M&A Non-Compete Agreement | A Complete Guide

Executive Summary

When a business changes hands, most buyers expect the seller to sign a non-competition agreement (non-compete) at closing. Few buyers will purchase a business without a commitment from the seller to not compete with them after the business is sold.

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 (e.g., storage facility, hotel, etc.) or retail businesses with a small market area and a long-term lease in a prime location (e.g., high-profile restaurant).

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

But 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?

We address those questions and more in the following article, including eight specific considerations to take into account when drafting a non-compete.

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 a business’s 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.

What if I Want to Stay in the Business?

If you are selling your business and want to remain in the business or industry, it’s best to express 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 (e.g., employee, owner, etc.) in which the seller can become involved. Competition can be either direct (e.g., owner) or indirect (e.g., passive investor) and can come in many other forms. This definition can also be inclusive (e.g., “The seller is allowed to…”) or exclusive (e.g., “The seller is prohibited from…”). Again, an experienced attorney will ensure the agreement meets the parties’ needs.

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 experienced attorneys agree that a five-year non-compete is enforceable.

In some states, such as California, non-compete agreements are illegal in certain contexts, such as an employer-employee context.

A non-compete in the sale of a business is legal in all 50 states. Most states also develop parameters of reasonableness that can be researched in both statutes and case law. In most cases, an in-depth understanding of the state’s nuances regarding non-competes is not necessary. A basic understanding of non-competes, in general, is often enough to draft an effective agreement.

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 (franchisee) has usually 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. However, it does not 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 would not have the capacity to enforce a non-compete unless the buyer were a party to the agreement.

Other Considerations When Signing a Non-Compete

The parties should also ask themselves the following questions:

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

Are Non-Compete Agreements Legal in a Business Sale?

Isn’t a non-compete illegal? If I am selling my business, how can a buyer make me sign a non-compete if it’s illegal? Can I ask my employees to sign a non-compete, or is that illegal, too? Are there alternatives to asking my employees to sign a non-compete that I can use to protect my business?

Yes, non-competes are illegal in certain states.

But only in an employment context. For example, certain states, such as California, Montana, North Dakota, and Oklahoma, ban non-compete agreements for employees.

Otherwise, if properly drafted, non-competition agreements are legal. Non-compete agreements in the context of selling a business are legal in all fifty states.

Summary

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 that a solid non-compete is part of the sales transaction.