Understanding the Impact of Restrictive Covenants in Small Business M&A
In small business M&A, restrictive covenants, such as non-compete and non-solicitation clauses, play a key role in protecting the buyer’s investment. These agreements prevent the seller from engaging in activities that could harm the business after the sale.
Types of Restrictive Covenants
Non-Compete Clauses
Prevent the seller from starting a competing business or working for a competitor within a certain geographic area and time frame.Non-Solicitation of Employees
Prohibits the seller from recruiting the business’s employees for a specified period after the sale.Non-Solicitation of Customers
Prevents the seller from contacting or doing business with the business's customers post-sale.
Why They Matter
Restrictive covenants protect the buyer’s investment by ensuring the seller does not undermine the business’s goodwill or customer relationships. Without these agreements, a seller could take valuable knowledge and start a rival business, diminishing the buyer's expected returns.
Enforceability Issues
The enforceability of restrictive covenants varies by state. For example, states like California impose strict limitations on non-compete clauses. To be enforceable, these clauses must be reasonable in scope, duration, and geographic range.
Negotiating Restrictive Covenants
Buyers should ensure that restrictive covenants are included in the sale agreement, while sellers should negotiate terms that are fair and not overly restrictive.