FTC’s non-compete rule could smooth the path to entrepreneurship
By Jennifer Weinhart, Senior Policy Advisor, Engine Advocacy & Foundation
The federal government is considering a rule change that would make it easier for would-be startup founders and employees to leave their day jobs and join the startup ecosystem. While the rule will likely face challenges in court if finalized, this marks a step in the right direction for the innovation ecosystem and would lead to the formation of more new innovative startups and give founders better access to the talent they need to grow.
Earlier this month, the Federal Trade Commission (FTC) issued a proposed rule to broadly ban noncompete agreements, except in limited instances, finding that their use amounts to unfair competition under the FTC Act. The rule comes on the heels of a 2021 executive order directing the FTC to “curtail the unfair use of non-compete clauses and other clauses or agreements that may unfairly limit worker mobility.”
In recent years noncompete agreements have proliferated across many industries and levels of employment. According to one study, roughly one in five workers are subject to a noncompete agreement, and almost 40 percent of employees have at one point been subject to a noncompete agreement. One of the biggest challenges faced by startups is the ability to access necessary talent. And with STEM workers in short supply and a broken high-skilled immigration system, post-employment noncompete agreements only serve to inhibit workforce mobility.
While the enforceability of noncompete agreements has largely been controlled by the states — with some states, like California, opting for blanket bans — the proposed FTC rule would apply across the country. If implemented, the rule would dismantle the barriers many exiting employees face in seeking new employment by broadly banning the use of noncompete agreements, with narrow exceptions. Defenders of noncompete agreements allege they’re necessary to protect trade secrets and sensitive business information. But other legal structures — including trade secrets law and nondisclosure agreements — already provide adequate protections for that information, and many employees subject to noncompetes don’t even have access to sensitive information.
The rule itself adopts a broad interpretation of the definition of “worker” to also include independent contractors, interns, and volunteers, among others, and applies to noncompetes imposed on workers but not corporate entities. Explicit noncompete agreements would be prohibited as would other de facto noncompete agreements, which in function act like noncompetes. For example, while non-disclosure agreements (NDAs) would not be subject to a ban, these agreements would be considered noncompetes “where they are so unusually broad in scope that they function as” noncompetes. If implemented, entities employing noncompete agreements would be required to rescind agreements in use that fall under the rule’s parameters.
Pursuing a broad ban on noncompetes will serve as a catalyst for increased vibrancy in the U.S. startup ecosystem. In California, the unenforceability of noncompete agreements is often credited as a contributing factor to the success of the state’s innovation sector, where workforce mobility permits ideas to “naturally flow to whichever company can best put them to use.” And as we’ve highlighted in the past, startups across the country also acknowledge the positive impact California’s noncompete ban has had on its startup ecosystem. In 2017, when she was at Madison-based startup gener8tor, she told Engine, “too much local talent and labor is stuck behind the real or perceived threats of noncompete agreements. . .One day I hope that we can achieve the virtuous cycle of innovation that is so core to Silicon Valley, where talent spins out of corporate employment, starts a company, and ultimately that company is acquired by a corporation, recirculating jobs and wealth back into the ecosystem.”
The proposed rule is open for public comment until March 20, 2023 and the FTC is soliciting comments on the proposed ban and possible alternatives, including the adoption of disclosure requirements, under which employers would disclose the use of noncompete agreements in advance of offering employment. If the rule is finalized, it would likely go into effect next year.
Engine is a non-profit technology policy, research, and advocacy organization that bridges the gap between policymakers and startups. Engine works with government and a community of thousands of high-technology, growth-oriented startups across the nation to support the development of technology entrepreneurship through economic research, policy analysis, and advocacy on local and national issues.