Nothing Can Compete with Mergers and Acquisitions
By Candace Groth
Many businesses are familiar with non-competes and non-solicitation provisions for employees. But when the business gets ready to sell or to buy, the owners may be thinking about the critical, but misunderstood non-compete/non-solicit. This article explains the general features of non-compete and non-solicitation clauses in the context of mergers and acquisitions, including key items to consider for owners and companies alike.
What is a Non-Compete? What is a Non-Solicit
Non-competes and non-solicits both fall under the general category of “restrictive covenants” meaning an agreement to restrict the behavior of a person (in this case, the selling company/owners). A non-compete is simply an agreement not to perform work or otherwise engage in activities in a particular industry area and/or geographic area for a fixed period of time. For example, “John Doe agrees not to directly or indirectly engage in IT consulting activities in the State of Texas for a period of twenty (24) months after the Closing Date.” The non-compete will typically also restrict the person from directly working with competitors and from indirect methods of competition (e.g. helping someone else compete in the area).
A non-solicit, similarly, is an agreement not to “solicit” a particular person or group of people, usually for the purpose of either a commercial contract with a customer, or for the purpose of an employment/independent contractor relationship. For example, Jane Roe may agree not to solicit customers of ABC Co. as of the Closing Date and the twelve months prior, for a period of twenty-four (24) months. Again, solicitation may be direct (Jane Roe doing something) or indirect (Jane Roe asks another party to do something). There can be some overlap between a non-compete and non-solicit.
You may also see non-disclosure or confidentiality provisions bundled with a non-compete/non-solicit. These provisions, simply put, require that the Seller(s) not misuse confidential information of the business/new Buyer, including misusing the information for competition.
I am selling my business. Why do I need a non-compete/non-solicit?
A Buyer in a merger or acquisition transaction typically asks for a non-compete and non-solicit to protect the value of the business they are buying. Generally, the Buyer wants to ensure that the owners selling the business do not sell the business and then immediately start a competing business, reducing the value of the business sold. Most mergers and acquisition transactions have a non-compete and/or non-solicit, with some rare exceptions for industries where it is prohibited/restricted, or the circumstances of the transaction are unique.
But this is unenforceable, right?
Wrong. Although some states restrict or prohibit non-competes and non-solicits in the employment context, these restrictions generally do not apply to a business owner selling his or her business. Indeed, even California, which prohibits employment non-competes outright, allows such provisions to apply to merger/acquisition transactions. In Texas, Minnesota, and many other states, non-compete and non-solicitation provisions of upwards of three to five years are common, and typically fully enforceable as long as they are otherwise reasonable under state law.
Important Parts of the Non-Compete and Non-Solicit
The important parts of a non-compete generally include the “Who, What, Where, When, and How.” These include:
- WHO: The person or persons subject to the non-compete is very important. A business’s owners may be subject to the non-compete. When the seller of the assets in a transaction is a company, the non-compete may include the company and its owners.
- WHAT: Specifically, what activities are prohibited? For both parties, the prohibited/restricted activities should be clearly defined. The Seller typically wants the “What” to be very narrow and only include the direct activities the business being sold engaged in pre-Closing Date; the Buyer would prefer a wide description of activities, including the activities of the Buyer pre-Closing and post-Closing Date in many cases. The Seller may ask for specific activities to be “carved out” so that they are permitted also. What may be a critical point for the Seller who is selling one business and opening others, may be less critical for the Seller intending to retire to the beach in Florida.
- WHERE: Non-competes typically have a geographic scope, which may be certain states, the entire U.S., or another geographic boundary. This location typically will match the areas in which the business being sold has customers/activities.
- WHEN: Non-competes also have a duration period, during which the “What” activities are restricted. This is commonly three to five years, but may be different depending on the transaction.
- HOW: Again, as described above, the non-compete will typically describe the activities being prohibited and limit both “direct” and “indirect” methods of competition.
We know this is a lot to digest, and selling (or buying) a business can be complicated. That is why it is critical to consult with an attorney who is comfortable doing these types of transactions to be sure you get them right. Hopefully this post will help you understand non-competition and non-solicitation provisions, and provide a starting point for consideration of these items in the context of the larger sale transaction.