A VC - Latest Comments in Thinking About Non-Competes

Re: Thinking About Non-Competes

awilensky — Wed, 05 Dec 2007 15:50:45 -0000

Ah...execution as replacement for the all powerful protector of IP, the patent. "Have you patented this new ThruDispatch idea?" Says one older angel.

"Not yet", I replied, "There may be code patents on the eventual mechanism that serializes the virtual dispatcher threads, but today;s technology patents for software innovations are in a state of great turmoil." I continued, "Often, it is the execution of the concept that survives long after the first patent fights are won and lost."

Re: Thinking About Non-Competes

richieblueeyes — Wed, 05 Dec 2007 15:00:26 -0000

I blogged about non competes a while back ...

http://www.bootstrapper.com...

There are 2 situations for NDA's. Between strategic partners and employees. For strategic partner/investors it is useless. My attitude is if i can't tell you my idea and out-execute you then i shouldn't be doing it. Between employees it is good so people don't steal clients and leave.

Re: Thinking About Non-Competes

Jay Parkhill — Tue, 04 Dec 2007 19:45:31 -0000

We are saying the same thing. The point of your original post, I think, was that a blanket non-compete puts an extra burden on employees when the NDA restrictions accomplish the practical objective. My comment above attempted to agree with you- the NDA gets the job done in most cases.

Re: Thinking About Non-Competes

Michael Masnick — Tue, 04 Dec 2007 18:01:14 -0000

Hi Fred,

Working on a post to put on Techdirt that highlights & discusses much of the research... hope to finish it tonight or tomorrow morning...

Mike

Re: Thinking About Non-Competes

bijan — Tue, 04 Dec 2007 16:48:56 -0000

hi jay,
it actually is quite different actually. anyone from yahoo, google, apple, ebay, etc can leave their company and start any company they want as long as they don't breach their NDA and non-solicitation agreement.

that is very different than the conditions in NY or MA.

Re: Thinking About Non-Competes

Steve Kane — Tue, 04 Dec 2007 15:41:17 -0000

hey guys

fred, this is a distinction without a difference. imagine if the "knockoff competitor" is google, or news corp, or microsoft. those humungous companies simply look at the startup/small company and say "so sue me" and offer protection to the VP Sales.

so non-competes put small companeis at huge disadvatnge versus big companies

and in any case, startups simply cant litigate, even against an individual -- VCs rarely if ever agree to fund litigation

also, in the end, yes it would be great if startups and small companies could pay people severance or "stand still" (non compete) compensation. but the truth is, they can't or won't and never do.

so non-competes are a de facto -- huge -- compensation reduction for people: they think they are being compensated on an annual basis, but in fact they are required to take themselves off the market for an additional period of time, without any compensation

to put it in perspective -- why is that directors of companies are never required to sign non-competes? because they are smart and would never serve on boards if they had to. yet they are privy to the most sensitive and competitive information...

Re: Thinking About Non-Competes

woke — Tue, 04 Dec 2007 13:16:11 -0000

You're assuming your conclusion. The advocates of banning non-completes claim that NCs hurt companies more than they help them. Your "imagine" specifically excludes that possibility.

It's not obvious that they're wrong - non-competes may well have the same sort of effect as restrictions on firing, and it's pretty clear that they reduce hiring.

Note that non-competes directly reduce the supply. Their effect on demand is second order.

Re: Thinking About Non-Competes

Simon Cast — Tue, 04 Dec 2007 11:13:15 -0000

I tend to err on the side of as much competition as possible and as such have a general dislike of them as an anti-competitive tool. And you are right in pointing out that non-competes essentially do create a temporary monopoly on the person's supply of labour.

Following the analogy of IP, then there should be a legal quid pro quo for a company to use non-competes so that some thought does go into their use. For non-competes, I would suggest a legal requirement to pay either on the employees current salary with a penalty rate to reflect the loss of (usually) higher salary that the employee is suffering due to the non-compete. The Austrian legal requirement of null when the employee is fired is also a good idea I think.

I don't think that non-competes are the best method for dealing with cases where the employee has walked off with the contacts DB or similar trade secret. I can understand why they are used that way as they allow the information to "rot" and therefore decrease the value of the information or secret.

My main concern still remains the depression of market price for the persons' labour. I understand Fred's concern as an investor but essentially by enforcing non-competes his portfolio companies are not paying market price for that person's labour. Even though Fred's protfolio companies are paying the person to be the Twelfth Man (http://en.wikipedia.org/wik... they are paying him at the current salary and not the person's market rate. None of the arguments seen about keeping non-competes address the issue of requiring payment of market price for the person's labour.

Re: Thinking About Non-Competes

fredwilson — Tue, 04 Dec 2007 07:41:02 -0000

Can you share that research with us? It's just hard to believe that one factor, particulalry non competes, is the difference in the two regions

Fred

Re: Thinking About Non-Competes

Stephen L. McKay — Tue, 04 Dec 2007 00:14:59 -0000

Fred,
Once again I must agree with you. I have to say that as a long time ago, low level employee of a compny called "Guest Informant" (long before they were bought by Lin, long before more, and long before our tech age), I made a move to replace some of the markets the company was dropping due to lagging sales, with my own books, and was hit right in the face with the "legal team". I was not going to take any market share that the company had not already given up, but who knows where it may have gone.
The line is fine for sure, and I don't mean to press the point, but old media/ new media is not a fluid transition. As we endure this rocky road however, some of the old rules of business will always apply.
What I would like to see are the stats.
Who (not names, just stats) have either of your firms incured losses (had defectors) directly related to violations of the clause?

Re: Thinking About Non-Competes

Anthony Kuhn — Mon, 03 Dec 2007 20:14:29 -0000

Fred:

the hardest part of your excellent plan to have corporations share the burden of a non-compete agreement would be getting them to agree to it!

I like it, sure, but how many companies would be willing to put their money where their mouths are? I mean, what's in if for them if they have to pay an employee to not work?

Anthony

Re: Thinking About Non-Competes

David Nelson — Mon, 03 Dec 2007 19:11:56 -0000

Simon - I like free and open markets as much as the next guy but in this case I do support the validity and use of non-competes (which you reasonably describe as "an anti-competitive tool"). I think the rationale for this is analogous to that for the granting of patents over new IP.

That is by establishing a temporary monopoly over the use of an asset (for IP a patent lasting 20 years; for labour markets a non-compete of say 6-12 months) you provide organisations the necessary incentive and protection to innovate, take risks and create value.

In a world without non-competes then I think these companies and star employees would both have less capacity to create value and consequently be worth less so it is a symbiotic relationship.

I would add that I think the use of non-competes is most justified for founders and/or senior employees where they hold a material equity/options stake.

Re: Thinking About Non-Competes

NICCAI — Mon, 03 Dec 2007 18:36:35 -0000

I think you and Bijan are both correct, but it has more to do with the reach of the non-compete (as many have commented). For many companies, they are ridiculously broad - to the point of being unenforceable. Many try to protect an entire vertical. To the employee, this is just scary, and unfair - after all, doesn't he/she just want to sign with you? Can a car dealer stop a sales man from switching dealerships? I venture to say, no. That said, I think the beach idea has some merit - but it should also preclude the employer doing the beaching from also hiring from the new employer during the same period. Tit for tat.

All and all, I think they lend more to litigation and increased opportunity cost than they do to protecting a company's assets. When all is said and done, if that star employee is leaving because of money, you have bigger problems.

Re: Thinking About Non-Competes

Sebastian — Mon, 03 Dec 2007 18:08:57 -0000

I recently took over a management position in an Austrian start up and looked at Austrian law, which clearly states the following:

1. Non-Competes are only allowed if you earn a more than 2150 Euro gross per month, so they try to allow that only for higher ranking staff.

2. Non-Competes can only be enforced if an employee leaves the company on his own. If the company fires or lays off an employee, no non-compete will work.

I think that these rules are good. Non-Competes shouldn't work for the normal employees and also not, if the employee is fired. If a company fires an employee and he choses to work for a competitor after that, the company should have no possibility to hinder them from doing so.
If the employee is so valuable, he shouldn't have been fired in the first place.

Re: Thinking About Non-Competes

MarkWaterstraat — Mon, 03 Dec 2007 17:50:38 -0000

This is a great topic Fred, and the comments, as is often the case here, are as valuable reading as your post. I'm currently interviewing new people for our post funding next stage ramp, and I can say emphatically that I'm including noncompetes -- even though I know from experience that they often aren't enforceable. I know that not everyone I ever hire will work out, but I do want to foster an environment among the new team which is consistent with the founding team -- we're all in this together to win. I have no trouble telling an applicant that if they aren't committed, I don't want them. I personally left a company once to go to a much larger competitor, but I told the competitor I would only accept an offer if it were in a part of the company which wasn't directly competing with my former employer. The formal noncompete in my employment agreement was not enforceable, but the "honor" part of it was -- to me. The offer letter and employment agreement to me are as valuable in setting expectations as they are legally.

Re: Thinking About Non-Competes

Michael Masnick — Mon, 03 Dec 2007 16:59:11 -0000

Hi Fred...

I usually agree with you, but on this one I think you're wrong. I've been working on a research project for nearly a year now, and as a part of it, went through a tremendous amount of research on the impact of non-competes. There is fairly compelling research (mostly done in the past ten years) on the differences in economic growth among tech companies in Boston vs. Silicon Valley -- and the *key* factor that shows why N. Cal succeeded where Boston petered out was the existence of non-competes.

It's almost scary how strong the evidence is concerning how important the lack of non-competes is... I've been meaning to write up a more detailed look at the issue, and this may convince me to get my act together to do so...

In the meantime, it actually makes for a really strong parallel to questions about DRM. DRM restrictions don't work and tend to only hold back the recording industry. Non-competes are effectively DRM on employees. They don't do what they're supposed to do and then end up only restricting what people want to do and what's necessary to grow a market. Both seems to make sense in the short-term for a company trying to block what others are doing, but in the long term, both are dangerous strategies that limit the potential of a market.

Mike

Re: Thinking About Non-Competes

Jay Parkhill — Mon, 03 Dec 2007 16:45:30 -0000

California doesn't exactly fail to recognize the issue. It won't enforce flat-out non-compete restrictions, but it does say that an employee can't use confidential information belonging to employer A in the service of employer B- including things like customer lists, business plans and products plans as well as technical "IP".

To people accustomed to the more stringent restriction available in other states this probably sounds loosy-goosy, but it actually gets pretty close to the same place. It may cause real-world problems a bit more often than in MA or NY (for example), but in percentage terms I'd be willing to bet the difference is pretty minor.

In Fred's example Employer A can advise Employer B that VP Sales is under a confidentiality obligation. Especially in startup contexts, the offer letter gets rescinded pretty quickly- in part because the (smart) letter itself makes VP Sales affirm that she is not under any confidentiality restrictions.

Re: Thinking About Non-Competes

DM — Mon, 03 Dec 2007 14:16:22 -0000

Any restriction on the employer causes less hiring, because it raises the effective price of labor and thereby reduces demand--that's just basic economics. The Valley has high labor demand relative to the rest of the US for other reasons, but that scarcely means that the region no longer operates by supply and demand (if labor were cheaper/less risky, there would be even higher demand).

Imagine two Silicon Valleys that were identical in all respects (ceteris paribus) except one had a law preventing noncompetes and one did not. There would be higher demand for labor in the latter. (But rockstar employees would likely be able to negotiate it out in any environment with high labor demand.)

Re: Thinking About Non-Competes

awilensky — Mon, 03 Dec 2007 13:42:57 -0000

In terms of employment contracts, which are very different than consulting contracts, the duties and ownership of IP are fairly well defined. In an outside analyst's SOW, it often states that the party contracted for opinion and adjudications of strategy cannot be enjoined from using this knowledge in other venues, but that quantitative and survey result datasets are property of the client.

Term sheets, as Mr. Wilson knows. are very different animals and much more complex. often being accompanied by key person riders and E&O underwriting policies.

It's all very messy; you can't (even in MA) stop someone from using their experience, but you can try to stop the misappropriation of actual IP. None of this is ever easy.

Re: Thinking About Non-Competes

bijan — Mon, 03 Dec 2007 12:26:02 -0000

DM,
I disagree that getting rid of non-competes means less hiring. Tell that to
the folks in Silicon valley. They can't hire enough people fast enough.

Re: Thinking About Non-Competes

DM — Mon, 03 Dec 2007 12:22:47 -0000

Aren't employees walking out with contact databases considered to be stealing company property, and therefore liable for damages, regardless of noncompete terms? They can "remember" contacts but walking out with the database is, as far as I remember, illegal.

Re: Thinking About Non-Competes

DM — Mon, 03 Dec 2007 12:17:39 -0000

Keep in mind that being onerous on companies often translates to being onerous on employees. For example, French law makes it extremely difficult to fire employees, and this results in very high unemployment because employers are reticent to hire anyone, for fear they won't be able to vary their workforce size in relation to their business. That means a large group of unemployed, which causes social unrest.

In this case, preventing employer/employee noncompete contracts could make companies less likely to hire people, and in the event they do, less likely to invest resources in that person.

Re: Thinking About Non-Competes

bijan — Mon, 03 Dec 2007 12:12:07 -0000

Scott Kirsner has a post on some recent research out of Harvard about the effect on non-competes in Michigan. http://tinyurl.com/2wu9a2

Re: Thinking About Non-Competes

fredwilson — Mon, 03 Dec 2007 11:55:05 -0000

Yes

Re: Thinking About Non-Competes

Mapo — Mon, 03 Dec 2007 11:40:40 -0000

Fred, what about non competes in shareholder agreements? In the case of the VP Sales walking to a competitor, do you withdraw their equity, terminate their options, etc?