Non-Competition Agreements When Selling a Business
When selling a business to someone else there is a good chance that the buyer of the business is going to require you to sign a non-competition agreement. The last thing a potential buyer is going to want is to make a significant investment buying the business from you, only to turn around and have you set up shop competing directly with them for the same customers.
To avoid this from happening a business buyer will typically require the seller to sign a non-competition agreement for sale. As a seller of the business, it is important for you to understand the type of agreement you are signing and the terms and conditions of the agreement. You want to make sure that you can live with these terms because the agreement is legal and binding.
What is a Non-Competition agreement?
Non-competition agreements are legal documents that employers commonly require employees to sign, where the employee promises not to compete against the employer for a specified period of time, even after the employer/employee relationship has ended. It usually prevents the employee for going to work for a competitor during that specified time period. However, non-compete agreements are also used in the sale of a business, where the seller agrees not to compete with the buyer.
Non-competition agreements are sometimes referred to as "Covenants Not To Compete." The purpose of these agreements is to prevent the seller from opening a competing business in a specified geographical area, possibly for a specified period of time. Sometimes they are referred to as non-compete agreements and other times they are simply referred to as non-compete clauses.
What are the Terms of a Typical Non-Competition agreement?
Non-competition agreements usually contain the type of business in question, the seller's promise not to compete directly or indirectly with the buyer, the geographical area the agreement covers, the specified time period of the agreement, and other rights that the buyer has, as well as other limitations that are placed on the seller.
Since this document affects you as the seller, more than it affects the buyer, it is important that you understand the terms of the agreement, and negotiate with the buyer for a non-compete agreement that you can live with. Since the agreement will state what your limitations are, as the seller, you should make sure that it also states what your rights are.
The geographical and time limitations specified in the agreement must be reasonable, or it will not stand up in a court of law. However, if it is reasonable, the courts will uphold the agreements validity. Therefore, it is in your best interest that you give a great amount of consideration to the terms of the non-competition agreement before signing it, making sure that you will still be able to abide by the terms for the entire period of time that the agreement covers.
It is important that the terms are very clear. You are promising not to compete directly or indirectly. Work with the buyer to determine exactly what is meant by directly and indirectly to avoid a dispute later on. You should work with your attorney when negotiating the terms of the non-competition agreement.
What are some of the Requirements Necessary in a Non-Compete agreement?
A Non-Compete agreement usually consists of the following terms:
- The time period - This covers the start and the end date that the agreement is in effect. In most states, the agreement must have a specified time. A non-specified time typically will not hold up in court.
- The parties of the agreement - This covers the people who make up the agreement, both the person or persons who must abide by the agreement, and the person or persons who are protected by the agreement.
- The business or industry - This covers the business or industry that the parties must abide by in the agreement where they are not allowed to compete in.
- The enforced location - This part of the agreement covers the location of the agreement. For instance, the agreement may not allow the business to be set up in a particular city or state. However, they might certainly be allowed to set up the business in a new city or a new state. It all depends on the nature of the agreement and must be specified here.
How To Make Sure The Non-Compete Agreement Passes Reasonability Tests
Many states will not enforce non-compete agreements to buy a business if they feel that the agreement is not reasonable. States place a high value on the ability of a person to earn a living. Therefore, they are going to want to make sure that the agreement is reasonable and does not prevent the abiding party from earning a living. These are some of the areas that they look at to evaluate how reasonable the agreement is:
- Agreement is too long - Typically two years is the maximum amount of time most states want to see an agreement for. Non-compete agreements with lengths longer than this will typically not be enforceable.
- Agreement covers too large of a geographic region - States are going to generally frown upon agree-ments that cover too large of a geographic region. This is particularly true with agreements that cover a number of different states.
- Agreement limits too many businesses or activities - States donâ€™t want to see agreements that limit the parties from engaging in too many businesses or too many activities. The agreement should be specific and limited to just the critical business activities that are necessary to protect the business from unfair competition.
States Laws Governing Non-Compete Agreements
In the United States, most states recognize the enforcement of non-compete agreements. It is completely acceptable and legal to have someone sign a non-competition clause for the sale of a business. However, there are certain states that have very specific laws. If you are in one of these states, you need to be aware of the laws before you sign a non-compete agreement.
- California has the harshest laws against non-compete agreements. With the exception of a small, very specific set of circumstances, they are outlawed in the state. Therefore if you are selling your business in the state of California, you will not be obligated to operate under the terms of a non-compete agree-ment.
- Florida is generally the opposite of California when it comes to non-compete agreements. They are generally going to enforce the agreement as long as it is not too broad, and the length of time that the agreement is enforced for is more than two years. If your business is in the state of Florida, this state is one of the toughest states to get out of a non-compete agreement.
- Virginia is a more difficult state to get non-compete agreements enforced. However, they arenâ€™t like California where they are completely outlawed. The court is going to make the decision on an individual case-by-case basis and it is typically up to the protected party to demonstrate why the agreement was necessary and how the agreement doesnâ€™t necessarily prevent the other party from earning a living.
- Texas is a state that will typical enforce non-compete agreements just as long as the terms are reason-able. The state looks at the time, the geography and the activity limited. They want to make sure these terms are limited in scope. Agreements with little to no limits in scope in these three categories will often be ruled as null and void in the state of Texas.
Why The Non-Compete Clause in a Business for Sale Is Important To The Seller
Unless as a seller you plan on retiring and not working anymore, it is important that you understand the terms of a non-compete agreement that you sign. This agreement has a direct impact on your ability to work and earn a living. Failure to abide by the terms of the agreement may result in a costly lawsuit and could potentially void the sale of your business.
What is your most important question when it comes to understanding non-compete agreements in the sale of a business?
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