Volume 9 Issue 5 -- September/October 1997
Everyone recognizes that protecting valuable business assets is an
integral part of succeeding in business and of business succession.
Most business owners would find it foolish not to purchase insurance
for tangible assets such as a building or equipment. However, what
about a business's intangible assets, like a client or customer base,
or some in-house technology or know-how?
Protecting a business's customer lists or technical information is an essential part of preserving the business's valuable assets, both for the present and the future. This is particularly true when it comes time for a business to be transferred, either by sale or by succession to a new generation of owners. Without such protection, there is no guarantee that such assets will be there and available to the new owners.
Last time we talked about some consequences of not protecting a lease. In this issue, the second in a series of insightful newsletters on business succession, the focus is on the loss or unauthorized use of an important asset, like a client list or proprietary know-how.
If you sell hardware or clothing, customer lists may not be of particular value, but to many who provide services (e.g., consulting) or specialized products (e.g., rare paintings), the list of who wants such services or products can be of great value. Likewise, your business may be built upon technical knowledge or experience that gives you an advantage over your competitors.
What if Marvin Cornwhacker, your valued assistant with 10 years of service with your firm, decides to leave and establish a competing business? Furthermore, what if Marvin decides to solicit your best customers or to employ the same knowledge or expertise he developed while working for you?
What if he has been the contact person and provided most of the services to your customers. Will they follow Marvin? Maybe. Many will remember that Marvin was their principal contact and that they relied on him and got to know him.
Or suppose that while working for you, Marvin acquires specialized skills or technical information that only you have. Marvin's ability to go into business and use that information or those skills can be devastating to your business.
Can you, the principal, prevent Marvin from competing? Yes, but you need to act well before Marvin is ready to leave, maybe even before you hire a Marvin. The protection you need for your list of customers is a "Covenant Not to Compete." In plain English, this is a promise by Marvin not to compete with you after he leaves your firm.
A covenant not to compete may also be effective, especially when used in conjunction with other means, to protect trade secrets, know-how, and other types of confidential information.
Well, okay, if there can be such a promise, why not have Marvin make the promise effective for the rest of his life or for any area in the world? That way, Marvin can only compete on the Moon and after he is dead (not much of a threat).
Is this fair? Perhaps yes, from your perspective, but it's hardly fair to Marvin and those dependent on him for the next several decades. The point is, Covenants Not to Compete must be reasonable in time and area so that Marvin does not become an indentured servant or ward of the state.
All levity aside, protection of your client or customer base -- your list -- can be critical. Do you want the hypothetical Marvin Cornwhacker to "whack" your business should he leave?
Many small and medium-sized businesses give little consideration to what happens if a key employee or associate leaves and decides to compete. If the concerns are addressed as employees are hired or promoted, reasonable agreements can be secured that protect the customer base or technical information you worked years to develop. An employee, associate, manager, partner or shareholder can be prohibited from competing for a reasonable period of time (several years) in a reasonable area (the one your business is active in).
Not all businesses need Covenants Not to Compete, but if you or your
clients need or deserve such protection, it needs to be considered in
advance. If you wait until Marvin Cornwhacker is ready to leave and
then ask him to sign such a promise not to compete, Good Luck! If you
think Marvin will sign an agreement at that time, then you have no
problem believing statements like "The check is in the mail" or "I
would never lie to you." Even if he signed an agreement at that time,
it probably would not be enforceable anyway for lack of consideration.
By Tax and Business Professionals, Inc.
9837 Business Way
Manassas, VA 20110
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