What kind of non-compete protection can be incorporated in a Shareholder’s Agreement?

17th Sep 2012
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As discussed earlier, a Shareholder’s Agreement or a Stockholder Agreement is a document which records the agreement reached between shareholders of a Private Limited Company.In every Shareholder’s Agreement, there are clauses regarding the rights and duties which the parties (in particular the investors [if any] and the shareholders) have vis-a-vis each other and vis-a-vis the company.

An important question which crops up in many shareholder’s agreements is over the non-compete protection which should be enforced.

Vis-a-vis other shareholders

A non-compete clause in a shareholders’ agreement is a clause which prevents shareholders from competing with the Company while they are working or involved in the Company, and also for a short period after the shareholder has left the company.

The purpose of this clause is to prevent the shareholders from leaving with the company’s secrets and business practices and working or starting a competing organisation.

Vis-a-vis the investors

In most term sheets, investors ask for a no-objection certificate from the investee company and its founders seeking a declaration that the investor can invest in or work with other companies which are in the same or similar sector as the investee company.

For instance, if an investor is investing in snapdeal.com, he may ask for a no-objection certificate that the investor can invest in Groupon or any other deals based website or company.

What rights does the Company have?

Although every agreement has the Company as a party, the company itself is not really in a position to enforce any of the rights. It is actually a matter where the investors and the other shareholders personally enforce rights against the other party.

As an entrepreneur, what clause suits me best?

As an entrepreneur, the shareholders’ agreement should definitely prevent other shareholders (and you) from leaving and working with other companies in the same or similar sector. Additionally, it should prevent you from starting another company doing the same kind of work. Finally, with the proliferation of the internet, geography is of no relevance. So it should also prevent you from starting another company of this nature in another country (so that your co-founder does not start a company in Singapore to overcome the limitations in the shareholders’ agreement)

Vis-a-vis the investor, you typically have little or no bargaining power, but it pays to scrutinise the invesment documents carefully. As long as you and your legal team are convinced that the documents will not affect your business’ freedom and personal freedom too much going forward, non-compete protection should not be a deal breaker.

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