A non-compete agreement is a common part of a business sale. It limits what the seller can do after closing, such as starting a competing business nearby. Both sides should understand how it works before they sign.
What a non-compete agreement does
When you buy a business, you pay in part for customer relationships and goodwill. If the seller opens a similar business next door the week after closing, much of that value could walk out the door. A non-compete agreement is meant to protect the buyer from that.
For sellers, it is a promise that limits future activity, so it deserves careful attention.
Terms to look for
Every agreement is different. These are the usual points to review.
- Length of time the restriction lasts
- Geographic area covered
- What activities are restricted
- Whether it covers soliciting customers and employees
- What happens if someone breaks the agreement
- How it connects to the sale price and any payments to the seller
Laws and enforcement vary
Rules on non-compete agreements differ by state and country, and they are often treated differently when connected to a sale of a business than when they apply to employees. Courts generally look at whether the restriction is reasonable in time, area, and scope. The topic has also been debated in recent years, so current rules may differ from what you expect.
Because the law changes, ask a local attorney about enforceability before you rely on any clause.
Tips for buyers
Ask for terms that reflect the real market of the business, not an unrealistic wish. A narrower agreement that a court will uphold is worth more than a broad one that fails. Combine the non-compete with provisions on confidentiality and a transition period, as discussed in our guide to the letter of intent.
Tips for sellers
Understand how the restriction will affect your plans. If you want to work in the same field later, negotiate the scope. Keep the terms reasonable and make sure the price reflects what you are giving up. The article on the emotions of selling a business may help you plan life after the sale.
Get advice on any non-compete agreement
Have an attorney draft or review the agreement, and make sure it matches the rest of your documents. For an overview of the whole process, see buying and selling a business opportunity. A clear, fair non-compete agreement helps both sides move forward with confidence.
More reading on the non-compete agreement and deal terms
- Letter of Intent for a Business Purchase: What It Should Say
- Built to Sell Book: Lessons for Owners Planning an Exit
- How to Find a Business for Sale: Where to Look First
- How to Buy an Existing Business: A Due Diligence Guide
- How to Value a Business Before You Buy: Multiples and Seller’s Discretionary Earnings
- Working With a Business Broker: How to Find One and What It Costs
- SBA guide to planning your business
Sources and background: The Wall Street Journal.
Keep reading
If this topic is useful to you, these related guides on SmartBizOpps are a good next step.
