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The Role of Non-Competition & Non-Solicitation Agreements in a Business Sale Transaction

The Role of Non-Competition & Non-Solicitation Agreements in a Business Sale Transaction

One of the advantages of being a twenty-five year mergers & acquisitions intermediary and personally facilitating over 300 transactions involving the purchase & sale of privately held companies is that I have had the privilege of listening to the counsel of and collaborating with in negotiations many of the top attorneys in the Pacific Northwest in the creation of stock and asset purchase agreements that were comprehensive and fair to both parties.

One standard element of the document set negotiated between legal counsel for a business sale transaction is a non-competition agreement. The purpose of this agreement is to provide the buyer with a “safe harbor” to run the business after the sale is completed without concern of competition from the seller.

To be enforceable a non-competition agreement should have the following four components:

  1. A description of the activity being established for non-competition.  It is recommended that the description accurately reflect the activities of the company being sold.  The ability to enforce the agreement can be impacted by the specificity of the verbiage selected.  An agreement preventing a seller from owning or managing a manufacturing or software company can be deemed by the courts to be too broad as the spectrum of products that can be created is limitless. It is far superior to prevent a seller from owning or managing a company manufacturing precision machined aerospace parts or developing marine navigational software.  Evaluation of future activities by the seller in reference to the non-competition agreement in the later situation should be black and white for a third party. Verbiage should also be comprehensive to cover all components of operations and products historically sold or in development.
  2. Geographic Area. The geographic area referenced in a non-competition agreement should be reflective of the area served by the business.  A community favorite Italian restaurant likely draws most of its customers from a ten-mile radius around the business.  Therefore, looking at a map and evaluating customer concentration a ten mile radius circle originating at the business would likely serve as an appropriate for the agreement. A non-competition agreement in this case of the State of Washington would be excessive.  Ask yourself, if the restaurant was in Tacoma what is the likelihood the business would lose customers if the seller opened up a new restaurant with his daughter in Spokane, Everett, or even Renton.  Most businesses have a database of customers or a served marketing area, this information should be used to establish the geographic area defined in the non-competition agreement.  If a company has a website and sells goods and/or services over the internet and virtually, the marketplace served can be national or even global.  Businesses as diverse as one selling jewelry boxes online or providing collection services for delinquent accounts can have a national clientele in 2019.
  3. Time Period. All non-competition agreements must have a time period.  Typically, the time periods range from one to five years in length in sales involving privately held companies and family businesses. A time period on the longer side of the spectrum can provide peace of mind for a buyer, but the reality is that business relationships grow cold quickly, someone who is out of business for as short a period as a year may have difficulty recapturing a customer, if the new owner provides good customer service and product quality after the transition of ownership.
  4. Consideration. Agreeing to not compete with a business for a period of time is a thing of value.  To make a non-competition agreement enforceable the party executing the agreement must receive consideration (commonly money, but it can be other assets of value like stock, stock options, real estate, or even Bitcoin).

Obtaining a non-competition agreement from a seller in a business sale transaction is an expectation of the buyer. It is rare for a transaction to be completed without a non-competition agreement.  A thorough business attorney will also commonly obtain a non-solicitation agreement from the seller in conjunction with the non-competition agreement to prevent the seller from recruiting key employees to work in an unrelated business they own in the future.

The seller is commonly regarded as the biggest threat to continuity of a business model after a sale for the buyer. Securing non-competition and non-solicitation agreements from the seller mitigates this threat. However, key employees can also create a threat to a business after a sale.   This threat can exist in multiple areas ranging from a salesperson opening their own business or migrating to a competitor stealing customers to a beloved manager leaving and having people in their department follow them to a new company.

It is often prudent for a buyer to address these threats prior to or at time of acquisition. Like with the non-competition agreement negotiated with the seller in a business sale transaction, consideration is a requirement to make an agreement with an employee enforceable.  Most transactions facilitated by IBA are asset sales resulting in the need for the seller to fire all employees and simultaneously the buyer hire all employees. This provides an excellent opportunity for a business buyer to secure non-competition and non-solicitation agreements from employees as salary & wage compensation is being provided as a consideration when the individual is rehired.  It should be noted that securing enforceable non-competition agreements from employees in Washington is becoming more problematic January 1, 2020.  Details of the pending law changes were highlighted by business attorney, Michelle Bomberger, on the IBA blog in August (https://ibainc.com/blog/guest-post/changes-washington-non-compete-laws/).  It is recommended that all entrepreneurs be cognizant of these law changes, as existing non-competition agreements signed by employees may become unenforceable next year, and discuss them with their legal counsel.  If a business attorney referral is needed, IBA is happy to provide them from our referral database of attorneys.  It is anticipated with many employees that a migration will occur in 2020 by ownership from non-competition agreements preventing employees from working in an industry to non-solicitation agreements that prevent them from soliciting customers, employees, and vendors if they stop working for the business.

Knowledge is a powerful tool in the negotiation and facilitation of business sale transactions.  Intermediaries with a significant resume of completed transactions often have the ability to enhance discussions and provide ideas on legal issues when working collaboratively with clients and their attorneys.  No transaction should be completed without legal counsel.   The quality and enforceability of the agreement will likely depend on the knowledge and experience of the lawyer and intermediary on your side of the negotiating table.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.

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