compete or clause:

Will the employee or contractor have access to proprietary information?

If so, it's advisable to consider completing a non-compete. If not, non-competes may not be necessary. To know for sure, you can always consult with a lawyer who specializes in business.

If you own a business in Texas, you should know that most NCAs (also referred to as a covenant not to compete) are illegal. Utah restricts the time limit to one year. North Dakota enforces them only in very limited circumstances. California law states that NCAs are void.

What are the Components of a Non-Compete Agreement? 

If you’re starting a business in food, apps, publishing, or any other competitive industry, it is particularly important to have a non-compete agreement or clause in place. Non-compete agreements, enforceable against employees and contractors in most states, may protect your business from people who cheat. By that, we mean employees or contractors who leave your company and immediately start a competitive business of their own using your hard-won trade secrets. A non-compete clause protects your business, but it’s not a stand-alone agreement. It is a single clause that is placed inside of an employment or service contract.

The main components of a stand-alone NCA include:

Naming of Parties Involved

This is pretty straightforward. Include the full legal name and address of your business entity (the “Protected Party”) and the full legal name and address of the employee signing the agreement (the “Non-Competing Party”). In a non-compete clause, you’ll likely just reference the parties by name as through the rest of the contract the clause is placed within.

Duration and Geographic Range of Agreement

Most non-compete agreements have limited lifespans. The lifespan is based on local law. You’ll also need to list the date that the document becomes effective. You must also specify the area across which the agreement applies, such as “the State of Oregon” or “within 40 miles of Boston city limits.” The restrictions are only enforceable if they are reasonable in the eyes of the law.

Details of the NCA

This is a sticky subject, legally speaking. In fact, if you get stuck, you should speak with an employment lawyer for help. Since most courts rule in favor of an employee’s  or contractor’s right to make a living, you can only really protect legitimate business secrets. Something else to keep in mind is that the court will not enforce something it considers to be against public policy, either. So, break down the most important cornerstones of your company’s plan for success. What methods is an employee prohibited from adopting? What businesses may they not go into or work for under the terms of the agreement? Are there particular clients that they must avoid soliciting for a certain amount of time? There is no need to provide specific names, but the types of businesses and practices to avoid must be clearly defined.

Compensation

In order for the agreement to be legally enforceable, the non-competing party must receive compensation. If the party is a new employee or contractor, the job itself is usually enough. However, if it’s an existing employee or contractor, compensation may take the form of a promotion, pay raise, or a one time cash payment or installments. Installments may be paid in any interval you choose, whether it is by the hour, by the month, or by the year.

Consequences

You must explain the consequences of violating the agreement. If you're not sure on the legalities, talk with an employment attorney. It details what the employer is entitled to receive should the other party break the rules of the non-compete agreements or clause. Often, these will take the form of a financial settlement or undesirable legal consequences.

Signatures

Like any legal document, a non-compete agreement is not legal without the signatures of all involved parties.

Pros and Cons of NCA's

Pros:

  • For employers, NCAs help promote long-term relationships with their employees and contractors, enabling employers to spend more money on training and skill development.

Cons:

  • NCAs limit worker flexibility and can force employees to relocate their entire life simply to pursue a new employment opportunity instead of staying with their old company.
  • NCAs restrict market competition and inhibit the free market.
  • NCAs reduce innovation.
  • According to a recent study from UCLA, NCAs reduce workers mobility and force them to stay in jobs where they make less money.
    • This study also suggests that firms invest more in research and development when their investment is protected by non-competes but also shows that workers bound by NCAs pursue less training thereby reducing overall investment in human capital.
  • Restricts competition.
    • Virtually every study on NCAs finds they reduce wages since many workers get their largest raises when they pursue jobs at other companies.
    • Noncompetes also tend to prevent growing businesses from hiring as quickly as they would like which can harm the overall economy by keeping talented workers from joining new companies.

Employees: How to Navigate NCA's 

When you might be asked to sign

The most common scenario for NCAs is when employers offer a worker a new job or promotion. If you are offered a new job and asked to sign an NCA, remember the following:

  1. Do not sign and accept on the spot. Instead, ask for a copy of the agreement to review.
  2. Be aware that refusal to sign a non-competes is often a red flags for employers. This does not mean, however, that you should automatically sign an NCA. Reasonable and informed responses to non-competes will encourage employers to provide more information that will either allay any concerns you have or prompt further negotiation.

How to protect original ideas as an employee when signing

Non-competes are designed to protect the proprietary information of employers, but what about employees and contractors? How do workers ensure their own ideas are not taken by their employer, or a competitor, without proper compensation? Follow these tips:

  • Do some research before working with new people or companies.
    • Know who you work with and for: Always make sure anyone you work with, or for, has a reputation for conducting business in an ethical manner.
    • Be proactive: Address any issue you see regarding proprietary information sooner rather than later.
    • Cultivate relationships with competitors.

Establishing mutually beneficial relationships with competitors is one of the best ways to protect your ideas.

  • By collaborating in appropriate ways with a competitor, they will have little incentive to steal your idea because they already benefit through collaboration.
  • File a provisional patent.
    • Provisional patents will protect your idea for up to one year. Once you file the provisional patent, you can label your idea as “patent pending.” You can file a provisional patent application online. There are also services that can do it for you. Filing an application costs around $100; filing a patent can cost thousands of dollars in legal fees.
  • Apply for a trademark.
    • Trademarks help legally establish your ownership of your idea or concept. The filing process is easy and online. This can cost several hundred dollars.

Tips for negotiating

Any worker in a creative field is likely to come across an NCA at some point in their career. Consider these tips during negotiating:

  • Ask for clarification: Read your employment agreement carefully, especially any section related to non- compete. If you find any language confusing, ask for clarification. Once you have a solid grasp of what your contract entails, negotiate the limitations of these provisions before signing it.
  • Make sure you’re legally protected: If you’re considering a new job with an NCA and you have one with an old job, look over the new contract to see if the new company offers legal protection in the event of a lawsuit by the previous company.
  • Consider state laws regarding geography: In states where NCA are not enforceable (e.g. California), workers can work for one startup company and move to another without any geographic limitations or penalties. In other states, like New York and Massachusetts, this is not the case.
  • Make sure the non-compete scope is specific: Clarify any vague language regarding the scope of non-compete. For example, if the NCA prohibits you for working with a “competitor” but does not provide a specific list, be sure to clarify what, exactly, denotes a competitor and which companies meet the definition.  If you don’t, what you consider a “related” company may be a “competitor” in your employer’s view.
  • Limit the duration of a non-compete: This is especially true if you work in a rapidly developing industry like technology. In industries like these, a long-term non-compete can significantly inhibit your ability to find better positions, or work at all.

Methodology

Our team at FormSwift wanted to determine which US states foster employee innovation the most and least. We created a state ranking by evenly weighting the following factors into a final score out of a base 100 points. These factors include: the number of employees in each state that sign non-compete agreements (based on the top five industries nationally in which employees must sign NCA's). whether each state can enforce non-compete agreements on workers fired without cause, the rate of new entrepreneurs and the rate of startup growth.

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