When Jennifer Lyle’s business partner wanted out of their joint business venture, Software Testing Solutions, she paid him an agreed upon amount, had him sign a noncompete agreement with a noncompete clause, and thought that was the end.
However, when the noncompete clause expired 18 months later, her former business partner surfaced at a company that was producing a competing product. The company emerged as STS’s only competitor, with her former business partner at the helm.
The loss of company secrets and other sensitive information through former employees and partners can be crippling to a business. With large companies, business secrets and individual employees have been the subject of costly litigation. For small to medium-size businesses, which are more likely to avoid litigation, loss of business trade secrets or employees to competing companies can cut into market share. For this reason, getting an agreement in writing, with protective measures such as noncompete clauses, nondisclosure agreements, and protection of company secrets, is an important measure for every business owner.
However, noncompete clauses can only go so far. While Lyle bought out her partner with cash and put into effect a noncompete agreement, it expired 18 months later and her former partner was free to create and market a similar product. While signing a noncompete agreement can legally protect an employer from losing an employee or partner to a direct competitor, these stipulations only apply for a specified, and often rather short, period of time, as Lyle discovered.
Plus, different states treat noncompete clauses differently. The California Supreme Court recently strengthened a state law that forbids employers from using noncompete agreements that limit employees’ rights to solicit former clients or work for a competitor after they leave a company.
How else can a company protect itself? In addition to using noncompete agreements, a business partnership should prepare for a potential split-up by having a business version of a prenuptial agreement in place. Experts recommend addressing this contingency even before forming a collaborative enterprise.
“(Business partnerships) are like a marriage in the fact that I think you want to definitely plan for divorce while you’re still really happy,” Lyle said. “Its not the thing you normally think about going into marriage; you think happiness is going to last forever and of course you’re going to be great partners now to eternity; nobody gets sick, and no family emergency issues come up. I wouldn’t be surprised if 50 percent of business partnerships end in divorce, just as 50 percent of marriages do.”
Business expert David Finkel agrees that a business partnership is like a marriage and stresses the importance of having business partners ease into it with “open eyes and a lot of communication on the important issues that will eventually come up.”
The fact is that the range of misfortunes and changes in circumstance that could affect a person could also impact a business, so it’s best to be prepared for any life-changing event that can happen to a company stakeholder, and get it in writing. Finkel says many entrepreneurs forget to anticipate what he calls “the five Ds of partnerships”: death, disagreement, debt, divorce, and disability. If a partner should die or get a divorce, does the partner’s ex or surviving spouse share control of the company? If a partner becomes bankrupt, will the other partner be liable for his or her debt? A written agreement should also have safeguards in place for cases in which there is a disagreement that can’t be resolved between partners, or when a partner becomes disabled and can no longer work.
On top of having a buy-sell agreement with a noncompete clause, Jennifer Lyle did have a stipulation that if one of the partners of Software Testing Solutions should pass away, the surviving spouse would own a part of the business and be entitled to profits but would not take part in the management of the company. However, beyond the brief window in which the limitations of the noncompete clause were in effect, there was nothing Lyle could do to prevent her partner from creating a competing product.
While it can be difficult to protect a company against actions by partners in the business, there are more effective options for circumscribing the actions of employees. Nondisclosure agreements, which are contracts that legally restrict the information employees can share with competing companies, can help protect a company’s trade secrets. Lyle has all her employees sign nondisclosure agreements and says she would pursue legal action for a nondisclosure violation.
In the end, although noncompete agreements have limited power to control competition, they can give you time to prepare for the worst-case scenario. These agreements, along with stipulations for the “five Ds,” still allow a company some recourse in the event of a partnership disaster. Taking into consideration all that can go wrong in a partnership before you begin can protect your company by the best means available.
When it comes to building a fortress around trade secrets, businesses may want to consider how Kentucky Fried Chicken protects Colonel Sanders’ original blend of 11 herbs and spices used for the company’s chicken. Only two executives are entrusted with access to the recipe and to get at the formula either person must first use a secret key to open a strongbox that contains a combination. The combination is used to open a vault at the Louisville, Kentucky, headquarters that holds a fireproof safe. After opening the safe, they face a strongbox with another combination lock that holds the handwritten recipe. In the final attempt to thwart potential thievery, the combination to the last lock is only in an executive’s memory.