Previously, we have discussed several key closing documents necessary for any purchase or sale of a business. In this article, we will discuss the Non-Competition and Non-Solicitation Agreement.
Non-Competition & Non-Solicitation Agreements
A Non-Competition & Non-Solicitation Agreement is a closing document found in 95% of deals. It is usually the most heavily negotiated aspect of an agreement. At its core, it restricts the Vendor from operating a similar business within a geographical area. It also restricts the Vendor from contacting any of the employees or customers of the selling business.
A Non-Competition Agreement (also known as a Non-Compete Clause NCC or a Covenant Not to Compete CNC) is a clause under which one party (the exiting owner) agrees not to enter into or start a similar profession or trade that will be in competition with or is a similar business to the purchased business. Some courts refer to these agreements as ‘restrictive covenants’ and, unless certain criterion are satisfied, are void for violating public policy.
A Non-Competition Agreement thus has to be limited in temporal (time) and geographical (space) scope. The agreement must only restrict for a certain period of time, usually less than 5 years. It cannot restrict the vendor from operating a similar business anywhere in the word; rather, its geographical scope must be reasonable, and is usually between 5 to 10 km from the location of the purchased business. Only where the temporal and geographical scope of a non-compete are limited and reasonable, is the document binding on the exiting seller.
A Non-Solicitation Agreement is a contract in which the exiting seller agrees not to solicit the business’s clients or customers for his or her own benefit or for the benefit of a competitor, after leaving the company.
Whether one is selling the assets or shares of a business, a Non-Compete and Non-Solicitation Agreement are key closing documents.
Pure Asset Sale
However, when one is selling pure goodwill, which occurs where a business sells its client lists and trade-name, it becomes crucial for the deal to include a non-competition agreement. This is because the crux of the purchase price is comprised of the goodwill of the seller. There are no hard or physical assets such as product, equipment or inventory which make up the value of the business.
Goodwill of a business is intimately tied to the seller who has generated that goodwill in the marketplace. If the seller continues to operate a similar business, the value of the goodwill is reduced to NIL effectively destroying the purchase.
If the vendor isn’t restricted by a non-competition agreement, the seller can open up shop across the street. Of course, all of its existing clients of the business which were ostensibly sold to the purchaser, will purchase product from the person with whom they already have a relationship with (the Seller). The purchaser will have purchased goodwill for a large sum of money that has been reduced to 0$ when the purchased clients don’t remain with the purchaser and revert back to the seller who now operates the very same business across the street.
For this reason, non-competition agreements are crucial in goodwill sales. However, these agreements remain extremely important in sales of assets or shares, regardless of the business.
-Shira Kalfa, BA, JD, Partner and Founder
© Kalfa Law, 2018
The above provides information of a general nature only. This does not constitute legal advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.