What Is a Noncompete Agreement?

What is a noncompete agreement?

A noncompete agreement or clause is a legal document that prohibits employees from competing with your business after their employment is severed. A noncompete agreement can provide several types of protection.

• Employees using trade secrets: A noncompete agreement can prevent former employees from sharing ideas, software, formulas, processes, client lists, or intellectual property obtained on the job with another employer or using this information to start their own business.

• Geographic and time restrictions: A noncompete agreement typically restricts employees from working for an organization’s competitor for a set period of time and/or in a specific geographic area after leaving the business.

• Poaching customers: A noncompete agreement can also be used to prevent employees from poaching customers from a business if they open their own business after separating from their former company.

The time frame for a noncompete clause can vary greatly, usually ranging from six months to five years but sometimes lasting even longer. The goal is to ensure employers don’t invest time and money training and molding an employee, only to have them transfer those skills to a direct competitor.

Tricia Meyer, founder and managing attorney of Meyer Law, said that the overall purpose of a noncompete agreement is as a limiting measure. “It acts as some kind of deterrent to keep employees from going out and start doing their own version of the business in direct competition.”

When is a noncompete agreement required?

Noncompete agreements are commonly used in several situations.

• Client-based industries: Noncompete agreements are commonly used in industries that require employees to build up their personal brand or client list during their employment. This often includes sales and service professionals. For example, if you own a salon, each service provider likely has a dedicated clientele. They may have built up this clientele through referrals and marketing services your business provided. If that provider were to leave and start their own salon in the same town, they would likely take their customers with them and become your direct competitor while leveraging business skills learned at your business.

• When businesses are sold: Noncompete agreements should also be used when businesses are sold. The buyer may require the seller to sign a noncompete agreement where they agree not to establish a competing operation. You wouldn’t want to buy a restaurant if the owner planned to start another restaurant across town immediately and steal back their customers.

• Where highly confidential information is involved: Noncompete agreements may be necessary if the employee will be privy to highly confidential proprietary information during their employment. Such information can be a special recipe for a product or a complex algorithm developed exclusively for your tech company. If an employee could use information learned from your business to replicate your product or service for a competitor in a way that would be detrimental to your business, consider having new hires sign a noncompete agreement.

Parts of a noncompete agreement

Even though each noncompete agreement is written specifically for each employer, Meyer noted that each should address three key components.

1. Duration: Long-term noncompete agreements rarely hold up in court. Typical agreements are two years or less, the most common being six months to a year. They can also include a severance option if the employee is terminated.
2. Scope: This clause must be specific as to the restricted work and particular services.
3. Geography: The local area where the company does business is a reasonable determination. Sometimes noncompete agreements specify a certain mile radius around the office address.

Noncompetition agreements can also include details on direct competition and damages.

• Competition: The employer must define who its competitors are. It’s not necessary to name them all individually, but it must define the types of businesses and industries employees are prevented from working in.
• Damages: This clause details what damages the employer is entitled to should an employee violate the agreement.

These are the keys to enforceable noncompete agreements:

• Follow state laws regarding noncompetes (each state is different).
• Make it reasonable for the employed individual to find other employment or establish a business.
• Make sure the agreement is proportionate to what is being protected and what the employee is giving up.

Challenges of a noncompete agreement

Despite them being widely used by employers, there aren’t any guarantees that noncompete agreements will hold up in a court of law. Many courts have been hesitant to enforce such agreements because they are often deemed unfair. For a court to enforce a noncompete, the agreement can’t last too long or cover too large of a geographical area.

Alternatives to noncompete agreements

One alternative to a noncompete agreement is a nonsolicitation agreement.

“In a nonsolicit, the employee agrees to not leave and take customers or other employees with them,” Meyer said. “This is much more enforceable and offers protection as well.”

Another option is a nondisclosure (or confidentiality) agreement, which is also more enforceable than a noncompete agreement. You can use nonsolicitation and nondisclosure agreements in conjunction with each other, depending on the industry and information or products being protected, and still create a deterrent that makes an employee think twice.

Noncompete agreement templates

While businesses would be best served by hiring a lawyer to draft a noncompete agreement specific to their organization’s needs, several sample templates are available online to review. You can find noncompete agreement templates online at these sites:

• Nolo
• Business in a Box
• Society for Human Resource Management

Several online legal services can help employers create basic documentation and employment paperwork. If you’re on a budget, this may be a good compromise between hiring an attorney and using a template. Just be aware of the limitations of these services.

Marci Martin and Chad Brooks contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.