Venture deals in IT: non-competition and non-diversion
- What is non-compete and non-solicitation?
- Who is covered by the obligations?
- How long can non-compete & non-solicitation be set for?
- What about the territory of validity?
- What else should I look for if non-compete and non-solicitation are included in the documents?
Hi everyone, ready to continue our look at the basic tools in venture capital deal documents? Today we have non-compete & non-solicitation on the agenda.
What is non-compete and non-solicitation?
| Non-compete is a commitment not to carry out competing activities, i.e. activities similar to your startup's business. Non-solicitation is a commitment not to hunt, i.e. not to poach key individuals and/or customers from the startup to other companies. |
Both instruments are usually aimed at protecting the investor's interests: they ensure the preservation of a stable team of professionals and protect the investor from unfair competition from the startup's funders/other key individuals. It is important for the investor to ensure that the knowledge that the funders have gained through co-operation in the deal is not applied to its detriment.
Who is covered by the obligations?
Let's start with non-compete. The non-compete obligation is most often set for:
- funders and
- key employees/key persons of a startup
The non-compete obligation will most likely not be extended to an investor, also because investors, as a rule, invest in startups in similar fields and will not sign up for such a restriction. An investor will refuse to accept such conditions as they would be contrary to its core business in general.
As for the non-transferability, it is possible to try to establish mutual obligations for the investor as well. If the investor has the right to invest in similar businesses, it is reasonable to restrict the investor from poaching employees or customers, and the investor is likely to agree to such terms.
How long can non-compete & non-solicitation be set for?
There is no basic rule about the validity period of the instruments in question, it all depends on your agreements with the investor.
In our experience, the parties have most often agreed on the following: if non-compete & non-solicitation obligations start from the moment of conclusion of TermSheet (what it is, we told you in one of the previous posts), then the term of validity of the obligations can be up to 5 years. If non-compete and non-solicitation obligations start from the moment of conclusion of binding documents, i.e. the transaction, then non-compete and non-solicitation are valid for the whole time the restricted persons are in the project + on average 2-3 years after they leave the project.
Let us repeat: there is no universal rule on timing. Therefore, if you feel that an investor offers too many restrictions, you can safely enter into negotiations with him. Besides, in the current dynamically changing world, knowledge and experience that is valuable now is likely to become obsolete in a year. Therefore, it also makes little sense to set very long deadlines for non-compete obligations.
What about the territory of validity?
Here, as with the term: it all depends on your arrangements.
You will often see wording stating that it is forbidden to compete and poach globally.
But sometimes such prohibitions are excessive: for example, your business is targeted to a certain region (China, EU, USA, CIS or any other). Then it is reasonable to establish non-compete & non-solicitation only in the relevant region.
What else should I look for if non-compete and non-solicitation are included in the documents?
First of all, the documents should define what is meant by competing activities and non-compete and non-solicitation, i.e. set their scope and the limits of the definition should be as clear and undefined as possible.
Wording such as "competing activities are any software development activities" is overly broad and unjustified. We don't recommend signing up for such terms, as they limit virtually any IT activity. By adding the field of development (fintech, EdTech, etc.) to the description and specifying the features of the product or activity, the wording can be significantly narrowed and, accordingly, reduce the risks of its potential violation, as well as leave the possibility of further development in other IT areas.
Secondly, the transaction documents should reflect all existing exceptions at the time of the transaction. Let's say that one of the key employees has a sole proprietorship and works under B2B contracts with other companies. This information should be immediately disclosed to the investor and, if the investor agrees, it should be recorded that the activities of such a person will not be subject to non-competition clauses.
Thirdly, pay attention to liability for breach of the terms. As a rule, the documents provide for liability in the form of a fine or a penalty option (what this is, we will tell you a little later in the following posts).
Non-compete and non-solicitation are important tools for both sides of the deal. They allow you to keep a stable team in the project and thus contribute to the best development of your business. The main thing is to remember: you can and should enter into negotiations with the investor and offer terms that will meet the interests of both parties.
Dear journalists, the use of materials from REVERA website in publications is possible only after our written permission.
For approval of materials please contact e-mail: i.antonova@revera.legal or Telegram: https://t.me/PR_revera
