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Restrictive covenants: Protecting your business whilst scaling-up

23/06/2021

At a glance

Having reached a certain size (both in terms of turnover and personnel), the scale-up phase of a company’s growth is often the most challenging and rewarding. At this point, the company is likely to experience a steep rise in employee headcount to support rapid business growth*. To help ensure that confidential information, trade secrets, customer connections and workforce stability are protected, decision makers in scale-ups should consider including effective restrictive covenants in employment contracts.

Stephen Ravenscroft and Alfie Bright from our employment team provide an overview of the key issues for scale-ups to consider when using restrictive covenants to protect business interests.

Why use restrictive covenants?

It is likely that your employees will access confidential information, strategic plans, customer and supplier details during their employment, and will be involved in relationships with customers and suppliers which may be critical for your business. They will also work with other key employees and consultants. Departing employees may be tempted to use such information and connections, either for their own business or at a new employer.

Restrictive covenants (also called post-termination restraints) are clauses included in employment contracts that are intended to protect against unfair competition from former employees for a limited period after their employment ends.

What restrictive covenants do you need?

Typical covenants include:

  1. Non-competition – prohibiting the former employee from being employed or engaged by a competitor;
  2. Non-solicitation – prohibiting the former employee from soliciting clients for their business;
  3. Non-dealing – prohibiting the former employee from dealing with the company’s clients;
  4. Non-poaching – prohibiting the former employee from enticing colleagues to leave; and
  5. Noninterference – prohibiting the former employee from interfering with the company’s relationships with suppliers.

To be enforceable, a restriction must go no further than is reasonably necessary to protect a legitimate business interest. What is “reasonable” will depend on your business circumstances and the particular employee’s role. Therefore, care should be taken to ensure that the duration and geographical scope of any restrictions, and the nature of the restricted activities, are drafted as narrowly as possible to protect your company’s specific legitimate business interests.

Length of restrictions

Restrictive covenants typically range from 3 to 12 months after employment ends. Whilst it may be attractive for a scale-up to require restrictions for 12 months (or more), a restriction of this length may be unreasonably long to be enforceable, and so careful consideration should be given to the duration of any restrictions and their interplay with any potential garden leave period prior to termination.

Geographical scope?

You may wish to limit a non-competition restriction to a specified area, for example within a radius of “x” kilometres from your business premises, or “within the UK”. This can help enforceability as it would be seen as being more reasonable in comparison to a worldwide restraint, although that may be acceptable if genuine competition can occur from any location via the internet.

Nature of restricted activities

The nature of the restricted activities should be narrowly defined to reflect the employee’s current role and responsibilities in order to assist enforceability. For example, a restriction preventing a former shoe salesman at John Lewis from working in a groceries role at Marks & Spencer is likely to be unenforceable, despite these companies competing with one another.

Review restrictions

Where employees are promoted or receive additional responsibilities, you may need to review whether their restrictions are adequate and appropriately targeted in scope. If they are not, updated restrictions should be agreed with the employee.

What now?

By tailoring restrictions in future contracts of employment and reviewing the restrictive covenants in current contracts, your business will be able to grow with the confidence that significant business interests are protected, as far as possible.

If you have any queries about restrictive covenants, please get in touch with our employment team.

(* The average number of employees UK scale-up companies is 103. Source: ‘ScaleUp Insights, ONS ScaleUp Landscape’ ScaleUp Institute – August 2020)

You may also be interested in our ‘Go to Glossary: A two minute glossary to common investment terms for scale-ups’

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Stephen Ravenscroft
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    Alfie Bright
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