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How the FTC’s Final Non-compete Rule Could Hurt VC Returns

Venture Capital Journal

The FTC’s final rule banning the use of non-compete clauses in employee agreements could hurt return on investment for VC-backed companies that get acquired, according to corporate attorneys who specialize in corporate M&A. But lawsuits against the new rule stand a good chance of scuttling it before it goes into effect in September, the attorneys said.

By exempting non-competes only in the context of a sale of a company to a “bona fide” third-party buyer, the final rule would not stop employees other than senior executives from going to work for a competitor and taking proprietary information with them, attorneys told Venture Capital Journal. Neither does the rule contain an exception that “expressly permits the use and enforcement” of restrictive terms – including post-service non-competes – in indications of interest, letters of intent or other agreements that have been negotiated before, but not finalized until, the rule were to become effective, said Kevin Passerini, a partner in Blank Rome’s trade secrets and competitive hiring practice.


One thing that private equity and venture investors should understand is that not only does the FTC’s final rule ban non-compete covenants in employment agreements, but “equity-based restrictive covenant agreements with employee equity holders are also thrown out other than as it relates to sale-based restrictions,” said Passerini at Blank Rome.

The FTC also clarified in the background commentary with the final rule that a “bona fide” sale of “ownership interests” that an employee equity holder has could be the basis for a restrictive covenant like a non-compete. “The problem is they clarified that it can’t be a redemption-type agreement or a transfer to a subsidiary or holding company other than the employer because they say it’s a sort of ‘sham,’” Passerini explained.

That means the FTC is only willing to consider non-competes with workers in the equity-holder context that involve a true third-party sale. However, because these are typically closely held or nonpublic companies, there’s a limited market for the equity to be sold in, likely precluding any sale-based restriction from being exempted from the ban outside the context of a true third-party equity or asset purchase, Passerini noted.

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"How the FTC’s Final Non-compete Rule Could Hurt VC Returns," by David Bogoslaw was published in Venture Capital Journal on May 6, 2024.