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Grey line between NDA and Non-Compete?

Hello fellow motivated individuals!

So, one of the great parts about living and working in California is Non-Compete agreements are basically illegal in the state. However, over time i've encountered more and more possible co-founders insisting that i sign an NDA before even talking with them. This just rubs me the wrong way every time and is usually the first red flag that i don't want anything to do with this person. But it kind of dawned on me just the other day, that there seems to be, at least logically, a non-zero chance that some of these NDAs could be used as a sort of back door around the non-compete situation.

Seeing how i'm pretty far off from being a legal expert i was wondering if anyone would have any knowledge of this being the case?

10 Replies

Jeb Stone > Analytics PhD
2
0
Decision & Data Scientist / Experimental Psychologist / Business Intelligence
I'm not a lawyer either, but I have been involved in non-compete litigation in the past. There's a lot of ground to cover; I'll try to provide the high points that I've had some experience with.

1) Non-competes generally aren't enforceable in California courts. The corollary to this is that if either you or your possible co-founder has grounds to sue in a state other than California, that state court will likely allow the lawsuit. In effect, both of you have to be based out of California to be protected by the California law. You are not protected if you live in California but get sued in, say, a Texas court. Likewise, for a non-compete agreement, you are only protected if you move from one California company to another California company.

2) Most state courts (excluding California) have come to rely on the doctrine of "inevitable disclosure" -- which means if you go to work for (or start) a competitor, the State assumes you will inevitably disclose confidential information. Therefore, in most states, the NDA you signed with your potential co-founder is effectively also a non-compete agreement. So, this scenario you mention isn't just a potential back door -- it's a widely-applied legal precedent. Secondarily, there's the issue that the party suing you can make a pretty broad case for what represents a "competitor"...

3) Those who haven't had direct experience with the civil justice system may not realize that it's a pay-to-play system. In a simple example, if you're sued for a non-compete, you must put up an affirmative defense or the court will automatically enter a default judgment against you. Putting up this defense could cost you $10k to $20k. Next comes the actual discovery process, in which you have to give your computer, all electronic storage, and passwords to all your email accounts to the other side's legal team. A vigorous defense in this phase might cost an individual an additional $20k to $40k. Also note that since these lawsuits can plausibly be argued to have been brought in good faith, it is highly unlikely you will get this money back even if you do win the lawsuit.

4) Many state courts are "blue-lining" non-compete agreements... basically, cutting the terms in half to meet a perceived middle ground. For example, if the term of your non-compete was two years, the court might cut it to one year -- which is technically a "win" in your case -- but you're still out the $40k to $70k total cost of the lawsuit. And you're out of your new job for a year. I've read that NDAs with no specific time limit often get blue-lined to 2 years, though you'd still have to pay to defend yourself.

The simple truth is that NDAs and non-competes give companies that can afford legal staff sufficient leverage to kick you out of the game if they decide to. Most of them are ethical enough not to do that sort of thing, but if you do sign an NDA and one or both of you is outside California, you're subject entirely to their good will unless you can afford the legal costs out of pocket. Most states will apply the inevitable disclosure doctrine if you do get sued, and you'll likely be on the sidelines anyway. So, you know, just don't make anybody mad :)

One potential safeguard might be to include language in your NDA that any violation of the NDA must be pursued in California court. Not sure how plausible that might be to do or whether it'd actually be effective.

Hope this helps get you started... again, this is not legal advice, but it does reflect my own experience with the process.

-Jeb


Rob Gropper
1
0
Rob Gropper Entrepreneur
Director at PetHero, SPC - Member at Eastside Incubator - Principal at Tuxedo Technologies Group
I"m no lawyer either, but in my experience, like most contracts, non-competes and NDAs are either good or bad depending on which side of the fence you sit. Especially if you are a developer, a well-written NDA can very much function like a non-compete. An NDA is not worth the paper it's written on if you don't trust the person signing it. While few VCs will sign them, they like knowing the company founders are diligent in protecting company IP and like to see founders use them.
Brian McConnell
2
0
Brian McConnell Entrepreneur
Head of Localization at Medium.com
I won't sign an NDA. Its mostly useless in California and its a signal of paranoia that can manifest itself in all sorts of ways. I just exercise judgment in what I reveal to new people and avoid legal entanglements.
Alison Lewis
1
0
Alison Lewis Entrepreneur • Advisor
CEO/Creative Director
I amDEFINITELYnot a lawyer, but here is our perspective as a hardware/fashion company who has clients and seeking funding.

We work discrete clients in a very competitive area, they require us to have an NDA to disclose what we are working on and that NDA is fairly heavy. When I first saw it, I felt it was a bit much, but over time I realized that it is what is best for the company and makes my clients and investors feel at ease. Truly, signing is really about the people and who you trust. If you are not comfortable signing an NDA, then let them know. In our case, it would mean we could not work with you, but that is not always the situation. In fact, many founders may respect your decision or make change to the NDA based on your needs and concerns.

When I am advising, 1/2 of the companies ask me to sign NDAs and 1/2 of them don't. It really depends on the company, product, and context.
Eric F. Galen
2
0
Eric F. Galen Entrepreneur
Partner at Hertz Lichtenstein & Young LLP | Venture Catalyst at Membrain Ventures
As a lawyer and entrepreneur, I suppose I ought to weigh in here ;-)

Post-term non-competes are tough to enforce in CA, and generally only used in cases where a shareholder sells all of his/her goodwill and stock to a company, in which case the company can enforce a non-compete for a reasonable time and within reasonable boundaries. Non-compete provisions that are effective during engagement/employment are of course far more enforceable.

NDAs are far easier to enforce, and while there are some limitations, I would never advise anyone to take an NDA lightly.

Beyond the strictly legal aspects, you raise the issue of whether being asked to sign an NDA before having initial conversations with a potential co-founder is a good thing. I've found that those who insist on NDAs before having even high-level discussions are generally more paranoid and/or less seasoned entrepreneurs. I won't sign an NDA just to start initial conversations with potential co-founders, nor do I ask others to sign an NDA in similar circumstances.

Having said that, if one has truly valuable and confidential information, then he/she should be careful about disclosing specifics without an NDA in place. In other words, I normally have high-level discussions sans NDA, and then get an NDA in place before sharing the secret recipe, so to speak.

I deal with NDAs, non-competes and all other co-founder and startup issues all the time - if you ever need help, just email me at [removed to protect privacy]


Jacob Kojfman
1
0
Jacob Kojfman Entrepreneur • Advisor
Experienced technology and corporate lawyer, focusing on SAAS
I am a lawyer. A non-compete is really designed to make sure you cannot go work for a competitor because you will have certain knowledge. In most Canadian areas, a non-compete is legal if it is reasonable: minimal time for non-compete, minimal geographic limitation. It is usually reserved for higher level people. When a CEO left Motorola to go work for Nortel he couldn't work until his non-compete ran out. Of course, as a c-suite, he had a great package when he left Motorola.

An NDA is designed to protect the non-public information that a disclosing party is giving to the recipient. In the case of these co-founders, they don't want you to steal their ideas. What it really does is give you a contract to fall back on in case the receiving party discloses the confidential information.
Benjamin Wheeler
0
0
Benjamin Wheeler Entrepreneur • Advisor
CTO at Telepathy
non compete applies to working in that industry at all, even with totally new ideas... and often includes non disclosure seconds too. non disclosure applies to working on those specific ideas and business methods (or may telling people about them). i am not a lawyer and definitely not a California lawyer. but i imagine it's not really true that "non competes are illegal", just that the right to work in an industry cannot be voluntarily revoked even in a written contract. so you could probably write a contract that you consider a form of noncompete as long as it doesn't attempt to revoke that right, and it could be enforceable. IF I'm correct about that, then would an NDA that includes pretty broad revocation of the ability to work in the industry be illegal? not exactly, instead those sections would just not be enforceable. but the other sections that involve not revealing info could still be enforced. -Ben 917 254 1578 This was probably dictated. Please forgive my errors and brevity.
John Rodley
0
0
John Rodley Entrepreneur
CTO & co-founder at Twiage
I don't sign NDAs, though I did once upon a time. What I did do last year that worked pretty well was to state when the question came up - "I'm not signing an NDA so don't tell me the special sauce." This was with a guy who had reached out to me and I had specialized experience in the field he was attacking. I talked to him many times over the course of a few months, never signed the NDA, never heard him state out loud what the special sauce was (though it was fairly easy to figure out). He had to jump through some hoops, but basically it was his problem, not mine. He talked around it and we had a fine time without it.

It was okay for him to ask, and we laughed about it, but it would have been dumb for me to sign. That kind of stuff happens.

The thing that turned me into an NDA refusenik was when I talked to a web analytics company about a straight up VP job. The next five guys I talked to were all doing web analytics and I realized that if I took that stupid NDA seriously I literally couldn't talk to any of those guys. Haven't signed one since.

It's also worth noting, anecdotally, that I've talked to a few dozen potential cofounders since joining FD and haven't run into an NDA once. The closest I've gotten is twice, the two most serious ventures, said something along the lines of "this is all NDA material" when they got to the juicy stuff.

I'd look at it this way in your shoes. You're a dev, and the guy with an idea who's looking for a tech cofounder needs you WAY more than you need them. You need to sing that to yourself until you believe it. You're not looking for "a job" where the power relationship is all on the employers side. You want to help make this guy rich and without you, or someone like you, that doesn't happen. If he's going to risk not getting the right guy within his window of opportunity because he's insisting on NDAs, then he's a chucklehead imho. Move on and be glad you learned something important about the guy at a very low time cost.
Matt Mireles
0
0
Matt Mireles Entrepreneur • Advisor
Good question. Signing a piece of paper would definitely give the counterparty some ammo in a specious, Winklevoss-esque lawsuit were your startup to get HUGE. From what I know about the law, it's easy to file a bullshit claim and win a settlement due to the high cost of fighting back. Being right doesn't matter so much as having the time/money/will to prove that you're right. The less evidence the other side has, the less time/money/will you will need to muster to prove them wrong. --
Jeevan Koneru
0
0
Jeevan Koneru Entrepreneur
Software Developer
Here is a perpetual question I've always had regarding NDAs. I've probably signed 4-5 (co-founder) NDAs in the past few months and not one of them talks about what it is that I am actually not supposed to 'disclose'. On what grounds does a company file a lawsuit saying that someone has broken said NDA? If there is no mention of the information that is being shared as part of an NDA, how would a court determine the source of such information?

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