Non-Competes as Part of a Business Purchase or Sale

In a business purchase/sale transaction, both buyer and seller have a lot at stake. Business purchase and sale transactions are complex, and one key area of importance and complexity is the future activities of the seller - himself or herself. The weight of the issue rests on the degree to which he or she has been the lead dog, primary rainmaker, industry icon or technical guru. That is, the degree to which the nexus for the web of important relationships that permeate the business and its vendors, customers, employees and industry contacts is the seller himself or herself.

Every business buyer wants to know, "Mr. Seller, are you going to be working for us or against us?" Without certainty that it's the former, few buyers will be willing to purchase at any price.

There are also two related but altogether different issues at play:

1.    What is the true interest, or desire, for the seller going forward?

2.    What are the legal rights of the seller going forward, or constraints therein?

Buyers want to know the answers to both questions.

The first question is important but more difficult to assess. The second is easier to assess, but its importance swings with the degree to which certain post-closing actions could harm the buyer/purchased company.

Seller Non-Compete Agreements

Business buyers should be very cautious not to place too much reliance on legal protection provided by a non-compete with a seller. Many a non-compete has been rendered unenforceable by the courts when challenged.

Why? Because one of the basic freedoms that our laws grant us, as humans, is the right to employ ourselves and support ourselves by engaging in commerce. Free trade.

While courts have been more willing to uphold non-compete agreements that arise in business purchase/sale transactions, skilled legal advice is absolutely essential for business buyers wishing to protect themselves with a non-compete type of agreement.

Similarly, business sellers need to think long and hard - and consult with legal counsel - before agreeing to forgo their right to freely ply their trade and enter into commerce.

Among the myriad of issues that the business buyer will want to nail down in the non-compete agreement with the seller:

• undisputable documentation of ample payment in exchange for a seller's agreement not to compete

• limited time of non-compete (2 or 3 years)

• limited geographic area

• limited industry sector

Courts of law will throw out a non-compete in its entirety if they deem the agreement too broad, long or onerous on the seller.

Tax Implications

Also at issue with non-compete agreements is taxation. Non-compete agreements are generally taxed as ordinary income to the seller (less than desirable) and expensed as incurred by the buyer (more favorable). But in some cases, the seller may be able to gain capital-gain taxation (favorable) by wrapping the non-compete payments into the general goodwill of the business and/or labeling and justifying all or a portion of the payment as "personal goodwill." In these cases, the buyer would be prohibited from expensing these payments as incurred (not favorable) but amortizing them as goodwill payments.

In this way, how the non-compete is structured becomes a negotiating point between buyer and seller.

Deals are complex, risky and time-consuming. Smart buyers and sellers will be aware of these issues and deal with them in a way that maximizes their interest. It starts with educating oneself and obtaining skilled and experienced specialized assistance.