Because of the “greying” of the investment advisory industry, it is becoming increasingly more important for investment advisory firms to consider succession planning issues, whether via prospective internal succession or an external acquisition or sale.
For an internal succession, it makes sense to execute a well-drafted shareholders’ agreement or operating agreement that addresses the terms and conditions for the disposition/succession of ownership interests (i.e., stock, membership interests, etc.) upon the occurrence of various events, including admitting new owners, regulatory disqualification, death, disability, retirement, and termination of employment. For an external succession, a firm should have a well-drafted purchase/sale/merger/joint venture agreement that adequately protects the respective parties’ interests before and after the transaction. However, whether the transition will be internal or external, critical to any potential successful succession is having the appropriate underlying documents in place to protect the firm’s proprietary interests in its client relationships; specifically, a firm’s needs restrictive covenant agreements.
While many principals of investment advisory firms think about the day that they may sell their largest asset, their firm, too many firms do not adequately protect their most important asset, their client relationships. It is imperative for every firm to make sure that it has taken appropriate steps to protect its client relationships relative to firm employees (generally, the firm’s investment advisor representatives) that may service those relationships. Without doing so, the firm is exposed to the unfortunate consequence of losing client relationships to departing employees. How does the firm avoid this unfortunate consequence? Require each employee who is responsible for establishing or serving clients to execute a restrictive covenant agreement. Although it is a relatively simple process, too many firms have either not done so, or have agreements in place that do not protect the firm for a variety of reasons, including poor drafting or lack of consideration.
Generally, there are two types of restrictive covenant agreements that an investment advisory firm can require its employees to execute:
- Non-Competition: Under this agreement, the firm generally seeks to prohibit the employee from accepting employment in the investment advisory/financial services industry for a certain period of time. In addition to a time limit restriction, non-competition covenants can be modified to limit the restriction by geography. For example, an agreement can include a stipulation that the employee cannot accept employment for a period of two years in a specific state, or within a one hundred mile radius of the firm’s offices.
- Non-Solicitation: Under this type of restrictive covenant, the firm does not seek to prohibit the employee from accepting employment in the same or similar industry, but rather seeks to prohibit the employee for a certain period of time from soliciting to render or rendering services to firm clients wherever located. The non-solicitation covenant can be modified to limit or expand the client prohibition to past and current clients, and prospective clients reasonably identified by the firm prior to the employee’s termination.
The Particular Benefits Of Non-Solicitation Agreements
Both types of restrictive covenants are intended to protect the company’s legitimate business interests, most important among them being its client relationships. The primary difference is whether the employee will be prohibited from seeking or accepting gainful employment in the same industry as that of the firm (i.e. non-competition), or the employee will be permitted to become employed in the same industry, but not with the benefit of the firm’s clients or employees (i.e. non-solicitation).
I favor the non-solicitation covenant. Certain states generally tend to look unfavorably upon or prohibit non-competition covenants based upon the principal that it is contrary to public policy to prohibit an individual from making a living in his/her chosen profession. Thus, if the enforceability and/or reasonableness of the non-competition covenant could potentially be challenged, the firm is much better off seeking a reasonable non-solicitation covenant that is generally enforceable.