Noncompete Clauses Foolishly Hinder Fintech Innovation. Let's Ban Them.
Plus, PayPal's days of breakneck growth are over.
Number of the Week: 10 (explanation below)
Noncompete Clauses Foolishly Hinder Fintech Innovation. Let’s Ban Them.
When Sam Altman, cofounder and CEO of OpenAI, was abruptly fired by the board of the San Francisco-based startup in November 2023, it sent shock waves through the technology industry. Corporate palace intrigue aside, the most gobsmacking aspect of the drama was Altman’s ability just a few days later to join Microsoft as CEO of its new advanced artificial intelligence (AI) research team, which would presumably compete with OpenAI, whose largest investor and partner was Microsoft.
If you were to randomly ask employees on the street about Altman’s shocking hire by Microsoft—and, really, who wasn’t paying attention to this business saga as it played out?—the likely reaction: It’s good to be Sam Altman (and that was before his triumphant return to OpenAI, with President Greg Brockman in tow, within five days of being forced out).
That’s because for U.S. employees in most states, the Altman-Microsoft scenario—or anything even remotely similar—is out of the question. Bound by noncompete agreements or clauses, often embedded within other corporate documents that are unwittingly agreed to, employees are handcuffed by post-employment restrictions that prevent them from working at a competitive company, developing a competitive product or launching a rival startup. At the very least, getting out from underneath a noncompete in states that allow them involves protracted, costly legal representation to challenge the agreement’s enforceability. “In general, I consider noncompetes to be anti-employee intimidation. They only serve the company. It can only be good for innovation when they are banned or disregarded,” said Techonomy Media founder David Kirkpatrick, longtime technology journalist, editor, and author of The Facebook Effect: The Inside Story of the Company That Is Connecting the World, in an email to FIN. “Business has become enamored of numerous small offensive and deliberately intimidating legal tactics to ostensibly protect its intellectual property.”
Call it mission creep. About one in five American workers are bound by noncompetes, according to the Federal Trade Commission (FTC). Only five states—California, Colorado, Minnesota, North Dakota and Oklahoma—ban virtually all noncompetes, with very narrow exceptions, such as for certain sales of businesses. New York was poised to become the sixth state to ban noncompetes, but Governor Kathy Hochul vetoed Senate Bill S3100A, sponsored by Senator Sean Ryan, in December 2023. Other states that allow noncompetes, including Maine, Maryland, New Hampshire, Rhode Island, Washington, Oregon and Nevada, are moving to put additional restrictions on them, such as higher compensation thresholds for employees.
Research shows that the widespread use and enforcement of noncompetes not only limit employee job mobility and wages, but also stifle information flows, innovation and entrepreneurship across industries, according to Catherine Lyons, director of policy and coalitions for the Economic Innovation Group (EIG), a bipartisan research and data-driven public policy organization founded by Sean Parker (of Napster, Plaxo and Facebook fame), John Lettieri and Steve Glickman. Lyons cites a recent working paper from the National Bureau of Economic Research, Innovation and the Enforceability of Noncompete Agreements, that specifically examined how policy changes to the use of noncompetes affected innovation and found “that an average-sized increase in noncompete enforceability resulted in a decrease in patenting by 16 to 19 percent over the following decade.” Further, other research found that “inventors subject to an increase in the enforceability of noncompetes are 67 percent more likely to change industries altogether. Together, these findings indicate that new inventions and breakthrough innovations are substantially reduced by the use of noncompetes,” Lyons said in an email to FIN.
The negative impact on employee wages, industry innovation and corporate competition is at the heart of the FTC’s proposed Non-Compete Clause Rule, which would prohibit employers nationwide from imposing noncompetes on employees. It estimates that the proposed rule, announced in January 2023, could increase wages by nearly $300 billion per year and expand career opportunities for about 30 million Americans (other estimates put the number as high as 60 million). The FTC, which received 27,000 comments on the draft rule, is reportedly due to vote on its final rule in April 2024.
Lina Khan, chair of the FTC, was blunt in her assessment of the rationale for the proposed rule, saying in an interview with Wired Editor at Large Steven Levy that noncompetes are economically harmful because “when you lock in workers, most innovation is totally blocked.” The proposed rule would also apply to independent contractors and anyone who works for an employer (paid or unpaid). In addition, it would require employers to revoke all existing noncompetes and notify workers that they are no longer in effect.
In EIG’s comment letter to the FTC, it argued that "[to] really understand how noncompetes relate to—and impede—innovation and competitiveness, it is helpful to look to regional industry clusters—the geographic areas in which most of the country’s most innovative and competitive industries concentrate. These clusters are sustained by networks of complementary firms, healthy worker churn, new entrepreneurs, technology spillovers, and intense competition in both product and labor markets.”
To that point, a look at venture capital (VC) funding by state is a telling indicator of where investment in innovation is occurring and which states arguably stand to gain economically from a virtual ban or placing more severe restrictions on the use of noncompetes. The top 10 states for VC investment include California, Massachusetts, Delaware, Wyoming, Vermont, New York, Washington, Colorado, Utah, and North Carolina, respectively (California and Massachusetts are tied), according to the Best States ranking by U.S. News & World Report. Of these, only California and Colorado have banned noncompetes.
While the FTC’s bold intentions with the rule are clear, it won’t be easy to put it into effect—and it will certainly be legally challenged, though the agency argues that it has the authority to enforce such a rule based on “a preliminary finding that noncompetes constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act.”
Banning noncompetes is a contentious issue at the state and federal levels, but the groundswell of opposition to them is intensifying, if for no other reason than it’s becoming harder to dismiss the data that suggests eliminating or severely restricting them will lead to greater job mobility and wages, innovation and U.S. gross domestic product (GDP), particularly in service-producing industries that are projected to see the fastest growth in output. From 2022-2023, three of the five fastest-growing industries in terms of total output are in the information sector, according to the U.S. Bureau of Labor Statistics, highlighting the increasing impact of technology and digital infrastructure on the U.S. economy, including its intersection with other vital sectors such as finance and insurance. “Limiting the use of noncompetes would have an outsized impact on increasing the flows of talent, ideas, and information, all necessary components for an innovative and dynamic U.S. economy,” said EIG’s Lyons. “Employers, employees, and consumers alike would stand to benefit from a national labor market with increased mobility and competition—the essential ingredients for more innovation.”
For its part, New York is the second largest U.S. fintech hub (behind California), with more than 1,500 fintech companies at various stages of funding and across different segments of the financial industry. After vetoing the Senate Bill, Governor Hochul asked the Senate to revise the noncompete bill, suggesting it contain carveouts like noncompete laws in Illinois, Maine and Washington that essentially balance the job mobility and wage needs of lower- to middle-income employees with a salary threshold of $250,000 and sale-of-business exception. Reluctant to include a salary threshold, Senator Ryan said “[a] salary threshold that restricts only high-end executives in a small upstate town could restrict every worker at a Manhattan tech company.” And, of course, high-paid tech executives in New York, a global financial center, are the most likely to have access to venture capital and the ability to recruit talent and launch a rival company or product. “Restricting the use of noncompetes, especially for those at higher income levels who are more likely to start their own firms, would allow more workers the flexibility to take their hard-earned knowledge and go into business for themselves, and likely lead to increased rates of new firm formation and the creation of more jobs,” Lyons said.
Some New York employment attorneys see noncompetes as an ineffective way to retain top talent and completely unnecessary, given the existence of other state and federal laws that “robustly” protect the trade secrets of companies. The use of noncompetes by employers amounts to what Miriam F. Clark, founding partner of New York employment firm Ritz, Clark & Ben-Asher, calls using “a stick instead of a carrot” to manage talent. As for New York state’s prospects of revising the bill so that noncompetes are banned or restricted in the future, Clark says: “The matter needs to be in the public eye. People need to be educated; even the business community needs to be educated. I’m in New York—there needs to be legislation. I'm clear on that.”
—Holly Sraeel
PayPal Is No Longer a Growth Machine
PayPal, which turns 25 this year, has been around for so long that it’s hard to remember what the financial world looked like before it emerged. Activities that consumers do every day with their phones—pay for a coffee at the register, or send money to friends—were unimaginable at the beginning of this century, and PayPal was at the forefront of digitized money. It piggybacked on eBay for more than a decade, and then spun off as its own company in 2015. Along the way, it invested in or outright purchased several important fintech companies, including Honey and Venmo. At the height of PayPal’s stock performance, in mid-2021, the company was valued at hundreds of billions of dollars.
And yet, in recent years, the company has often seemed like it lost its way. In an attempt to keep itself on the cutting edge, PayPal has tried to be all things to all people, leading to some head-scratching moments. For example, in October 2021, Bloomberg reported that PayPal was considering purchasing the social media site Pinterest for $45 billion (for comparison, PayPal’s market capitalization today is about $63 billion). The deal never happened, but shareholders were confused.
Last summer, PayPal announced that it was creating its own stablecoin, backed 1:1 by U.S. dollars. “The shift toward digital currencies requires a stable instrument that is both digitally native and easily connected to fiat currency like the U.S. dollar,” said Dan Schulman, who was then president and CEO of PayPal. A few months later, the company revealed that the stablecoin was under investigation by the Securities and Exchange Commission; the details of that investigation have not been publicly revealed.
Last month, Alex Chriss, who became CEO in September 2023, said the company was about to introduce new features that would “shock the world.” The actual release involved incremental changes, such as cash-back offers and enhanced business profiles on Venmo; the world was largely unshocked.
The company has also gone through a significant leadership change. In November, having recently installed a new CEO, PayPal also announced new executives as chief financial officer and chief technical officer.
And, like many fintech companies, PayPal grew too big in the wake of the pandemic lockdown. “Our size has been slowing us down,” Chriss said in the Q4 earnings call on Wednesday. The company laid off about 2000 employees in early 2023, and another 2500 employees last month.
But even with the layoffs, PayPal seems sprawling and unfocused. In Wednesday’s earnings call, Chriss admitted: “The company has gone through significant growth over the last few years and a lot of acquisitions. We have not invested enough in creating a single platform. That again slows us down when it comes to innovation, and it slows us down when it comes to being able to leverage the data across the ecosystem.”
As a result, PayPal’s years of breakneck growth are not coming back any time soon. The company said, unusually, that it will no longer provide guidance for annual performance. Wall Street analysts, who’d expected the company’s new leadership to create growth and/or increased profit margins, were not impressed. On Thursday morning, PayPal stock was down more than 9%, although it bounced back a bit on Friday.
It’s unclear where future PayPal growth will come from. PayPal has been slowly losing active users for several quarters. In the earnings call, chief financial officer Jamie Miller attributed this to “ongoing churn of unengaged accounts in less developed markets, predominantly in Latin America and the Asia Pacific region.”
Venmo, too, has been experiencing slower growth. In December, Amazon announced that it would drop Venmo as a payment option.
Of course, PayPal remains a financial colossus. It boasts 400 million users worldwide and nearly $400 billion in total payment volume. But its transaction margins have been dropping, and its status as the king of payments no longer seems guaranteed. In a sense, PayPal is the victim of its own success. Having blazed the path for digitized payments, it now competes with several payment options that many consumers prefer, including Apple Pay, Google Pay, and various Buy Now, Pay Later services.
—James Ledbetter
FINvestments
🦈Number of the Week: The European Parliament overwhelmingly passed a measure that will require money transfers in the euro zone to take place within 10 seconds. Comparable transactions in the U.S. can take hours or even days.—James Ledbetter
🦈An Austin-based startup called Closinglock this week announced a $12 million fundraising round; the company specializes in preventing fraud in real estate transactions.—James Ledbetter
🦈 Digital Currency Group and Gemini Trust are back in the crosshairs of New York State Attorney General Letitia James, who expanded her lawsuit against the companies this week and is now seeking $3 billion in restitution—three times the original estimate—from them for allegedly defrauding more than 230,000 investors in a cryptocurrency scheme.—Holly Sraeel
🦈 BillGO, a same-day bill payment platform, is among the latest fintechs to get swept up in company layoffs this year. It just announced that 80 people—mostly engineers—would be let go by the end of March, attributing the move to a “material change” in the Fort Collins, CO-based startup’s current business opportunities. BillGO has raised nearly $144 million, with its latest funding an option/warrant round of $2.5 million in January 2024.—Holly Sraeel