Non-Compete Agreements

When a business changes hands, most buyers will expect you to sign a non-competition agreement, or non-compete, at closing. Few buyers will purchase a business without a commitment from you to not compete with them after you sell the business. 

Non-competes are more heavily negotiated in certain industries, such as professional practices or service-based businesses, in which the seller may retain a strong ability to compete with the buyer after the sale. 

They are not as important in other industries where replicating the business would be difficult for the seller after the sale, such as industries involving a large investment in infrastructure. These would include storage facilities or hotels, or retail businesses with a small market area and a long-term lease in a prime location, such as a high-profile restaurant.

Employer/employee non-competes are illegal in some states, such as California. But a non-compete involving the sale of a business is legal in all 50 states.

What if you want to stay in the industry after the sale? What is a typical time frame for a non-compete? What about geographic boundaries?

Most buyers will expect you to sign a non-competition agreement, or non-compete, at closing. 

Typical Time Frame and Geographic Boundaries of Non-Competes

The time frame for most non-competes usually varies from three to five years. The geographic area covered by the non-compete typically coincides with the market area served by the business. For example, if your customers come from a 5- to 10-mile radius, most parties will negotiate a 10-mile non-compete.

Often, the seller has no intention of re-entering the business. In these cases, most sellers offer a liberal non-compete, such as for five or more years, and covering entire counties or states. Some sellers tell us they are willing to offer the buyer a 100-year non-compete.

Enforceability of Non-Competes

Some believe a shorter non-compete is more enforceable, although the degree to which this is true varies from state to state. Most attorneys I have spoken with agree that a three- to five-year non-compete is enforceable. 

Non-Competes for Franchises

When selling a franchise, signing a non-compete may be unnecessary, as this is often addressed in the franchise agreement. The seller, or franchisee, has most likely signed a non-compete with the franchisor that would prohibit the seller from competing if the seller sells the franchise.

This agreement would bind the seller after the sale. But, it doesn’t hurt to offer the buyer a non-compete to make them feel comfortable. Additionally, you must generally be a party to an agreement to have the capacity to enforce it, so the buyer wouldn’t have the capacity to enforce a non-compete unless the buyer were a party to the agreement.

Other Considerations When Signing a Non-Compete

You should also ask yourself the following questions:

• Am I solely obligated to sign the non-compete, or does my spouse also have to sign? 
• Is the non-compete assignable if the buyer sells the business at a later date? 
• Is the non-compete revocable if I finance a portion of the sale and then the buyer later defaults? 
• Is the non-compete revocable if I have to take the business back and occupy the premises? 
• What are the methods of enforcement and remedies for violation? 
• Can I work as an employee for another company after the sale? 
• What types of businesses can I engage in after the sale? 
• Does the non-compete address solicitation of the employees, customers, and vendors?

Determining the terms of a non-compete is an integral part of the process of buying or selling a business. Give careful thought to the issues covered here and make sure you are clear on the specifics in order to ensure a solid non-compete is part of the sales transaction.

Staying In the Business

If you’re selling your business and want to remain in the business or industry, it’s best to state your intentions to the buyer clearly. Discuss your plans with the buyer and what you would like to do after the sale. An experienced attorney can then draft a non-compete that expresses your mutual agreement.

A non-compete should be specific as to what activities are permitted. A well-drafted agreement will clearly define a “competitive business,” and it will define the capacity, such as employee or owner, in which you can become involved. Competition can be direct, as an owner, or indirect, such as being a passive investor, or it can come in many other forms. This definition can also be inclusive, as in “The seller is allowed to …” or exclusive, like “The seller is prohibited from …”. Again, an experienced attorney will ensure the agreement meets the parties’ needs.

Conclusion

The intricacies of the offer stage are vast and can seem overwhelming, but if you look at each component carefully and understand how they function, you will be able to separate the good deals from the rest. Earnouts, holdbacks, and non-compete agreements all have their place in transactions, but it comes down to understanding how they work, when and why to include them, and if they fit your goals of selling your business in the first place. 

Too often, sellers will jump at receiving an LOI and celebrate, thinking they have sold their business. Buyers know this, and riddle offers with mechanisms to their benefit. Armed with an understanding of these mechanisms, you can protect yourself, get the most for your business, and get it sold. 

“The intellect is always fooled by the heart.”

– François de La Rochefoucauld, French Author