Quick answer: A non-compete in a business sale is the seller’s promise not to compete with the business after closing, and a non-solicit is the promise not to approach its customers or employees. Buyers require them because they are paying for goodwill that the owner could take back. Activities covered, geography, duration, start date, who is bound and remedies are all negotiable, and enforceability varies by state and by the facts, so the owner’s attorney should review the scope before the letter of intent is signed.
Key points
- A buyer asks for a non-compete because it is paying for goodwill the owner could otherwise take back, so the covenant should be as wide as that goodwill and no wider.
- Scope depends on the activities barred, the geography or customers covered, the duration and start date, who is bound and the remedies, and each of these is negotiable.
- Enforceability varies by state and by facts, and covenants given in a sale are often treated differently from employment covenants, so counsel in the governing state must review the draft.
- The definition of the business and the start date of the restriction can cost an owner more than the headline duration.
What the covenants restrict and why a buyer asks for them
A covenant in a business sale is a promise the seller makes in the purchase agreement about its conduct after closing. Four kinds are common. A non-compete bars the owner from owning, running or working for a competing business. A customer non-solicit bars approaching the company’s customers. An employee non-solicit bars recruiting its people, and a no-hire goes further by barring their hiring even when they apply. Confidentiality covenants protect pricing, formulas and customer data.
A buyer asks for them because of what it is paying for. The price rests on earnings that depend on customer relationships, staff and know-how, and the owner is the person best placed to take any of them back. The guide to key-person risk shows how heavily a price can lean on the owner. Covenants make those earnings safer to buy, and the letter of intent usually states them in a line. The decision rule for both sides is that a covenant should be as wide as the goodwill the buyer bought and no wider. Anything beyond that restricts the owner’s livelihood without protecting anything the buyer paid for.
Sale covenants and employment covenants are treated differently
Courts in many states look at a covenant given in the sale of a business differently from one imposed on an employee, and often allow it more room, because the seller is being paid for the goodwill the covenant protects. The difference varies by state and by facts, and this guide states no rule. Two practical points follow.
The labels do not settle the question. An owner who becomes an employee may sign covenants in both the purchase agreement and the employment or consulting agreement, and the two can carry different scope, start dates and tests. A small-stake or non-managing seller may be treated more like an employee than like a seller of goodwill. Counsel should say which standard applies to this owner and which document holds each covenant. The second point is that a seller should not assume a court will narrow an overbroad covenant into a reasonable one. Some courts do and some decline, which is a reason to settle the scope in the draft. The guide to transition periods and post-closing roles covers the employment side.
The terms of a covenant and what each side asks for
| Term | What a buyer asks | What a seller negotiates |
|---|---|---|
| Restricted activity | Any business similar to the company’s, or to what the buyer plans to offer | The lines the company actually conducted at closing, with carve-outs for passive investments, unrelated lines and other businesses the owner discloses |
| Definition of “the business” | The business of the buyer and all of its affiliates | The acquired business only, so the owner is not barred from the buyer’s whole industry |
| Duration, start and extension | A long period running from the later of closing and the end of the owner’s role, extended on breach | A fixed period from closing, sized to how long customer relationships take to transfer |
| Geography | Everywhere the company or the buyer operates | Where the company actually sold and held customers; for online or national sellers, a list of customers or product markets instead of a map |
| Customers and employees | All customers and prospects, and no solicitation or hiring of any employee | Customers served in a look-back period or a named list, solicitation only, and carve-outs for general advertising and for staff who left or were dismissed |
| Who is bound | The owner, family members and every entity the owner controls | The selling owner and controlled entities; for passive or minority sellers, a non-solicit and confidentiality only |
| Remedies and release | An injunction, damages, forfeiture of deferred payments and fee shifting | Notice and a cure period, forfeiture only for a proven breach, and release if the buyer misses a payment or drops the product line |
Owners overlook two terms. A covenant that protects the buyer and its affiliates can bar the owner from a whole industry when a large company bought the business, and a period measured from the end of the owner’s role is longer than it looks when the role itself lasts.
Setting the scope from the goodwill
A scope that can be defended comes from the business and not from a form.
- Define the business as it stood at closing. List the products, services and customer types that produced the earnings.
- Map where the goodwill sits. Identify the customers, territories and employees that depend on the owner.
- Estimate how long the owner’s influence lasts. The handoff plan in the transition agreement is the best evidence.
- Fit each restriction to the map and write down why. A restriction the seller can explain is easier to negotiate and, if tested, to defend.
Illustrative example: One covenant, two drafts
An owner sells a regional flooring distributor to a national group and agrees to work for the buyer for two years. The buyer’s first draft bars the owner from the flooring business of the buyer and its affiliates, nationwide, for five years after the owner’s employment ends. The owner’s revised draft bars competition with the acquired distributor, in the regions where it sold, for three years after closing.
| Provision | Buyer’s first draft | Owner’s revised draft |
|---|---|---|
| Business covered | Buyer and all affiliates, all flooring lines | The acquired distributor’s product lines |
| Territory | Nationwide | Regions where the distributor sold in its last full year |
| Starts | End of employment | Closing |
| Length | Five years | Three years |
| Customers and staff | All customers, prospects and employees | Customers served in its last full year; solicitation of staff only |
| Total time bound from closing | Seven years | Three years |
Because the first draft starts at the end of a two-year role, it runs for seven years from closing, and the revised draft runs for three. The first draft also bars the owner from a national group’s entire industry, while the revised one protects what the buyer purchased. The employment agreement can carry its own restrictions, so both documents must be read together. The terms, lengths and facts are invented to show the mechanics and are not benchmarks, and what a court would enforce varies by state.
What the covenant costs the owner
The covenant is part of what the buyer pays for, so most deals attach no separate fee to it, but it has a price in the owner’s opportunity cost. For an owner who plans to retire, a broad covenant costs little. For one who intends to start another venture in the same industry, it can cost more than the premium in the price, and it should be negotiated like price. The usual trades are a shorter period in return for a longer consulting term, a defined carve-out for a planned sideline, or a narrower territory in return for stronger customer protection.
In an asset sale the agreement may also allocate part of the price to the covenant. That figure changes the result for each side’s taxes, so the owner’s CPA should review it, as the guide to purchase price allocation explains. Payments that depend on compliance, such as an earnout or seller note, can be tied to the covenant, which makes a breach a loss of money as well as a lawsuit.
Questions for the owner’s attorney
- Which state’s law governs, and how does it treat a covenant given by a seller of a business compared with one in an employment agreement?
- Is this owner treated as a seller of goodwill or more like an employee, given the size of the stake and the role?
- Does the definition of the business cover only the acquired company?
- When does each period start, and what extends it?
- Does a missed payment by the buyer, or the buyer dropping a product line, release the covenant?
- What remedies does the buyer have, and are deferred payments at risk?
- Do the employment or consulting agreements add separate covenants with different dates?
- Is any amount allocated to the covenant, and has the CPA reviewed it?
The covenants are drafted into the contract described in the guide to purchase agreement terms, and the guide to how to sell a business shows where the negotiation falls among the other stages. This guide is general education and not legal or tax advice.
Frequently asked questions
Is a non-compete enforceable after the sale of a business?
It can be, but enforceability depends on the state, the scope and the facts. Courts in many states look at a covenant given by a seller of a business differently from one imposed on an employee, but they still ask whether the restriction protects a legitimate interest and is reasonable. An attorney in the governing state must confirm.
How long should a non-compete last after selling a business?
There is no standard length. A defensible period follows how long the goodwill takes to transfer, meaning how long customer relationships and know-how stay tied to the owner, and what the owner will do next. Buyers ask for longer periods than sellers offer, and counsel tests the proposal against the governing state’s standards.
What is the difference between a non-compete and a non-solicit?
A non-compete bars the owner from running, working for or owning a competing business. A customer non-solicit bars approaching the company’s customers, and an employee non-solicit bars recruiting its staff, but neither bars working in the industry. A seller who plans to stay in the industry may propose them in place of a full non-compete.
Do all selling owners have to sign the covenant?
Buyers often ask every selling owner to sign. Passive or minority sellers commonly push for a non-solicit and confidentiality only, arguing that they hold no customer relationships to protect. How a small holder who also worked in the business would be treated is a question for counsel.
Is money allocated to the non-compete taxed differently?
It can be. In an asset sale the agreement may allocate part of the price to the covenant, and that amount can be taxed differently to the seller than the amount allocated to goodwill. The allocation is negotiated, and the seller’s CPA should review the figure before signing.
Thinking about a sale or an acquisition?
The Impetus Group provides sell-side and buy-side M&A advisory, from preparation and buyer outreach to negotiation and closing. A transactional valuation is often the first step, scoped and priced separately.
Related guides
- The Purchase Agreement: Key Terms Sellers Should Understand Before Signing: The purchase agreement is the binding contract in a business sale. See its key terms, from price adjustments to indemnification, and the questions to ask counsel.
- What Happens to the Owner After a Business Sale: Transition, Consulting and Employment Terms: After closing, the owner’s role is set by contract: a short transition, a consulting agreement, employment or a board seat. See the terms that move pay and price.
- How to Read a Letter of Intent: The Terms That Decide What You Receive: A plain-language guide to the letter of intent in a business sale: price, structure, working capital, exclusivity, diligence and the terms that move your proceeds.
- Purchase Price Allocation in an Asset Sale: The Seven Asset Classes and Form 8594: How the price of an asset sale is divided among the seven IRS asset classes, why buyer and seller want different splits, and how to negotiate the Form 8594 schedule.
- Key-Person Risk: How Owner Dependence Affects Valuation: How buyers measure owner dependence, why it lowers value and shapes deal structure, and what an owner can change in the years before a sale to reduce it.
- How Long Does It Take to Sell a Business? Phase by Phase: How long a business sale takes depends on its slowest phase. See what controls each stage, where delays occur and what shortens the path.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.