Non-Compete & Non-Solicitation Clauses in Acquisitions

When you acquire a business, you're paying for goodwill - customer relationships, brand reputation, and market position that the seller built over years. Non-compete and non-solicitation clauses protect that investment by preventing the seller from turning around and competing against you with the very advantages you just purchased.

These restrictive covenants are among the most heavily negotiated provisions in any acquisition agreement. Getting them right requires understanding enforceability rules, structuring provisions that courts will uphold, and balancing buyer protection against seller flexibility.

Acquisition agreements typically include three distinct types of restrictions:

• Non-compete clause: Prohibits the seller from owning, operating, managing, or being employed by a competing business within a defined geographic area and time period
• Customer non-solicitation: Prohibits the seller from soliciting or doing business with customers of the acquired company. Often considered more enforceable and more practically important than a pure non-compete
• Employee non-solicitation: Prohibits the seller from recruiting or hiring employees of the acquired business. Protects against the seller poaching your team to start a competing venture

Best practice is to include all three as separate, independently enforceable covenants. If one is struck down by a court, the others survive.

Non-competes in the context of business sales are generally enforceable across most US jurisdictions - even in states that restrict employee non-competes. Courts evaluate three key factors:

Typical enforceable periods for business sale non-competes:

• 2-3 years: Generally upheld in most jurisdictions
• 3-5 years: Common and enforceable, especially with goodwill allocation
• 5-7 years: May be enforceable for high-value acquisitions with significant goodwill
• 7+ years: Increasingly difficult to enforce; courts may reduce the period

The appropriate duration depends on customer contract cycles, industry dynamics, and how long it takes to cement relationships with the acquired customer base.

The geographic restriction must relate to the actual market area where the business operates. A local plumbing company's non-compete shouldn't cover the entire state; a national SaaS company's might justifiably be nationwide.

• Local service businesses: County or metropolitan area
• Regional businesses: Multi-state region matching actual operations
• National/digital businesses: Nationwide or even global (for truly global operations)

Restricted activities must be defined precisely. Courts disfavor vague terms like "similar business" or "related services." Instead, define the specific business activities being restricted.

Good:"Seller shall not own, operate, or manage a residential HVAC installation and repair business."

Bad:"Seller shall not engage in any business that competes with any aspect of the Company's operations."

The FTC's 2024 rule broadly banning non-compete agreements specifically exempts non-competes arising from the bona fide sale of a business. This means:

• Seller non-competes tied to a business acquisition remain fully enforceable under federal law
• The exemption applies when the seller has a substantial ownership stake (typically 25%+) in the business being sold
• Employee non-competes (for retained employees) may be affected by the FTC rule - consult counsel
• State laws still apply and may impose additional restrictions

The legal environment continues to evolve, so always have local counsel review your restrictive covenants.

Enforceability varies significantly by jurisdiction. Key states to understand:

• California: Generally prohibits non-competes (Business & Professions Code §16600) but has a specific exception for the sale of a business or its goodwill. Keep restrictions narrowly tailored.
• Texas: Enforces non-competes if they meet statutory requirements for reasonableness (duration, geography, scope). Courts can reform overly broad covenants.
• New York: Enforces reasonable non-competes; courts apply a balancing test weighing employer needs against hardship on the restricted party.
• Florida: Statutorily favorable to non-competes; rebuttable presumptions that 2-year restrictions are reasonable and 5+ years may be unreasonable.
• Massachusetts: Enforces non-competes in business sales but requires garden leave or other consideration for employee non-competes.

For cross-border acquisitions, restrictive covenant rules vary dramatically:

• UK: Enforceable if reasonable; courts will not modify overly broad covenants (unlike some US states)
• France: Non-competes must include financial compensation to the restricted party; 2-year maximum is standard
• Germany: Seller non-competes in business sales generally enforceable; employee non-competes require compensation (50% of prior salary)
• EU generally: Many jurisdictions require financial compensation for non-compete periods, even in business sale contexts

Follow these principles to maximize enforceability:

1. Separate each restriction: Draft non-compete, customer non-solicitation, and employee non-solicitation as independent covenants with separate severability clauses
2. Include blue-pencil language:Ask the court to modify (rather than void) overly broad provisions: "If any provision is deemed unreasonable, the court may modify it to the minimum extent necessary to make it enforceable."
3. Articulate legitimate interests: Include recitals explaining why restrictions are necessary to protect the goodwill being purchased
4. Allocate purchase price: Assign a specific portion of the purchase price to the non-compete, demonstrating valuable consideration
5. Include injunctive relief provisions: State that breaches cause irreparable harm and the buyer is entitled to injunctive relief without posting bond
6. Carve out passive investments: Allow the seller to hold less than 5% in public companies (reasonable exception that shows good faith)

• Start with market terms: Propose restrictions similar to comparable transactions - overreaching invites pushback
• Focus on what matters most: If customer relationships drive value, fight hardest for customer non-solicitation
• Tie to seller involvement: If the seller is staying in a transition role, argue for longer restrictions since they'll have ongoing access to relationships
• Use earnouts as use: Make non-compete violations a breach that terminates earnout obligations
• Bundle with financial penalties: Tie violations to seller note acceleration - more effective than litigation threats alone

• Narrow the activity scope: Don't accept blanket prohibitions - insist on precise definitions
• Limit geography to actual operations: A 3-county business shouldn't warrant a statewide restriction
• Negotiate duration: Push for shorter periods tied to realistic customer transition timelines
• Carve out future opportunities: If planning to pursue an adjacent business line, negotiate an explicit exception
• Request additional compensation: In some jurisdictions (especially Europe), demand payment for non-compete periods

• Stepped restrictions: Broader non-compete for years 1-2, then only customer non-solicitation for years 3-5
• Geographic zones: Absolute non-compete in core market, less restrictive covenant in adjacent areas
• Customer-specific restrictions: Rather than prohibiting all competition, restrict only solicitation of customers active in the last 12-24 months

If the seller violates restrictive covenants, you have several options:

1. Cease and desist letter: Formal demand to stop the prohibited activity
2. Temporary restraining order (TRO): Emergency court order to halt ongoing violations
3. Preliminary injunction: Court evaluates likelihood of success and irreparable harm
4. Trial on the merits: Full proceeding to determine enforceability and damages
5. Permanent injunction and damages: Court order barring future violations plus monetary recovery

Consider building financial penalties into the deal structure itself: earnout forfeiture, seller note acceleration, and escrow clawback provisions are often more effective deterrents than the threat of litigation.

Restrictive covenants are part of a broader strategy to protect value during the transition. They buy you time to cement customer and employee relationships, but they're not a substitute for proactive management during the critical first 100 days.

Coordinate with your employee retention strategy - ensure key employees sign their own confidentiality and non-solicitation agreements, offer retention bonuses, and communicate the transition plan clearly.

Before finalizing restrictive covenants:

1. Research enforceability in the governing jurisdiction
2. Verify seller's ownership stake qualifies for FTC sale-of-business exemption
3. Define restricted activities precisely based on actual business operations
4. Set geographic scope to match the business's actual market footprint
5. Propose defensible duration given industry norms and customer cycles
6. Include separate, independently enforceable non-solicitation provisions
7. Add severability and blue-pencil language
8. Allocate purchase price portion to covenant not to compete
9. Include injunctive relief provisions and financial penalty triggers
10. Ensure all selling parties sign identical covenants
11. Have local counsel review before signing

No. The FTC's 2024 rule broadly banning non-compete agreements specifically exempts non-competes arising from the bona fide sale of a business. This means seller non-competes tied to a business acquisition remain fully enforceable under federal law, provided the seller has a substantial ownership stake (typically 25% or more) in the business being sold. However, employee non-competes for retained employees may be affected by the rule, and state laws impose additional requirements. According to Gibson Dunn's 2024 analysis, the FTC exemption for business sales was one of the least contested aspects of the rule, as courts have long recognized that protecting purchased goodwill justifies reasonable post-sale restrictions.

For most search fund acquisitions, 3-5 years is the standard and most defensible duration. According to the American Bar Association's 2023 analysis of restrictive covenants in M&A, 3-year non-competes are upheld in virtually all US jurisdictions, while 5-year terms are enforceable in most states when supported by adequate consideration and goodwill allocation. The right duration should match customer contract cycles -- if the average customer contract is 2 years, a 4-year non-compete gives you two full renewal cycles to cement relationships. In Europe, shorter periods (2-3 years) are standard, and many jurisdictions (notably France and Germany) require financial compensation for the restricted period, even in business sale contexts. A common compromise is a stepped restriction: broader non-compete for years 1-3, then only customer non-solicitation for years 4-5.

Allocating a specific portion of the purchase price to the non-compete covenant strengthens enforceability by demonstrating valuable consideration. The typical allocation is 5-15% of the total purchase price, though the exact amount should be guided by tax strategy. For the seller, amounts allocated to the non-compete are taxed as ordinary income (not capital gains), which is less favorable. For the buyer, the allocation creates an amortizable intangible asset that can be deducted over 15 years under IRC Section 197. According to Beck Reed Riden LLP's 50-State Non-Compete Chart, courts are more likely to enforce non-competes when the purchase agreement explicitly assigns a dollar value to the covenant and the allocation is reasonable relative to the total deal value. Work with your tax advisor to balance enforceability with the seller's after-tax proceeds.