Loosening restrictions on non-compete for start-ups

By Dániel Aranyi, László Zlatarov, Adel Gelencser

07-2020

CodeCool Kft. (CodeCool) is a Hungarian start-up which provides training courses for software developers without any prior education. In early 2019, in a scale-up type investment round, Enter Tomorrow Venture Capital Fund (Enter Tomorrow) replaced the Luxembourg-based HAMV Foundation (HAMV) as joint venture partner to fellow venture capital fund PortfoLion. As a consequence, HAMV lost its rights granting joint control, but remained a minority non-controlling stakeholder in CodeCool. Before and also after the investment round, certain individuals instrumental to the foundation, development and operation of CodeCool remained minority stakeholders (Key Professionals). 

Enter Tomorrow notified the transaction to the GVH in early 2019. While the GVH did not raise objections (see here), it however initiated a separate investigation regarding the compliance of the 2019 investment agreement (Investment Agreement) with competition law because HAMV and the Key Professionals agreed upon a non-compete clause for a period longer than two years following the eventual sale of their respective stakes with a wide territorial scope. 

During the procedure and following negotiations with the GVH, Enter Tomorrow offered commitments to amend the non-compete provisions of the Investment Agreement as follows:

  • limit its duration to 2 years after the sale of the respective stakes of HAMV or the Key Professionals;
  • limit the territorial scope by specifying the countries to which it extends; and
  • exclude a key employee who does not own a stake in CodeCool.

The so modified non-compete clause would still go beyond what had been so far approved by the GVH according to its practice on ancillary restraints. However, the GVH decided to accept the commitments and, as a matter of principle, widen the possible scope of non-compete undertakings in the case of start-ups by accepting that:

  • a strategic investor in a start-up may undertake a non-compete obligation even though, after losing its control rights, it remains a minority owner;
  • key professionals of a start-up who are and remain non-controlling minority shareholders may agree to a non-compete clause in the frame of a transaction as an ancillary restraint in spite of the fact that they are not otherwise involved in the transaction;
  • the above non-compete undertakings may be accepted as ancillary restraints not only until the sale of the respective stakes of the strategic investor or key professionals, but also for a period of two years afterwards.

This shift in interpretation fits in with the GVH widening its practice concerning ancillary restraints already noticeable when it reviewed its General Merger Notice in early 2019.

According to the reasoning of the GVH, this case warranted special assessment, because of the target company being a start-up. It is common for start-ups that they cannot perform and grow without the key employees and other individuals who possess the know-how for the specific niche segment, technology or service. Therefore, a non-compete obligation surviving the exit of these key individuals (strategic investors) may be justified in order for the financial investor to recoup its investment in the start-up.

The CodeCool Decision is available here (only in Hungarian), and the related press release is available here (in English). The GVH’s non-objection decision is available here (in Hungarian).

For more information contact Dániel Arányi or László Zlatarov.