Non-Competition
What is the Non-Competition section? One of the ways a Buyer protects its investment is by limiting future competition by the Seller, who is more knowledgeable about the Business (and often the industry) than the Buyer. By limiting competition from the Seller, this covenant protects the Business’s relationships with customers, suppliers, employees, and other stakeholders.
The Middle Ground: In most acquisitions, the Seller agrees not to compete with the Business after the Closing. The covenant terms describe who is not allowed to compete (generally, the Seller and its Affiliates); the duration of the restriction, which varies from state to state based on differences in state law (typically anywhere from 1-10 years); the specific acts that are restricted, either defined in detail or by reference to the acquired Business (e.g. any business that directly or indirectly competes with the Business); the geographic scope of the restriction, which is also either defined in detail or based on where the Business operates; and any exceptions to the restriction on competition. The covenant will likely also prevent the Seller from inducing any current or prospective clients to end their relationship with the Business, although this restriction is sometimes included in a separate non-solicitation covenant.
Purpose: This covenant is an essential component of the Agreement because of its impact on the value of the deal to the Buyer. In small to mid-sized businesses, much of a company’s value is derived from the owner’s relationships with customers, suppliers, and others in the community. Significant value also stems from the owner’s know-how and familiarity with the industry. If the owner were to go out and start a competing business following the acquisition, the value of the Business in the hands of the Buyer would likely plummet.
Buyer Preference: The Buyer wants each term in the covenant other than the exceptions to be defined as broadly as possible while still being enforceable. Restrictive covenants such as non-compete agreements are disfavored by the courts. In this context, that means overbroad restrictions that don’t directly protect the acquired Business will likely not be enforced. Whether a restriction goes too far depends on the facts and circumstances surrounding the particular acquisition, as well as the state law that governs the Agreement, so it’s important to tailor the covenant terms to the situation.
Seller Preference: Whether the Seller wants to spend significant time and effort negotiating these terms depends on its post-acquisition plans, but in general it wants the restrictions to be as limited as possible and the exceptions to be plentiful. More specifically, if the Seller plans to invest in other ventures following the acquisition it wants to make sure that this covenant does not prevent it from doing so. Some investments will undoubtedly be restricted (e.g. investing in a direct competitor), but the Seller wants to make sure that any such restrictions are directly related to protecting the value of the Business. If the Seller is only selling a division of its business, it also needs to make sure none of the restrictions affect its ongoing operations.
Differences in a Stock Sale Transaction Structure: None.
