Following Silicon Valley’s lead? Reforming non-compete arrangements in Australian PE/VC deals

For over a year, the Commonwealth Government has been considering ways to revitalise competition policy by developing options for long‑term pro‑competitive reforms, including through the Council on Federal Financial Relations. This has put the issue of non-compete clauses in employment and related contexts squarely on the table.

The Commonwealth’s Employment White Paper of September 2023 identified non-compete clauses as potentially hampering job mobility, innovation and wages growth. In April 2024, the Competition Review Taskforce released an issues paper entitled Non-competes and other restraints: understanding the impacts on jobs, business and productivity for public comment. And the question of whether the use of non-compete clauses should be restricted was raised again in the Revitalising National Competition Policy consultation paper published in August 2024.

While the focus has been on restraints contained in employment contracts, the commercial exposure is clear for venture capital (VC) and private equity (PE) firms, and the businesses in which they invest, given investors routinely require founders and key management to be bound by non-compete clauses as a condition to providing capital.

Recent developments abroad

In looking at the issue, the Australian Government is following an international lead. In May 2023, the UK Government proposed to limit the duration of non-competes to three months. This proposal has not yet been enacted by the new UK Government.

A more decisive stance is evident in the United States. On 23 April 2024, the Federal Trade Commission (FTC) voted to finalise a rule banning non-competes nationwide. The FTC speaks of public policy benefits, estimating this will result in over 8,500 new businesses and up to 29,000 additional patents per annum. The rule was scheduled to take effect on 4 September 2024, however a Texas federal court judge recently set aside its enforcement.^[1] The dispute over the enforceability of non-competes continues, with the FTC “seriously considering a potential appeal” and litigation ongoing in other US jurisdictions.

Potential impact on VC and PE firms

If Australia moves to restrict the use of non-compete clauses, the implications for VC and PE firms will be significant:

• deal structuring: reforms could alter deal structures in M&A and investment rounds, as investors may be reluctant to acquire or invest in businesses without protections to ensure key employees do not depart to competitors.
• talent retention: retention strategies for key employees would need to be revisited, with a greater weight placed on management equity in the absence of non-competes.
• valuation concerns: there may be increased uncertainty in deal valuations, especially where considerable value is tied to the know-how of key individuals or their customers, staff and business relationships. Increased uncertainty may lead to lower deal valuations, which will be a negative outcome for business owners.

The Silicon Valley model

It has been argued by some that Silicon Valley’s rise has benefitted considerably from California’s prohibition of non-compete clauses, dating back to 1872.^[2] Proponents assert that this has accelerated innovation, with “knowledge spillovers” allowing individuals and their ideas to spread to where they are more likely to be commercialised.^[3] In California, there are many examples of the movement out of ventures by employees who form new start-ups. For example, after leaving Oracle, Marc Benioff founded Salesforce, now valued at over US$150 billion.

Non-compete clauses and their prevalence in Australia

In Australia, non-competes are commonplace, restricting both senior executives and (somewhat surprisingly) junior employees from joining competitors or starting new competing businesses after the relevant employment relationship expires or is terminated. Legal limitations apply, for example on the duration of the applicable period and activity restrained. The e61 Institute says that one in five Australian workers have a non-compete clause in their employment contracts. These clauses are particularly common in financial services, professional services and technology sectors.^[4]

Benefits and the need for entrepreneur reinvention 

Non-compete clauses offer several benefits for companies and investors. When a key executive, deeply knowledgeable about a particular business or sector leaves, the business risks losing both the individual and its competitive edge. To mitigate this, non-competes ensure:

• safeguarding investments: securing value and know-how gained by employees via training, research and development funded by the business;
• intellectual property protection: preventing unauthorised use of trade secrets and confidential information (such as solicitation of clients and suppliers); and
• promoting employee development: incentivising business to undertake development and training initiatives, with the assurance that their capital and intellectual assets are safeguarded.

Where non-compete clauses are in place, key executives and other employees who leave a business must either wait out the restraint period, or turn their mind to a new venture or industry, promoting innovation and entrepreneurship.

Non-compete clauses in business sales and funding rounds

Non-competes are also common in business sale agreements and funding round documentation, including in venture and PE deals. Non-competes can secure the value of a business for the investor by preventing executives or significant equity holders from engaging with competing ventures.

Yet, as the Law Council of Australia notes, Treasury’s Issues Paper is “silent on the use of restraints of trade in a business sale context”, despite significant overlap with post-employment restraints.^[5] This omission is unhelpful for VC and PE firms trying to navigate this minefield.

Protecting interests

With potential regulatory shifts in Australia on the horizon, it is timely to now review employment contracts and business sale agreements in this context. At the same time, it is worthwhile considering additional or alternative legal means of investment protections, e.g. confidentiality agreements, management incentive arrangements and fixed term contracts for executives.

Restraint of trade law is complex, involving several sources of law.  The risk of challenges to non-compete clauses in the current environment is high. That risk can be minimised in the interests of all parties with proper drafting and review of specific circumstances non-compete clauses on a case-by-case basis, ensuring the specific clause is no wider than is reasonably necessary to protect a business’s legitimate interests. That is a central legal test. Put bluntly, mitigating potential disputes over non-compete clauses requires proactive measures. 

Looking ahead

Whether Australia will follow the lead of the UK or the US remains to be seen. Regardless, the need to protect intellectual capital remains. While non-competes have traditionally been used to protect investments, the shifting regulatory landscape calls for a re-evaluation of these strategies. The know-how acquired by key personnel forms part of a venture’s vital intellectual capital. As uncertainty grows, VC and PE firms must adapt to ensure their investments and deployed capital are adequately safeguarded.

^[1] Ryan LLC v Federal Trade Commission (ND Tex, No. 3:24-cv-00986-E, ECF No. 211, 20 August 2024).
^[2] See California Business and Professions Code § 16600.
^[3] Ronald Gilson, “The Legal Infrastructure of High Technology Industrial Districts: Silicon Valley, Route 128, and Covenants Not To Compete” (1999) 74(3) New York University Law Review 575. 
 ^[4] Hui Chia and Ian Ramsay, “Employment Restraints of Trade: An Empirical Study of Australian Court Judgments” (2016) 29(3) Australian Journal of Labour Law 283. 
^[5] Law Council of Australia, Submission to Competition Review Taskforce, Worker non-compete clauses and other restraints (7 June 2024) 17 [71]. 
^[6] Equity law (duty of good faith and fiduciary duty), statutory law (Corporations Act 2001 (Cth) and the Restraint of Trade Act 1976 (NSW) and common law (specifically contract law).