Non-compete agreements when you buy a business

When you buy an established company, much of the price pays for things you can't touch: the name, the reputation, and the relationships the owner built with customers, suppliers and staff. All of that is worth far less if the seller opens a competing business down the road a month after closing, or quietly steers the best customers somewhere else.

A non-compete agreement (also called a covenant not to compete) is the seller's written promise not to do that, for a set time and in a set area. It's a normal part of buying a business, and many sellers expect to be asked. But it has to be written carefully to hold up, and the rules vary from state to state. This post explains the ideas so you can have a useful conversation with your attorney, who should draft it.

Why it matters

Say you're buying a hypothetical pest control company that sells for about 3 times a year's owner earnings (profit plus what the owner pays themselves, before loan payments and taxes). Only part of that price pays for trucks and equipment. Much of it pays for customers who renew month after month because they trust the company. If the seller could call those same customers next year from a new company, the price you paid would make little sense.

A non-compete protects that value while you build your own relationships. It also protects you from a seller hiring away the technicians who know the routes and the customers.

What a non-compete usually covers

A non-compete limits three things:

• The activity. The kind of work the seller can't do, usually tied to what the company actually does rather than every possible line of work.
• The area. Where the seller can't compete, usually tied to where the company actually operates or draws its customers.
• The time. How long the promise lasts, usually counted in years from closing, or from the end of any role the seller keeps after closing.

It often comes with two related promises:

• Non-solicitation. The seller won't try to take the company's customers, or hire away its employees, even in a role that wouldn't otherwise count as competing.
• Confidentiality. The seller won't use or share the company's private information, such as pricing, customer lists or methods.

The non-compete is usually part of the purchase agreement or signed alongside it at closing. The purchase agreement explained covers how the pieces fit together.

What "reasonable" means: Florida as an example

Courts generally won't enforce a non-compete that reaches further than needed to protect the business. Florida's statute on restrictive covenants, section 542.335 of the Florida Statutes, is a useful example of how one state handles it. Among other things, it says:

• It must be in writing. A court won't enforce a restrictive covenant unless it's in a writing signed by the person it's being enforced against.
• It must protect a legitimate business interest. The person enforcing it has to prove one. The statute lists examples, including substantial relationships with specific existing or prospective customers, and customer goodwill tied to a specific location or trade area. A covenant without a legitimate business interest behind it is void.
• It must be reasonably necessary. The restriction has to be reasonably necessary to protect that interest. If a court finds it broader than needed, the statute tells the court to modify it and grant only the protection that's reasonably necessary.
• Time for the seller of a business. For someone who sells a business (its assets or an ownership interest), the statute presumes a restriction of 3 years or less is reasonable in time. It presumes one of more than 7 years is unreasonable. These are presumptions that can be challenged, not fixed limits.

The same statute sets different, shorter presumptions for employees, and other rules can apply to them too.

Laws change, courts interpret them, and every deal is different. Other states take their own approaches, and some treat non-competes very differently. Treat this as background for a conversation with your attorney, not as the rule for your deal.

What tends to be reasonable in practice

Without getting into legal specifics, a non-compete is more likely to hold up, and to be accepted by a seller, when it fits the actual business:

• An area that matches where the company's customers really are, not the whole state.
• An activity that matches what the company really does.
• A time long enough for you to become the familiar face to customers and staff.

Asking for more than the business needs can backfire. An overbroad restriction may be cut back by a court or invite a fight, and it can sour a seller who was happy to agree to something sensible.

Who should sign

Every owner who is selling should sign. Depending on the business, your attorney may suggest others whose departure could take customers with them, such as a family member who has been the face of the company.

Key employees are a separate question with separate rules. Don't ask anyone on staff to sign a restrictive agreement without your attorney's advice. Key employees covers how to find and keep the people the business depends on.

Taxes and the price

Part of the price is often assigned to the non-compete, and how much matters for taxes on both sides. In an asset purchase, the buyer and the seller each report to the IRS how the price was split among the assets, on Form 8594. The IRS treats a non-compete signed as part of buying a business as a "section 197 intangible," and a buyer generally deducts the cost of those over 15 years. The seller's taxes on that part may differ from those on the rest of the price, so expect the seller and their accountant to care how much is assigned to it. Agree on the split with both accountants involved.

How to raise it with an owner

• Bring it up early, in your first written offer, so it's no surprise at closing.
• Explain why. You're paying for the company's goodwill, and you need time to earn the customers' trust yourself.
• Make it fit the seller. A retiring owner who plans to fish every morning may not mind at all. An owner selling to start something new may push back, so ask what they plan to do next and shape the agreement around a real concern rather than a hypothetical one.
• Don't treat it as an accusation. It's standard, and it protects both of you by making expectations clear.

What a non-compete can't do

It doesn't keep customers loyal. A good handover, with the seller introducing you to important customers, does more for you than any document.

Enforcing a non-compete can also mean going to court, which takes time and money. Often the best protection is a seller who wants you to succeed, for example because part of the price is paid over time. Price versus terms explains how that kind of structure works.

What to do this week

• List which customers, services and areas you'd most need protected in the business you're considering.
• Ask the seller, early and plainly, what they plan to do after the sale.
• Ask your attorney to draft the non-compete, non-solicitation and confidentiality terms, and ask which state's law applies and what's likely to hold up.
• Ask your accountant how much of the price to assign to the non-compete, and why.