When you make the determination that it’s finally time to sell your business, it’s likely not a decision you’ve arrived at easily. Parting with the company you’ve worked so hard to build is not strictly a business decision — your emotions are front and center too.
One of the reasons why the merger and acquisition (M&A) process can be daunting for business owners is because of a legal stipulation known as a Non-Compete Agreement. Non-Compete Agreements (also commonly referred to as Non-Competition Agreements) can impact your future earnings and business opportunities.
In this article, you’ll learn everything you need to know about Non-Compete Agreements, specifically as they relate to the sale of your business. You’ll learn what they are, why they’re important, and how they specifically differ from non-disclosure forms. You’ll also learn what you can do to prepare for Non-Competes when selling your company.
Non-Compete Agreements — The Basics
A sale of business Non-Compete Agreement form is a document contained within the Definitive Agreement. It generally clarifies that the seller can not create or enter into a competing business against the buyer.
Although Non-Compete Agreements can vary, they’ll typically outline that the seller cannot participate in certain:
- Business activities
- Geographic areas
They’ll also specify the length of time the seller is restricted from participating in these activities and outline how the seller is to treat Goodwill and intangible assets like intellectual property.
You might be familiar with Non-Compete Agreements that are common in employment contracts. These non-compete clauses prevent employees from leaving a company and joining a competitor, where they can share confidential information and trade secrets.
Much like the Non-Compete Agreements seen in business sales, employment agreements have a time frame in which the contracts are enforceable.
Having said that, the language can be a bit different between the two. While there are non-competes specific to former employees, business owners need to be particularly concerned about the ones in the Definitive Agreement pertaining to the sale of their company. That’s what we’ll focus on here to help you prepare for when it’s time to sign one.
Why Sale of Business Non-Compete Agreement Forms Are Important
Non-Compete Agreements are an important component of the Definitive Agreement. They protect buyers. Otherwise, there would be nothing preventing sellers from immediately opening a new business.
Imagine you own a company specializing in supply chain management and distribution in New York City. You sell your company in an asset sale. You are an expert in the field and have a firm understanding of how things operate in the city. You’ve developed hundreds of business relationships in the area.
Without a Non-Compete Agreement, there’s nothing stopping you from taking the funds from your sale, buying new equipment, and relying on your business connections to start a new company. You’d be in direct competition with the buyer who purchased your original company. This buyer, as a result, would be at an unfair — and perhaps insurmountable — disadvantage.
This example also demonstrates why a reasonable geographic scope is an important component of the terms of the agreement. The buyer may not care about the period of time you’re out of operation (there’s always a chance you get the itch to start another company) as long as you’re far enough away that you are not in direct competition or poaching customers.
That very much depends on the type of business you own — this may not be the case for e-commerce companies, as an example.
How Non-Compete Forms Differ From Non-Disclosure Forms
Now, let’s distinguish between Non-Compete Agreements and Non-Disclosure Agreements (NDA). Both are technically confidentiality agreements, but they cover different things.
As we’ve pointed out, Non-Compete Agreements exist to protect buyers during the M&A process. They prevent sellers from entering into business against buyers.
NDAs, however, protect sensitive information during the sales process. The terms of the Non-Disclosure can vary, but they basically exist to protect both parties from revealing confidential information about one another.
Only 20% of businesses listed for sale actually end up selling. During the due diligence process, both the buyer and the seller of a business are likely to come across information about one another. A Non-Disclosure states that neither the potential buyer nor the seller can share this information with outside parties.
Even if a sale falls through, the Non-Disclosure is still enforceable if drafted correctly. As the Association of Corporate Counsel states, “Non-Disclosure Agreements are only as effective as they are enforceable. A valid Non-Disclosure Agreement can result in monetary damages or an injunction against the breaching party. An invalid agreement may result in the information losing its confidential status.”
In summary, Non-Competes protect business interests after a definitive sales agreement is completed. NDAs protect these interests during and after the sales process. The enforceability of both of these contracts depends on state laws. It’s important that business owners seek legal advice from their team of attorneys, brokers, and advisors to help protect their legitimate business interests during the sales process.
How to Best Prepare for Non-Compete Agreements
As a business owner, there are a few important things to remember when selling. For one, you should always prepare to sell earlier rather than later. Most business owners wake up one day and realize that it’s time to sell their company.
However, during the sales process, they may realize that there is a valuation gap in place, meaning the purchase price is going to be lower than what they were expecting or needing.
Signing a Non-Compete Agreement essentially takes away the opportunity for future earnings within the industry that you’re most familiar with. Because of this, it’s imperative that you maximize earnings from your sale and ensure that your goals are going to be met as a result of the sales process.
This is one of the reasons why you should talk with a trusted team of advisors early on, even if you don’t think you’re ready to sell. Advisors who have been down this road before can not only provide legal advice about signing contracts, but they can also provide valuations so that you have a rough idea of how much you’re going to earn from a sale.
If the valuation is too low, you’ll have time to make improvements and address pain points. If you wait too long to begin this process, you don’t give yourself much of a buffer.
Sale of Business Non-Compete Agreement Forms Will Impact Future Earnings
Selling the business that you’ve grown is a big decision. One of the most important things to consider is how a Non-Compete Agreement will impact your future earnings potential. Since these forms typically come with time periods and geographic restrictions, you’ll likely not be able to start a new business in the same industry or enter into direct competition with your buyer.
The earlier you get the sales process started, the more prepared you’ll be. To learn more about your potential sales options, reach out to the team at Allan Taylor & Co. Our experience and know-how can guide you through the entire sales process, from preparation and planning to finding the right buyer and closing the deal.