You and several friends start a new business and operate it as a limited liability company (LLC). Now that you’ve completed the first step—choosing a business entity—it is essential to prepare an operating agreement. The operating agreement is a contract that governs the operations of the LLC and sets forth the arrangements made among the members, including their rights and responsibilities upon the withdrawal of a member. Although a departure from the business may be the last thing on anyone’s mind, planning is essential. A non-competition or non-compete clause can help protect the company from harm inflicted if a former member forms a competing business.
What Is a Non-Competition Clause?
A non-compete clause protects business assets like goodwill, confidential information, and trade secrets by preventing the former member from using the knowledge gained while participating as a member of the LLC to compete against the LLC.
If the operating agreement contains a non-compete provision, a former member can be precluded from engaging in a similar type of business directly or indirectly in competition with the LLC. The former member may compete with the LLC if the operating agreement does not contain such a clause.
In addition, the non-compete clause may prevent the member from soliciting the LLC’s clients or customers for the business. Usually, such provisions take effect after the relationship has ended, although they sometimes may preclude members from competing with the LLC during their membership in the LLC.
Because non-competition provisions restrict the former member’s ability to secure future employment, they will only be enforced if they are not unduly burdensome. They must limit competition only for a reasonable period and in a reasonable geographic area, and the services the former member may provide in a competing business must not be unduly restricted.
- Note that the standards for the enforceability of non-compete clauses vary from state to state, so work with an experienced business planning attorney to ensure your non-compete clause and LLC operating agreement are enforceable. For example, in some states, the LLC statute imposes a duty not to compete on managers and members that must be explicitly waived in the operating agreement to avoid applicability.
Does My LLC Really Need One?
Members of LLCs often have intimate knowledge of the business, such as its trade secrets, confidential information, and customer lists. If members may compete with the business immediately after they withdraw and in the same geographical location, the financial success of the original business could be jeopardized.
Although many LLCs are formed by small groups of friends or family members who get along well and trust each other in the beginning, you cannot ignore the possibility of a dispute arising. Circumstances can change, and it is essential to try to prevent disagreements from undermining the success of your business. Including a non-compete clause in your operating agreement will help protect your business against preventable harm.
We Are Here to Help
If you are interested in protecting your new or existing LLC, we can help you draft or amend your operating agreement to include necessary provisions, such as a non-compete clause and others specifically tailored to meet your business’s needs. Please contact us today to schedule a discovery phone call.
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