M&A Non-Compete Agreement | A Complete Guide
When a business changes hands, it’s customary for most buyers to request that the seller sign a non-competition agreement (commonly known as a non-compete) during the closing process. In fact, many buyers are hesitant to acquire a business without a firm commitment from the seller to refrain from competing in the same market after the sale.
The significance of non-compete agreements can vary across industries. In sectors where the seller could easily reenter the market and compete with the buyer, like professional practices or service-based businesses, these agreements tend to be more intensely negotiated.
Conversely, in industries where post-sale competition by the seller would be challenging, such as those requiring substantial infrastructure investments (e.g., storage facilities, hotels) or retail businesses with limited market reach and long-term leases in prime locations (e.g., high-profile restaurants), non-competes may carry less weight.
It’s worth noting that some states, like California, deem employer/employee non-compete agreements illegal. However, non-competes related to the sale of a business are generally legal in all 50 states.
But what if you intend to remain active in the industry post-sale? What’s the typical duration of a non-compete, and are there geographic boundaries to consider?
We delve into these questions and more in the following article, providing insights into eight specific factors to contemplate when crafting a non-compete agreement.
Typical Time Frame and Geographic Boundaries of Non-Competes
Typically, the duration of most non-compete agreements falls within the range of three to five years.
The geographic scope of the non-compete clause usually aligns with the business’s market reach. For instance, if the business draws its customers from a 5- to 10-mile radius, it’s common for both parties to negotiate a non-compete spanning that distance.
In many cases, sellers have no intentions of re-entering the same business arena.
In such scenarios, sellers often offer generous non-compete terms, extending for five years or more, and encompassing entire counties or even states. Some sellers have even expressed willingness to extend the non-compete duration to an astonishing 100 years.
What if I Want to Stay in the Business?
If you’re selling your business but wish to continue your involvement in the same industry, it’s crucial to communicate your intentions clearly with the buyer. Engage in a candid discussion about your post-sale plans and what you envision doing. Subsequently, enlist the expertise of a seasoned attorney to draft a non-compete agreement that reflects your mutual understanding.
A well-crafted non-compete should leave no room for ambiguity. It should precisely outline the permissible activities.
A meticulously drafted agreement will provide a precise definition of a “competitive business” and specify the roles or capacities (e.g., employee, owner) in which the seller can engage. Competition can manifest in various forms, whether it’s direct (e.g., as an owner) or indirect (e.g., as a passive investor). This definition can be either inclusive (e.g., “The seller is allowed to…”) or exclusive (e.g., “The seller is prohibited from…”). Rest assured, an experienced attorney will ensure the agreement aligns with the parties’ specific requirements.
Enforceability of Non-Competes
The enforceability of a non-compete agreement can be influenced by its duration, with some asserting that shorter non-competes are more likely to hold up in court. However, the extent to which this holds true can vary significantly from one state to another. Generally, most seasoned attorneys concur that a five-year non-compete is typically enforceable.
It’s worth noting that non-compete agreements are illegal in certain contexts in some states, most notably in California, where they are prohibited in employer-employee relationships.
In the context of selling a business, non-compete agreements are legally permissible in all 50 states. Moreover, most states establish criteria for what is considered reasonable in such agreements, often delineated in both statutes and case law. In many instances, delving deep into the intricacies of a specific state’s non-compete regulations is unnecessary. A fundamental understanding of non-compete principles, in general, is often sufficient to craft a robust and effective agreement.
Non-Competes for Franchises
When it comes to selling a franchise, the need for a separate non-compete agreement often becomes redundant, thanks to the existing provisions within the franchise agreement itself. Typically, franchisees are already bound by a non-compete agreement with the franchisor, which effectively prohibits them from competing in the same market if they decide to sell the franchise.
This pre-existing agreement remains in force even after the sale. However, it can be a good practice to offer the buyer an additional non-compete agreement to bolster their confidence in the transaction. It’s important to note that, generally, only parties to an agreement have the capacity to enforce it. Consequently, unless the buyer becomes a party to the existing non-compete agreement, they may not have the legal standing to enforce it independently.
Other Considerations When Signing a Non-Compete
Both parties involved should consider the following key questions:
- Is the non-compete agreement solely binding on the seller, or does it also extend to the seller’s spouse?
- Is the non-compete agreement transferable if the buyer opts to sell the business in the future?
- Can the non-compete agreement be revoked if the seller provides financing for the sale, and the buyer subsequently defaults?
- Is the non-compete agreement revocable if the seller needs to reclaim the business and occupy the premises?
- What are the available methods for enforcing the agreement and the remedies in case of a violation?
- Is the seller permitted to work as an employee for another company following the sale?
- What types of businesses can the seller engage in post-sale?
- Does the non-compete agreement cover the solicitation of employees, customers, and vendors?
Are Non-Compete Agreements Legal in a Business Sale?
Are non-compete agreements even legal? Can a buyer require me to sign one when selling my business, and is that legal? Can I impose non-competes on my employees, or would that also be illegal? Are there alternative ways to safeguard my business without using non-competes?
Yes, non-competes are indeed restricted in some states.
However, this prohibition primarily applies within an employment context. For instance, states like California, Montana, North Dakota, and Oklahoma prohibit non-compete agreements for employees.
Nevertheless, when properly crafted, non-compete agreements remain legally valid. In the context of selling a business, non-competes are legally enforceable in all fifty states.
Establishing the parameters of a non-compete agreement stands as a pivotal component in the buying or selling of a business. Delve into the considerations outlined here with precision, ensuring a robust and unequivocal non-compete agreement becomes an indispensable facet of your sales transaction.