Without non-competes, how can you protect your intangible assets?

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Non-compete clauses may soon be a relic of the past if the US Supreme Court accepts a new Federal Trade Commission (FTC) ruling.

Changing one rule might not seem like much, but it’s important to point out that little things could end up being major problems for companies. And just because it’s happening in the US doesn’t mean there aren’t plenty of lessons for companies across the globe.

First off, the core details of the FTC’s ruling, issued on April 23:

The new rules won’t come into force for about 120 days and during that period the change will need to overcome the considerable legislative bar of the Supreme Court. The Supreme Court could still strike it down and send the decision to individual states (non-competes are already banned in California, North Dakota, Oklahoma and Washington DC).

Also, the FTC’s rule will only ban new non-competes and contains a “grandfathering” exception for some existing non-competes. It also exempts non-competes that are entered into in connection with the sale of a business.

Many American employees will applaud the change since non-competes are often onerous legal handcuffs that punish skilled workers, forcing them to either stay in a job that pays less or shift to an entirely different field. They’ll no doubt be happy to see non-competes go the way of the dinosaur.

But many business owners will be a bit nervous if non-competes are no longer allowed.

The reason for this trepidation – and why this American issue is worth an entire article – is that the skills learned by a person while working in a business cannot be protected by that business. If the person leaves the company, they take this intangible knowledge with them.

Non-competes don’t protect things like trade secrets, intellectual property (IP) or patents. Those are already defended by non-disclosure agreements (NDAs) and copyright or trade mark laws. However, in a highly competitive world where the slightest innovation or the allegiance of a major customer can mean life or death for a company, any law that makes the theft or accidental leakage of intangible assets more difficult is useful. Non-competes may be worth less than the paper they are written on, but they do act as a deterrent to stop IP leakage.

Trade secrets are easy to scoff at. After all, every business thinks its way of doing things is a “secret sauce,” when in reality its methods are easily replicable. But even if these methods are easily copied by a rival, the point is that they aren’t being replicated right now. That slight advantage is critical and it is sufficient for a company to insist on non-compete clauses.

A non-compete gives a company time to change its methods should a skilled employee leave. By asking that worker to pause for 12-18 months before starting their next job the company can use that period to better protect itself in case those methods get out into the wild.

Although a company can never “own” an employee, where this gets messy is that the skills gained by an employee while working at one company – which may be critical to its success – are stored inside the brain of a human being with legs who sometimes get itchy feet.

Non-competes exist because there’s no guarantee that these skills won’t accidentally spill out when they work for a rival firm. Even if they keep their mouth shut forever, the skills of that worker are an intangible asset. That’s why the person was so valuable in the first place. The mere risk of that skilled employee working at a rival business is a good enough reason to lock them up for at least 12 months in a non-compete contract.

Remember, this is all about how non-competes are seen from a company’s perspective.

Another example of risk would be if a sales rep has many clients. Should they be able to jump ship and take them to the next company? Even if the client lists are company property, the company doesn’t own the relationships. Relationships are an intangible asset, and they can be protected with good company systems. But they ultimately belong to the people who hold them, not to the business to which they are employed.

There are other justifications for companies to be concerned about the loss of an important tool to protect their valuable intangible assets.

While most employees wouldn’t dream of poaching customers or leaking critical knowledge to their new employer, some will. Couple this with basic human incentives and the situation could get quite dicey. After all, when fewer barriers exist to stop people from acting in a certain way, even the good people will be incentivised to do bad. Without non-competes as a deterrent, this will only embolden bad actors which means the risk of intangible asset loss will rise.

It’s important to reiterate here that most people won’t job-hop to selfishly take their skills from one rival company to the next. But the number of such employees is never zero. The question is: how many employees will be incentivised to act in this way? Will it be <1% or >1%? Who knows? Companies very understandably don’t want to find out the hard way.

Firms everywhere – not just in the US – should be thinking about this problem. The biggest lesson is that laws must not be the only way to protect innovation.

It’s always best to make sure employees actually want to stay at a company, rather than forcing them to stick around under legal pressure. Because workers will always see non-competes as a way for their boss to justify paying them less, if they are compensated properly for their skills, the risk of them being poached or leaving will be much, much lower. Loyalty costs money.

That’s the first lesson. The second lesson is that non-competes will always have a place.

Let’s say skilled people want to work at a business because of the founder’s reputation. In that scenario, that business owner should be subject to a non-compete if they sell the business, because they could start up another with a different name and devalue the business they just sold. That’s why the FTC carved out an exception for precisely this situation.

Yet even with the best remuneration package on the planet, companies could still be doing a lot more to defend their intangible assets.

Too many trade secrets are left abstract which means people will have different views on them, which results in misunderstandings when those people change jobs. Knowing what you have – and how valuable it is to the company – is much more important than hoping an employee won’t talk about it if they leave.

There are many ways a company can protect its intangible assets without making life miserable for the employees. But non-competes do have a place in modern business and the loss of these legal tools will make it easier for IP to walk out the door.

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