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Sunday, 23 November 2014 22:00

Are noncompetes a barrier to growth? Competing philosophies lead to different answers

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Executives at West Michigan technology firms generally fall into two “diametrically opposed” camps when it comes to outlining employment agreements for their workers.

While some leaders say non-competition agreements work to protect their investments in intellectual property and proprietary processes, others feel they have a chilling effect on the labor market and stifle entrepreneurial firms and startups from attracting talent within the region as they grow.

Atomic Object LLC President Carl Erickson falls into the latter category, noting that he doesn’t like non-compete clauses “at all.”

The co-founder of the Grand Rapids-based software development firm said he prefers to focus on creating a work culture that attracts the best employees rather than outlining what his 55 employees at offices in Grand Rapids, Ann Arbor and Detroit can and cannot do if they chose to seek employment elsewhere.

“As the leader of the company, I want the pressure to stay on me to make sure that we stay the most attractive place to work,” Erickson said. “Not tying anyone’s hands means they can leave if they are not happy, they can leave if they are not fulfilled. … That is what I want to happen. It forces you to pay attention to (employees’) needs, and that is really healthy.”

Traditionally, non-competition agreements were reserved for only the highest-level executives so firms could ensure that corporate secrets remained in-house. But over the years, more companies started mandating the agreements as conditions of employment for workers across a range of positions and industries.

The pervasiveness of non-compete clauses in the workplace made national headlines in October when The Huffington Post reported that sandwich chain Jimmy John’s requires its workers at all levels of the company, including low-skill, low-wage sandwich-makers and delivery drivers, to sign the agreements.

Under the terms of the Jimmy John’s agreements, employees are barred for two years from working at a competitor, defined as any restaurant within three miles of a Jimmy John’s location that “derives more than ten percent (10 percent) of its revenue from selling submarine, hero-type, deli-style, pita and/or wrapped or rolled sandwiches,” the report stated.

PROTECTING INVESTMENTS

For more than 15 years, all employees at Grandville-based IT provider Trivalent Group Inc. have been required to sign non-competition, non-solicitation and confidentiality agreements, said Chief Services Officer John Hey.

The firm’s non-competition agreements are “very reasonable,” Hey told MiBiz, noting that they simply restrict former employees from working for a direct competitor within a 100-mile radius for a period of one year.

“We are a service provider,” Hey said, noting that the company sees each new hire as an investment. “There is nothing to stop (a former employee) from working for (a company such as Amway or Steelcase). It would only stop them from going to work for a direct competitor.”

Given that West Michigan supports a minimal number of IT service firms, Trivalent executives think it would not be very difficult for an employee to take its processes or practices to a competitor, Hey said.

Trivalent has enforced a number of its agreements and occasionally got its attorney involved upon learning that an employee was looking to break or had broken the terms of the non-competition agreement or other aspects of the employment contract. The company has yet to resort to filing a lawsuit to enforce the agreement, Hey said.

While Hey acknowledged that non-compete clauses could lead to employees continuing to work for a company they no longer want to work for, he said the agreements have resulted in healthy dialogue at Trivalent. In instances when Trivalent learned that an employee was looking to leave the company for a competitor, it caused the company to start the discussion about what it could be doing better, Hey said.

A MATTER OF LOCATION

Whether a company uses non-competition agreements depends in part on its geographic location, sources said.

The agreements are rare in tech hubs like Silicon Valley, particularly because states such as California and Washington have laws that very much favor employees over employers, Hey noted. On the other hand, Michigan is among the states known for some of the strictest laws in favor of employers when it comes to non-competition agreements.

But nationwide, those laws have been the subject of increasing scrutiny, particularly from groups looking to support the growth of startup companies.

Earlier this year, the venture capital community in Massachusetts attempted and failed to change that state’s strict laws regarding non-competes, according to a story on business news website Xconomy.com. The VCs argued that the restrictions make it too difficult for entrepreneurs to start innovative companies that form the backbone of today’s economy.

Recent research by a professor at the Massachusetts Institute of Technology (MIT) shows the argument could have merit.

The 2011 study by professor Matthew Marx of more than 1,000 engineers determined that because of non-compete clauses, one-third of engineers were forced to change industries if they eventually looked to switch jobs, resulting in them not “applying specific skills they had developed.”

In effect, the non-competition agreements present employees with the choice of remaining in their jobs or “taking a career detour that can lead to lower pay and less use of the skill sets they have developed over years or even decades,” Marx stated.

The opponents of non-compete clauses argue that it’s not good for the economy when highly skilled professionals are essentially barred from working in their given area of expertise.

COURT DATE

Another side effect of strict laws supporting non-competition agreements is that companies often file lawsuits against former employees to enforce the terms of the contracts. A 2013 Wall Street Journal report noted that litigation over non-compete clauses has significantly increased over the last decade or better.

The story specifically pointed to Michigan as a state where workers were “less likely to start their own businesses or jump to a startup or small firm” because they did not want to face lawsuits.

In Kent County, disputes over non-compete agreements often wind up before 17th Circuit Court Judge Christopher Yates.

Yates, who oversees the county’s Specialized Business Docket, said he’s written “dozens of opinions” on local lawsuits involving non-compete agreements. For better or worse, the agreements are becoming a more common part of the business landscape, he told MiBiz.

In his experience hearing arguments over non-competition agreements, Yates said he has seen two schools of thought appear. One side believes the practice “restricts labor markets” because workers don’t have the ability to move around to jobs or to strike out on their own.

On the other hand, Yates said some people believe that if a business hires an employee and makes the investment in training that person, it would not be right for the employee to go into the labor market with the skills they received from the previous employer.

“I’m not suggesting that either school of thought is right,” Yates said. “It just seems that there are two competing philosophies, and each one has a fair bit of merit but they lead to diametrically opposed views.”

Nationally, lawsuits over non-competition agreements have increased 61 percent since 2002, according to the WSJ story. The report said that the statistics likely belie the actual volume of cases since many of them are settled out of court and therefore go unreported.

INHIBITING GROWTH?

The national discussion about non-competition agreements comes as companies face growing competition for talent.

That’s particularly true among local tech firms, according to the summer/fall 2014 Technology Employment Forecast released by Holland-based Paragon Recruiting LLC. The outlook noted that more than half of West Michigan respondents plan to hire IT professionals in the next six months, adding that “software application developers are in high demand.”

Given the demand for tech workers, executives like Atomic Object’s Erickson wonder if non-competition agreements serve as a hindrance to attracting new talent into the industry.

“If you think about the ecosystem of companies in the West Michigan area, then I think we’re all much better off without non-competes so that people can move around,” Erickson said. “A flexible labor market is a good thing for everybody.”
Inasmuch as non-compete clauses restrict skilled entrepreneurs from starting new companies and growing the economy, that gives Kevin McCurren pause.

The executive director of the Richard M. and Helen DeVos Center for Entrepreneurship and Innovation at Grand Valley State University’s Seidman College of Business, McCurren notes that research from the Missouri-based Ewing Marion Kauffman Foundation found that in recent years, entrepreneurs have had the greatest success starting a business once they reach the age of 55 to 64. Many of those entrepreneurs have backgrounds as corporate managers, he said.

“They know how to grow companies,” McCurren said. “If they are restricted from (starting companies), then it does hurt the entrepreneurial environment.”

In instances when a former employer files a lawsuit against a startup entrepreneur, it significantly slows down the process of getting a company off the ground, he added.

On the other hand, non-competition agreements can go a long way in helping a startup firm initiate best practices and safeguard intellectual property, said attorney Jeshua Lauka, an associate at Grand Rapids business law firm David and Wierenga PC.

“With a startup, you don’t even know what your potential is,” Lauka said. “You are at the beginning of what could be a breakthrough in an industry. There is a lot of damage that could be done.”

MISPLACED FOCUS?

Grand Rapids tech entrepreneur Ryan Vaughn said it seems strange for companies to focus so much on rules and restrictions given the pace of the technology industry.

The co-founder of Varsity News Network Inc., a high school sports news platform, said in his opinion, executives would be better off paying attention to the implementation and development of their ideas.

“In software, if you have a good idea, 10 other people are already working on it,” Vaughn said in an email to MiBiz. “If you have a great idea, 100-plus people are already working on it. Your advantage is not protecting your idea. Your advantage is executing it better than the competition.”

But so long as states like Michigan continue to have strong protections for companies in non-compete clauses, businesses are likely to continue using them, sources said.

As the entrepreneurial and high-tech economies continue to grow in the state, litigation over the use of non-compete agreements may simply become part of the cost of doing business, said Judge Yates.

“It’s interesting to me because, once upon a time, the American Dream really entailed going to a business, learning a skill or trade and then going out and making your way in the world and hopefully starting your own company,” Yates said.

“Now the American Dream still looks like that, except one of the steps that has been added is that, in all likelihood, you’re going to be sued for violating a non-competition agreement.”

Read 5343 times Last modified on Sunday, 23 November 2014 21:44

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