When a business is sold, there are often concerns about the seller or key employees starting a new company and competing with the business buyer or taking sensitive information with them to a new job.
To address these concerns, you should always include a non compete agreement as part of the sale agreement. Obviously, if the seller starts a new business exactly like the business you just bought, that would be a problem.
The non compete agreement exists to protect you the buyer, after you purchase a business.
What is a Non Compete Agreement
A non-compete agreement is a legally binding contract that prohibits the former owner or key employees from competing with the business for a certain period of time after the sale.
This agreement can include stopping the seller from starting a new business in the same industry, working for a competitor, helping someone else start a business in the industry, or taking sensitive information with them to a new job.
It is important to make sure that the non-compete agreement is enforceable in your state. This means that it should be written in clear and concise language and should be signed by all people who are covered by the agreement.
Why a Non Compete Agreement matters
If the seller started a new business offering the same products and services as the company you just bought, they could try to take all of your customers. This would put you at a disadvantage because they are probably familiar with the seller and don’t know you from a hole in the wall.
There are a bunch of other reasons why it would be bad for you, so a Non Compete Agreement is really important.
What to look for in a Non Compete Agreement
- Duration – This is just a fancy term for how long a seller can not compete with you. I would shoot for 10 years but would not accept anything less than 5 years
- Scope – Another lawyerly term meaning a list of activities they can’t do. For example, if you are buying a mechanics shop, you would want to list all of the products and services that the shop offers as things a seller can not continue to do.
- Geographic Area – This outlines which area they can not compete in. It is usually a radius of miles from the business, but it could be the city, or entire state depending on the situation.
- People – This will list which people are covered by the non compete agreement.
Expert Tip – If the seller is trying to negotiate the shortest duration for the non compete agreement, I would ask them if they intend to get back into the industry, and if they are, I would be careful.
One other issue that may come up is the ability of the seller to earn a living after the sale. The agreement should not be so restrictive that it prevents the former owner or key employees from earning a livelihood, but it should be sufficient to protect your interests.
One other thing to consider is that in many states, it is difficult to enforce a non compete agreement. Many states have ruled that a person has a right to earn a living.
Also, if you sue someone for violating a non compete agreement, a court case could drag out for years and cost you thousands of dollars in attorneys fees. In my experience, I have never met a seller who sold their business and then turned around and started a competing business. It is possible this could happen but I would say it is very unlikely.
This is where it is important to get to know your seller and find out why they are really selling and what they plan to do after the sale. Don’t be afraid to ask a seller more in-depth questions to understand their motivations.
Go deeper
At BizBuyerCentral we always advise you to get a lawyer or legal adviser to help you with contracts, and we are not talking about your neighbor Carl who “knows stuff”.
However, if you want to educate yourself on legal issues and contracts when buying a business, it may be a good idea to buy this book: Here’s The Deal: Everything You Wish a Lawyer Would Tell You About Buying a Small Business.
Final thoughts on a Non Compete Agreement
Buying a business is a major financial decision and you want to be protected as much as you can. A non compete agreement is crucial to protect you and your new business.
It is so important that in my opinion, I would not buy a business without one. If a seller does not want to sign a non compete agreement, I would run away and move on to the next opportunity. Though it is rare, the last thing you want to do is compete in the same industry as your seller. And remember, always get a lawyer to look at the non compete and any other legal-looking documents that are involved in the deal.
FYI, here is a link to an actual non competition agreement used in a business sale.
No go out there and change your life!
