Non-competes: good for companies, bad for economies

Business,Startups by on December 3, 2007 at 1:31 pm

Bijan Sabet at Spark Capital started a healthy debate on getting rid of non-compete agreements (which already aren’t enforceable in CA and other states). His assertion is that non-competes are a significant barrier to startups and innovation.

Jason Mendelson and Fred Wilson have countered that non-competes are very much in the interest of portfolio companies and their investors.

I actually think that both Bijan and Jason/Fred are correct (although they’re arguing non-opposing points of view).

Are non-competes good for companies (and startups)?
Yes. Non-competes create barriers in the talent market that reduce the likelihood of an employee from directly competing against their company.

What company wouldn’t want that?

Are non-competes good for economies?
No. The negative impact of non-competes is most likely felt by employees within larger companies. Very few employees at large companies have the negotiated non-competes that Fred & Jason suggest. These employees tend to get standard non-competes that offer neither just compensation nor limited scope.

The simple threat of a lawsuit is often enough to discourage the employee from leaving to start a company. Scott Kirsner points to HBS research (pdf) that reinforces the impact of this market inefficiency:

Marx and two colleagues [at HBS] looked at what happened after legislators in Michigan accidentally made non-competes enforceable in 1985. Inventors were suddenly 34 to 51 percent less likely to move from one company to another. And the “star” inventors were the least likely of all to move.

I’m not quite sure how this translates into economic impact, but it does suggest that it could be substantial.

Non-disclosure agreements provide companies with significant protection. Non-solicits provide even more protection (and have been enforced in states like CA). The non-compete does not create net economic value.

What is a company to do?

Bijan ended his post with a call for VCs, CEOs and founders stop requiring non-compete agreements. While I applaud his willingness to take a stand, I don’t think that it is reasonable advice for a startup.

Business can and should take every ethical strategic advantage available.

Amazon thinks that the patent system needs reform badly. They aren’t boycotting the system by refusing to file patents or allowing competitors to infringe their existing patents. Instead they’re lobbying for reform.

Don’t begin reform by placing your business at a strategic disadvantage. Instead lobby hard and change the system from within.

This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 2.5 License. | Dave Naffziger's BlogDave & Iva Naffziger