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Non-competes, franchising, investment

Recent Events Roundup: Highlighting Key Concerns of Non-Competes, Franchising and Investing

The Triangle Business Journal recently highlighted a couple of locally-arising events that have potential consequences and implications that are anything but local in scope. Consider these examples as they may apply to your business and employment endeavors.

Employment Agreements and Promises not to Compete or Solicit. First up is an article about a suit brought by Quintiles for breach of contract “against a former senior business development employee … who allegedly left the company last month and re-emerged at a competitor.” This case brings up issues important for those who must write employment agreements with restrictive covenants in them, as well as those asked to sign those agreements.

Basic contract law says that if you sign an agreement you’re presumed to have read it and to understand it. So anytime you’re presented with an employment agreement, it’s important to read it carefully and address any issues or questions before signing. But basic contract law also says that ambiguous contract terms will be construed against the drafter. As such, both drafters and draftees must be very careful when writing or reading employment agreements. This is doubly the case when restrictive covenants are involved, because non-competes, non-solicits and the like have lasting impacts on employer and employee often long after separation of employment.

Let’s review the basics of restrictive covenants in the employment context:

Non-competes are designed to prevent employees from providing or selling products and services that compete with those provided or sold by the employer. Non-solicits are typically framed in one of (or both of) two ways: preventing interference with the employer’s relationships with its customers and with its other employees. By signing these agreements that contain these promises (i.e. the promise not to compete in the designated way or solicit customers or employees to come with the departing employee or otherwise adversely alter their relationships with the employer), the employee is voluntarily agreeing to restrict his or her ability to earn a living after this employment ends. Voluntary, you say? Yes, because you don’t have to take the job and could go elsewhere.

Because your ability to find work or earn revenue post-employment is limited, courts are not big fans of these promises and agreements, but will enforce them if written properly. Generally, the onus is on the employer to write restrictive covenants so as to be enforceable. To do this, the restrictive covenants agreements must be (1) in writing, (2) reasonable as to time and territory of applicability, (3) included in the employment agreement, (4) supported by consideration, and (5) designed to protect the employer’s legitimate business interests.

Some of these requirements are straightforward (such as the in-writing requirement), but others are fodder for litigation if not properly analyzed and applied in the drafting of the employment agreement; in particular, the requirements of reasonableness and serving the employer’s legitimate business interest are rife with potential for issues. Employers must be careful to write restrictive covenants that are reasonable and specifically designed to protect their legitimate business interests (such as protecting existing customer relationships) or the agreement may be struck down in court. Employees must carefully read and negotiate, to the greatest extent possible under the circumstances, restrictive covenants that will allow the earning a reasonable living after the pertinent employment ends or they may be faced with a breach or move decision to make. Perhaps you’d like to open up your own shop or move to a leading competitor. Pay attention to the terms of the contract. Either way, it is incredibly important to handle restrictive covenants properly, and it is strongly suggested to seek the advice of counsel.

 

Franchise and Investor Agreements. A second interesting story recently posted by the TBJ is that of a pair of Raleigh entrepreneurs making what may be considered a successful appearance on the television show, Shark Tank. According to the story, the business owners made a deal with one of the “Sharks” based on, among other things, their company’s revenue history and new business opportunities in the form of franchisees – two very appealing aspects to a potential investor. This story highlights at least a couple of very important concepts for considering growth and opportunity in business: franchising a business and seeking and acquiring investors.

Franchising. With respect to the franchise aspect of the story, the basic idea of franchising is that a company will license the right to use its brand and operational model in exchange for royalties and other payments. From the franchisee’s (i.e., the party acquiring the license) point of view, the benefits include starting with a (theoretically) proven model, an established brand and ready-made client base. For instance, if I buy the right to open and operate three McDonald’s locations, I may have a strong expectation of success and don’t have to worry about building a brand or new business from scratch (Not an endorsement of McDonald’s! Do your own due diligence!). The benefits to the franchisor include monetizing established operational principles and brands in a way that could provide revenue for years to come, without having to put up the capital or handle the actual business operations for each location.

Both sides of franchising involve the potential for strong reward; but, they also have plenty of risk. For the franchisor, risks including properly researching and compiling the necessary franchise documentation and the time and cost required thereby, complying with federal and state laws in the establishing and operation of an often multi-state franchise, and selecting the right franchisees. The franchisee’s risks include the up-front capital requirements, ongoing operational demands, complying with the franchise documents (the pages of which can number in the hundreds) and requirements and others.

Key planning is required for both sides of the franchise. The franchisee, for instance, needs to work with the franchisor to minimize risk and address exit strategy (i.e., how to transfer the franchise and how to limit liability on the expiration or transfer of the franchise license). Due consideration and forethought must be given. Remember that it is easier and cheaper to plan how to handle trouble than it is to get out of trouble down the road.

Investing. Every business will need to raise capital at one point or another – typically at multiple points. One way of doing so is to bring in outside investors. And investing can be a great way for investors to diversify income streams and find new opportunities and for businesses to expand and fund operations. But careful planning and issue analysis and resolution is a must.

I’ll admit that I am not privy to the terms of the offers made by a “shark”, but I would not be terribly surprised if they took a “take it or leave it” approach. There will be times in business where one party has the will and leverage to pursue a deal along those lines. From a practical standpoint, that will not usually be the case. For one thing, entering into a business relationship with someone who feels that they lost may not be the best indicator of success. A bad deal, perceived or actual, can incentivize or be used to rationalize a breach of contract. So that means meaningful and mutually beneficial negotiation will be the name of the game.

Each party will have its own goals, which will vary on a case-by-case basis. Typical concerns include, for the investor, whether to be just a money-guy or to negotiate for a seat at the proverbial table, protecting and prioritizing investment and return, optimizing potential for future investment or one-off deals, limiting liability and facilitating the exit. For the company or business owners, concerns typically include protecting control of the company (investors often want some control over management of operations), both in terms of ownership percentages and management rights, and carefully choosing investors and structuring investments to facilitate future growth and opportunities. For both sides, another key concern is complying with any applicable securities regulations.

You may have guessed the trend with these issues: careful and proactive planning is vital. Properly drafting the investment and entity documentation to handle and accomplish these and other goals and concerns will save time, money and heartache in the long run. And while one can’t predict the future, if proper forethought and analysis is given, perhaps you can at least identify the likeliest eventualities and plan for how to handle them.

 

LEGAL DISCLAIMER

The information herein is not legal advice and does not create an attorney/client relationship. The information is in the form of legal education and is intended to provide general information about the matter.  The above is not, nor is it intended to be, legal advice.  Consult your attorney with questions.

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