Corporate law: Non-competition clause among founders

Why do founders have to ‘tie their hands’?

In founder-founder and founder-investor relationships, non-competition clauses serve a different function than in classic employer-employee relationships. It is not only about protecting trade secrets, but also about securing the value of shares and the credibility of the entire investment project.

In the early stages of development, a start-up requires the full commitment of key individuals. A non-competition clause – often linked to an operational exclusivity obligation – is intended to ensure that the CEO, CTO or other founder does not develop a competing venture in parallel, using the company’s know-how, business contacts, team or resources.

From an investor’s perspective, capital is invested in a specific team and its ability to implement a strategy. The departure of a key founder and their engagement in competitive activity may significantly reduce the value of the company, hinder subsequent rounds of financing and, in extreme cases, undermine the entire investment. The non-compete clause is therefore an element of risk allocation between the founders and the investor – a kind of security for VC capital.

The non-compete clause also protects relationships within the founding team. It is intended to prevent a situation in which one of the founders leaves the company, taking with them key know-how, customer relationships or technological partners, leaving the other partners with a project with significantly limited market potential.

In practice, non-competition clauses are sometimes supplemented by an obligation to dedicate a certain amount of time to the company’s activities (a so-called full-time commitment). For example, a founder may be required to devote a minimum of 30 hours per week to the development of the project. Although this is not a classic non-competition clause, it effectively limits the possibility of running other projects in parallel and reinforces the exclusivity of the commitment.

What documents can introduce a non-competition clause?

A non-competition clause for founders is not a uniform construct. Its content and intensity vary depending on the stage of the company’s development and its ownership structure. In practice, non-compete provisions appear in three key documents:

1. Founders Agreement

This is the first and often the most important moment in regulating relations between founders – even before the formal establishment of the company or at the very beginning of its operation.

The Founders’ Agreement serves as the ‘team’s constitution’. At this stage, the non-competition clause is primarily intended to prevent the parallel development of competing projects and to protect the project from a situation in which one of the founders leaves and launches a similar business model.

At a very early stage of a start-up’s development, the non-competition clause should be constructed in a balanced manner. If the project fails after a few months, restrictions that are too long or too broad may in practice prevent the founders from returning to professional activity. Therefore, at this stage, it is important to ensure that the scope, duration and territory of the prohibition are proportionate.

2. Investment Agreement

When a VC fund comes in, the non-competition clause becomes ‘rigid’ and very detailed. The investor imposes restrictions to maximise the chances of success. Breaching the non-competition clause in the investment agreement may result in contractual financial penalties and the initiation of a compulsory share buy-back procedure or the activation of a reverse vesting clause.

3. Articles of association

The articles of association/statutes may also regulate issues related to the non-competition clause for certain partners (founders) and members of the company’s management board. Including a non-competition clause in the articles of association strengthens its corporate nature and may facilitate the enforcement of liability, but the specific sanction mechanisms (penalties, call options, vesting) are usually regulated in the investment agreement or separate agreements.

Scope of non-competition for founders

In investment practice, the definition of ‘Competitive Activity’ is usually formulated broadly. The investor seeks to cover the entire area in which the company conducts or plans to conduct its business with the prohibition, so as to eliminate the risk of bypassing the clause by changing the business model or customer segment. Standard wording includes: activities identical or similar to those of the company, activities competitive to current or planned products, activities targeting the same customer group. From the investor’s perspective, this approach is rational – the prohibition is intended to protect not only the current product, but also the development strategy and technology roadmap. For the founder, however, it is crucial that the definition be linked to the actual business profile of the company and provide for carve-outs that will allow for continued professional activity after the termination of the cooperation.

Non-Solicitation

In transactional practice, the acquisition of key human and contractual resources often poses a greater threat than competitive activity itself. A founder leaving a company may attempt to recruit its employees, acquire contractors, or persuade customers to terminate their cooperation. Therefore, investors attach great importance to non-solicitation clauses, which: prohibit the active recruitment of the company’s employees and associates, include a prohibition on persuading customers to terminate contracts, and remain in force for a specified period after the founder’s departure.

Unlike a classic non-competition clause, non-solicitation does not exclude conducting business in a given industry, but protects the company’s key business relationships. For this reason, it is sometimes seen as a more proportionate and effective solution.

The situation after the Exit

The key question when drafting a non-compete clause concerns how long the prohibition remains in force after the sale of shares or the founder’s departure from the company. The market standard is a period of 12 to 24 months from the termination of the corporate or contractual relationship, with the length depending on the nature of the company’s business, the level of know-how protection and market dynamics. From the founder’s perspective, it is important that this period is proportionate and takes into account the circumstances of leaving the company. In practice, a reduction of the prohibition to 6-12 months or its exclusion in the event of bankruptcy or liquidation of the project is negotiated so as not to block the possibility of returning to activity in the area of one’s own competence.

Unlike in an employment relationship, in corporate and B2B relationships, a non-competition clause after the termination of cooperation may, in principle, be free of charge, but its scope and duration must remain proportionate. An overly broad and lengthy prohibition, combined with a lack of any compensation, may be considered an excessive restriction on the freedom of economic activity.

Summary

Non-competition clauses in relations between founders and between founders and investors are a powerful tool. On the one hand, they are a basic mechanism for protecting the value of a company, securing know-how and team stability, and giving investors a real sense of capital security. On the other hand, if formulated too broadly and disproportionately, it can significantly restrict the founder’s freedom of economic activity and hinder their further professional development after leaving the company.

It is crucial to precisely define competitive activity, reasonably determine the duration of the prohibition, and consciously regulate exceptions and sanction mechanisms. A well-constructed non-compete clause should not be a repressive instrument, but an element of a balanced allocation of risk between the partners and the investor, which protects the value of the company without depriving the founder of a real opportunity to operate in the future.