FTC’s Proposed Non-competes Ban Raises Doubts for Start-Ups’ Dealmaking
A proposed rule by the Federal Trade Commission that would ban employers from imposing non-compete agreements on their workers, if passed, is likely to upend the way in which M&A deals involving venture- and private equity backed tech companies are negotiated, say lawyers and advisers who facilitate these deals.
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“Investment firms are going to have to figure out whether there are alternative types of restrictions that provide them the comfort that they need to get a return on their investment or to make the investment in the first place, in the absence of a non-compete,” Kevin Passerini, a partner in Blank Rome’s trade secrets and competitive hiring practice, told Venture Capital Journal.
“If you’re investing in a start-up business that’s either tech-driven or engineering-driven in terms of developing a product, there are people at that business who either don’t hold equity or who likely own a very small amount that would be very damaging if they left,” Passerini said. That would put a greater focus on retention benefits to try to keep employees from leaving, he noted.
It’s noteworthy that because non-compete clauses are already prohibited under California law, the FTC rule would be moot in Silicon Valley.
As currently written, the proposed ban applies only to non-compete provisions for employees who hold less than 25 percent of the equity in their company at the time they agree to the provision and are selling all, or substantially all, of their equity to the buyer.
Passerini said he’s optimistic that the FTC’s final rule will look similar but “will have a lower percentage threshold for equity ownership” in order to qualify for the non-compete exception. “They’ve signaled they’re open to anything between 10 and 50 percent,” he said. “Obviously, 50 percent would be outrageous because very few partners or worker-equity holders would ever be subject to a non-compete if that were the threshold,” given the dilution that occurs with multiple funding rounds.
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"FTC’s Proposed Non-competes Ban Raises Doubts for Start-Ups’ Dealmaking," by David Bogoslaw was published in Venture Capital Journal on March 15, 2023.