The small business case for non-compete agreements

The Federal Trade Commission (FTC) thinks it knows how to run small businesses better than their owners. That is the message the FTC sent the millions of small business owners across the country with its ban on non-compete agreements, set to take effect on September 4.   

By some estimates, 48% of small business owners use non-compete agreements. The FTC’s response to those who complained about the ban was to condescendingly assure them that they will be better off and advise them how to reorganize their businesses. But the FTC’s ivory tower economic analysis is no substitute for the hard-learned lessons of the small business owners. They see non-compete agreements as vital to protecting their innovative ideas for new technologies, their training and investment in their employees’ professional development, and their workplace cultures where each employee is valued. As of now, that protection will soon disappear. 

Non-compete agreements have been used by small businesses for centuries. The earliest-known court case involving a non-compete agreement occurred in 1414, shortly before the Battle of Agincourt. A tradesman apprentice was sued by his master tradesman for purportedly breaking his agreement not to practice his trade for six months in the same town.  

The modern legal standard for non-compete agreements—permitting limited, reasonable restraints and prohibiting general ones—was established in a small business case over 300 years ago. In 1711, an English court upheld the agreement of a baker who leased his bakery not to work as a baker nearby for the duration of the lease. The standard established in this case carries into the current regulations of the 46 states that permit the use of reasonable non-compete agreements. It has endured for so long for several good reasons. 

Businesses built on proprietary ideas rely on non-compete agreements to protect those ideas and facilitate collaborative work environments. In response to the FTC’s initial proposal to ban non-compete agreements, small business owners who built their businesses on inventions, engineering designs, and artisanal crafts wrote in to object. They expressed concern that without non-compete agreements, larger competitors with more resources could poach their employees. Poached employees would take with them a business’s unique ideas and designs, risking the entire business.  

The FTC claims that these firms could rely on non-disclosure agreements instead. But it is implausible that a former employee would be asked not to use the knowledge they have acquired when it is directly applicable to their new role. If the ban goes forward, these businesses likely will end up siloing their employees to protect their proprietary information and, in the process, harm the development of the firms’ products and their business culture.  

Many businesses also rely on non-compete agreements to protect the specialized training and other investments they make in their employees. Small businesses rely on skilled labor of all varieties and can decide to develop those skills in their employees at a cost to the business’s finances and productivity. These firms surely make that decision because it is worth it in the long term to have well-trained employees. Non-compete agreements give businesses some assurance that they will not become a free training program for their competitors.  

Instead of using non-competes to protect training and investment, the FTC suggests that small businesses simply “compet[e] on the merits to retain workers,” as if this idea had not occurred to them. But it is the non-compete agreement that makes investment feasible in the first place by reducing the risk of poaching. And the FTC at least partially agrees. In its justification of the ban, the FTC cites two empirical studies that found investment by firms is reduced when non-compete agreements are less enforceable. And it concluded that the ban could impose up to a $41 billion cost on firm investment nationwide.  

Banning non-compete agreements also has an intangible impact on the workplace itself. A business that can have an open culture in which to innovate and that can invest heavily in its employees is likely to offer a better work environment. Employees of such businesses learn more and obtain skills they can carry with them throughout their career. And they can commit those skills to doing good work for their employer. All of us intuitively understand that our jobs are about more than just our salaries and optimizing productivity. We want a workplace in which we are valued and in which we derive some sense of value from the work we are doing. Non-compete agreements help enable such a workplace.   

Take, for example, ATS Tree Services, LLC—a Bucks County, Pennsylvania-based tree care business. Pacific Legal Foundation is currently representing ATS in a legal challenge to the FTC’s non-compete agreement ban. ATS is committed to the professional development of each of its employees as skilled members of its tree care team. It spends thousands of dollars and sacrifices time and productivity to train employees in the specialized skills and safety protocols necessary for tree care. These skills include learning technical climbing skills that are used while removing large tree limbs from high in a tree and lowering them safely to precise locations on the ground.  

ATS’s training program has earned the company a reputation for quality tree care service in its area, and it is regularly called in by other companies to assist with difficult jobs. ATS asks that its employees demonstrate their commitment back to ATS by agreeing not to work for a nearby competitor in the same capacity for one year after leaving. It is a limited request that enables ATS’s culture of mutual commitment to flourish and creates a positive work environment for its employees.  

The FTC is not concerned with such issues. It has concluded that, in the aggregate, everyone will be better off without non-competes. But the theoretical aggregate provides little comfort to small businesses like ATS, whose means of protecting its investment in its employees and preserving its successful culture will be outlawed on September 4. The FTC’s one-size-fits-all ban fails to truly grapple with important reasons small businesses use non-compete agreements. By forging ahead with the ban’s implementation, the FTC will end up harming both the businesses and the employees that it purports to want to help.