Non-compete agreements/clauses are generally required when a business or substantially all of its assets are sold. Buyers require this generally to prevent the management and high-level employees of the seller from opening a new business in competition with the one that has just been sold. For obvious reasons, the buyer does not want the seller’s employees competing against the just-sold company by using their established relationships with customers, vendors, business partners, suppliers, etc. Non-compete agreements also prevent high-level — often called “essential” — employees from joining a competing company/firm (which can be just as damaging as essential employees starting a new company).

Generally, non-compete agreements are coupled with confidentiality agreements that prohibit essential employees from disclosing trade secrets, intellectual property information, and other confidential business data, processes, and methods.

Despite the fact that many States have laws making non-compete agreements illegal for “normal” employment relationships, all of the statutes have exceptions for when a business or its assets are sold.

There are several key components to non-compete agreements. The first and most important concern is what work or type of work is prohibited. A person cannot be contractually prohibited from all types of work. Thus, a valid non-compete can only prohibit a type of work that will be — or could be — in competition with the business that has just been sold. The specific language might include a type of work, a field, or an industry and might specifically identify procedures, techniques, and methods that might be in competition with the just-sold business.

Further, as noted, non-compete agreements will prohibit the signatory from joining competitors. Typically, the definition of “competitor” is very broad, including as many related jobs and industries as possible. The definition of “joining” will also be very broad to bar any type of relationship, including employment, consulting, independent contracting, etc. In addition, a list of business, companies, and/or firms are often presented.

Next, a non-compete must have a term period. It is not lawful for a person to be permanently barred by contract from working in his or her field, industry, or profession. Courts have voided non-compete agreements where the term is too long. Generally, two to three years is acceptable. Courts have considered that two-to-three years is sufficient for a newly acquired business to actualize the returns expected from the acquisition.

Fourth, a non-compete must be limited in geographic location, scope, and/or market channel. This CAN be nationwide or even global, but the larger the geographic scope of the non-compete, the more scrutiny that the non-compete will receive if the non-compete is tested in court. Further, there must be some relationship between the scope of the business and the scope of the non-compete. If the business primarily engages in selling products in Chicago, there is no reason to prohibit the signatory from working in New York or Los Angeles. There is also a linkage between the term and scope. A long-term might be compatible with a very narrow scope and vice versa.

Contact the Business Attorneys at Revision Legal

For more information, contact the experienced Business Lawyers at Revision Legal. You can contact us through the form on this page or call (855) 473-8474.

Enforceability Standards in the Asset Purchase Context

The enforceability of non-compete agreements in the context of an asset purchase or business sale is governed by state law and, in most states, subject to standards that are substantially more permissive than those applicable to employment non-competes. Courts in the majority of states apply a “rule of reason” analysis requiring the covenant to be: (1) ancillary to an otherwise enforceable agreement (the asset purchase agreement); (2) supported by adequate consideration (the purchase price); and (3) reasonable in scope, duration, and geographic area.

California — which prohibits employment non-competes as a matter of public policy under Cal. Bus. & Prof. Code § 16600 — permits non-competes in connection with the sale of a business’s good will under Cal. Bus. & Prof. Code § 16601, provided the restrictions are “reasonable.” Michigan’s business sale non-compete statute (MCL § 445.774a) expressly authorizes non-competes for business sellers and articulates the reasonableness standard. Most states that broadly restrict employment non-competes provide similar carve-outs for business sale transactions.

The FTC’s Non-Compete Rule and Its Impact on M&A Non-Competes

In April 2024, the Federal Trade Commission finalized a sweeping rule that would have banned virtually all employee non-compete agreements. However, the FTC’s rule was challenged in federal court, and in August 2024, the U.S. District Court for the Northern District of Texas set aside the rule nationwide, holding that the FTC lacked statutory authority to promulgate it. As of the date of this article, the FTC’s non-compete ban is not in effect — non-competes remain governed by state law.

Notably, even the FTC’s proposed rule — which was vacated before taking effect — would have exempted non-competes between sellers and buyers of a business when the seller owned at least a 25 percent equity stake in the entity. This confirms the recognized policy distinction between employment non-competes (which restrict workers’ ability to earn a living) and M&A non-competes (which protect the legitimate commercial value of a business acquisition).

Non-Compete Consideration: Ensuring the Covenant Holds Up

A non-compete not supported by adequate consideration is unenforceable. In an asset purchase context, the payment of a purchase price that reflects the value of the seller’s covenant not to compete is generally adequate consideration. However, several issues can arise:

• Allocation of purchase price to the covenant. The parties should expressly allocate a portion of the purchase price to the non-compete covenant in the asset purchase agreement and report that allocation on IRS Form 8594. A seller who receives consideration for a non-compete reports the allocated amount as ordinary income; a buyer amortizes the covenant over 15 years under IRC § 197. Courts have treated the allocation as evidence of the adequacy of consideration and the parties’ intent to make the covenant binding.
• Personal covenants from key individuals. When the seller is a corporate entity, the buyer typically requires that key individuals — the founder, CEO, and other essential employees — sign personal non-compete agreements in addition to the corporate entity’s covenant. The personal covenant must be independently supported by consideration, which may take the form of a direct payment, a signing bonus, or a consulting fee.
• Integration with the Asset Purchase Agreement. The non-compete should be incorporated into the asset purchase agreement rather than executed as a standalone document. Courts have occasionally questioned whether a separately-executed non-compete signed after the closing was supported by the same consideration as the overall transaction.

Non-Competes and Transition Services: Complementary Protections

In many asset purchases, the buyer’s primary concern about competition from the seller and key employees is greatest during the immediate post-closing transition period — before the buyer has had an opportunity to build its own relationships with customers, suppliers, and vendors. A Transition Services Agreement (TSA) — under which the seller and key employees agree to provide specified services during a defined period — can complement the non-compete by ensuring continuity of operations while committing those individuals to serving the buyer’s interests during the transition. A well-structured TSA specifies the services to be provided, the compensation for those services, the duration of the transition period (typically 90 days to 12 months), the standard of care, confidentiality obligations, and the terms of early termination.

Revision Legal’s business attorneys advise buyers and sellers on the drafting, negotiation, and enforcement of non-compete provisions in asset purchase and business sale transactions. Contact us at (855) 473-8474.