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Do non-compete clauses risk stifling cloud innovation?

Non-compete clauses in tech employment contracts are commonplace – and understandably so – but could they be limiting innovation in the public cloud?

The fact that hairdressers feature highly on the list of professions frequently sued for breaching non-compete clauses neatly illustrates the wide variety of industries affected by restrictive covenants that effectively ban employees from seeking work with a competitor once they leave.

In the technology world, non-competes are rife, and the reason is quite simple. “Trade secrets and confidential information are key to the success of almost every business in the technology industry, and that’s why lawsuits in this world are more common, and also why obtaining the relief that the plaintiff wants is easier than in a lot of other industries,” says John R. Bauer, partner at law firm Lawson & Weitzen in Boston.

While many technology companies have non-compete clauses to cover themselves, the reasons why go beyond concerns about their rivals getting their hands on any product design secrets.

In the cloud computing arena, for instance, there is a huge demand for sales talent. It is for this reason that Amazon is suing a former Amazon Web Services (AWS) sales executive in Seattle for taking a job with Google Cloud, which is alleged to constitute a violation of a non-compete agreement.

While technical talent may know the ins and outs of the technologies that could help their rivals prosper, the sales team will have the customer knowhow and close ties to organisations working in specific geographies or vertical markets.

And it is here where the cloud sales agent’s non-compete clause would share a degree of overlap with the one a hairdresser may have to sign. “Among hairdressers, goodwill is really important,” says Bauer. “If a salon hires a hairdresser and helps them to build up a following, and then that hairdresser leaves to go to another salon or start his or her own, it’s not uncommon for the first salon to file a lawsuit to enforce a non-compete – sometimes they win, and sometimes they lose.”

Judges can enforce a non-solicit clause instead of a non-compete one, which may not preclude the employee from working for a competitor, but stop said employee from contacting customers they dealt with while working for a former employer.

Keeping technology trade secrets under lock and key

Aside from intellectual property and goodwill, there are also trade secrets which both sales and technical employees may be privy to that need to be covered by non-competes.

“It doesn’t have to be about knowing how to design a driverless car, it can also be knowing the profit margins of the company, knowing plans in development, undisclosed financial figures and plans for expanding employment,” says Bauer.

And while it makes sense for employers to put non-competes in place to protect themselves, it may be harming technology innovation altogether – particularly in the cloud computing space where there are three clear dominant suppliers in AWS, Google Cloud and Microsoft Azure.

But non-competes are not enforceable everywhere; perhaps most surprisingly, they are not enforceable in California, the home of Silicon Valley. The general consensus is that this is to ensure that the talent pool can move from one employer to the next in the technology hub of the US. As a consequence, places like Massachusetts have had a talent drain.  

“People from places like Boston have moved to California to avoid being forced to sign a non-compete that would preclude them form starting their own business or moving to another competitor,” he says.

 But the three cloud giants are not just located in California – they have global offices – and this is why court cases pertaining to non-competes still occur in other regions.

While one argument is that California would remain an innovative place to work, enabling people to use what they’ve learnt to create their own business, or join smaller cloud suppliers – the vast majority of the US and other jurisdictions around the world may not cater for that same type of innovation.

Read more about competition in the public cloud

It is also worth remembering that California is also not a cheap place to live, let alone start a new business. Indeed, California still favours the bigger businesses, because it would be easier for them to poach talent from a startup business without non-competes in place. This could subsequently lead them to developing similar technologies in-house, rendering the startup obsolete.

But for Jordan Bishop, founder of Canadian tech startup Yore Oyster, the reason he considered putting non-compete clauses into his employees’ contracts is out of wariness of them launching their own startups.

“A large part of our competitive advantage is the fact we are small and nimble and are able to do things very quickly whereas the bigger players don’t have that ability. They can build the tech and have the contacts but they have other priorities,” he says.

Bishop says his existing employees have agreed to non-compete clauses, which mean they can’t work for a select number of companies for a two-year period after leaving Yore Oyster.

This will protect them from prohibitive litigation if an employee leaves and shares the company’s IP with a competitor. However, putting in non-competes for a startup is trickier than for a big vendor as it could make the job less attractive to a candidate.

On the flipside, it would be hard to turn down an opportunity at one of the biggest companies in the world.

“I lectured a class at MIT and it amazed me how many students in that class – who could all be future entrepreneurs – worked for Google or Amazon while attending business school, and they were signing non-competes that could prevent them from launching their own businesses,” says Bauer.

Acting early

In other words, the big suppliers are acting early to ensure the very best talent work for them. That isn’t to say they are stifling innovation altogether; it makes sense for them to hire the best talent and enable these employees to innovate in-house.

However, by making students sign non-competes, they are essentially limiting the number of great talents that could learn their trade at a big tech firm and then use their experience to build their own startup.

“The impact of a non-compete on the employee can be huge, as it relates to their ability to make a living, and because of the power imbalance between employers and employees, we can’t always assume that the employee was comfortable accepting the obligation in the first place,” says Eitan Jankelewitz, a partner at tech-focused law firm Sheridans.

Of course, an employee who agreed to a non-compete could still leave AWS, Google or Microsoft, and wait until their post-termination restriction is over before starting up their own business. Except, of course, there is always a risk that because technology moves so quickly, an idea that someone has may already be in the works during the post-termination period.

It’s for this reason that Bishop believes China has prospered, as it has lax rules around intellectual property.

“People are constantly building off of what other people have built, and that’s been a really big driver for why China has been so successful in technology over the last few years, it would be great to apply even a small piece of this into the Western world to make more innovators,” he says.

A cloudy future

 With so many startups either having cloud as a focus or as a backbone of their infrastructure, it is important for cloud providers not just to list their current competitors in non-compete clauses. “The competitive landscape can change very quickly as companies launch new services and capabilities,” says Brian Kropp, head of HR research at Gartner.

“Some companies have therefore dramatically expanded the list of companies they put on a non-compete list. However, companies need to realise that in today’s tight labour market, this might become a limiter on attracting the best talent,” he adds.

In some cases, a judge could enforce a non-compete to preclude an employee from going to work for a company that isn’t yet competing, but which is planning to compete.

The power that providers like AWS have go even further, because while it has sued employees for going to a rival like Google Cloud, it didn’t sue Dorothy Copeland, who joined IBM in a senior role similar to the one she had at AWS.

The company also attempted to sue Gene Farrell, for taking a job at AWS customer Smartsheet, a company that wouldn’t really be considered a competitor – although a settlement was later reached.

This suggests the company is deciding which non-compete agreements to enforce on a case-by case basis, depending on the person or situation, so employees may not know exactly what is considered a breach of a non-compete until they actually decide to leave. This can leave them financially vulnerable, as a preliminary injunction precludes them working for the competitor, meaning they’re out of a job , with no income and can’t afford to defend the lawsuit.

“As a consequence, they settle a lot of these cases after the preliminary injunction motion is heard and it makes it especially difficult and costly for employees,” says Bauer.

Fear factor

This fear factor is likely having a huge effect on innovation; why would an employee risk starting up a business or taking a job at a smaller company which isn’t even considered to be a competitor if they might be sued.

The cloud giants will claim otherwise – and of course, they are not always in the wrong in these cases, but while non-competes make sense to protect IP and a customer base, cloud providers are overstretching their use, and are under-explaining what they mean to their employees.

As a result, there are fewer new businesses touting cloud services of some sort on the market, a bigger divide between the big cloud suppliers and the small to medium sized cloud providers, positioning the big cloud firms to continue dominating the market for decades to come.

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