PART 2: Key Legal Questions to Consider when Starting and Growing a Tech Business

February 7th, 2012
MMM Tech Perspectives

What are the Top 10 legal questions to consider in starting and growing a tech business? Outlined below is question #2 in this series of questions a lawyer asks an entrepreneur to minimize liability and maximize profitability (click here to view question #1). These questions address legal issues faced by tech companies through the business life cycle. While these questions may not apply to all companies, they’re a helpful road map to address legal pitfalls in building a successful tech business.

Following the question below, there are secondary questions designed to elicit important information from the entrepreneur. Then, the legal conclusion and practical pointers are included. As referenced below, the new venture to be formed by the entrepreneur is Newco and the current (and soon to be former) employer of the entrepreneur is Employer.

Q2: What restrictive covenants imposed by the Employer apply to the entrepreneur/founder that may impact the success of Newco?

Before an entrepreneur finalizes the business plan and forms Newco, an analysis must be undertaken to determine the Employer’s restrictive covenants that limit the entrepreneur’s ability to execute the Newco business model. Several fundamental legal questions have to be answered to determine the significance and enforceability of the restrictive covenants imposed on the entrepreneur by the Employer.

A. In what state is the entrepreneur residing? Will the entrepreneur also perform services in that state?

B. Is the entrepreneur a party to an existing employment agreement, independent contract agreement or restrictive covenants agreement? What law governs the interpretation of this document?

C. Are the restrictive covenants – – non-competition, non-solicitation of customers, non-solicitation of employees and non-disclosure – – enforceable under applicable law?

D. Notwithstanding the issue of enforceability, how likely is the Employer to pursue a legal action against the entrepreneur for its alleged violation of one or more of the restrictive covenants?

E. Can the entrepreneur subject to the restrictive covenant be isolated within Newco to perform limited responsibilities to avoid violating the covenants?

F. Will the existence of the covenants present an insurmountable impediment to Newco raising outside capital?

G. Can and should the entrepreneur approach its soon to be former Employer to seek clarification related to scope of the restrictive covenants?

H. Should the entrepreneur seek a declaratory judgment from a court as to the unenforceability of the restrictive covenants imposed by the Employer? Is the outside investor for Newco prepared to fund such litigation?

Entrepreneurs are generally ready to move quickly to form a new venture and begin their business. Their impatience often results in failure to analyze the above questions, especially to assess the likelihood that a former Employer will threaten or initiate legal action against the founder and Newco.

Adding to the complexity, each co-founder will need to analyze the questions to determine their application to the founder’s specific circumstances. Even if the co-founders are all departing from a common Employer, their respective legal positions may result in a differing analysis of their restrictive covenants and fiduciary duties to the Employer.

In Georgia, an additional question relates to applicability of the Georgia Restrictive Covenants Act effective for agreements entered into after March 11, 2011 (click here to read more on the Act).

Related questions include:

A. Should the entrepreneur delay departure from their existing Employer to wait for the more favorable time to leave and form Newco?

B. Are there opportunities for Newco to enter into a strategic relationship with the former Employer (for example, to service existing customers of the former Employer)?

C. Will the former Employer be interested in making an equity investment in Newco? If so, when is the appropriate time to approach the former Employer about such an investment?

D. Should the entrepreneur move to California or another state in which restrictive covenants in the employment context are invalid?


To view Question 1 of this series, click here.