Inclusion of covenants not to compete or a “non-compete” agreements is usually a condition of executing an equity transfer of closely held firms. Such agreements specify that the departing owner cannot solicit their former customers, clients or patients (CCPs) (or start a competing firm in the same market) for a certain term of years. The logic is obvious since the idea of the transfer is to convince current CCPs to shift their allegiance to the new owner. Absent a “non-compete” agreement the selling owner could simply open up shop and retain the CCPs that the buyer was buying immediate access to. In effect, the non-compete agreement prevents the seller from stealing back the "inventory" of CCPs that he or she is selling to the new owner.
In many cases CCPs have ongoing relationships with non-owner employees. A change in ownership may impact the non-owner employee’s willingness to stay with the firm. Absent a binding non-compete with these employees, the successor owner may lose significant CCPs despite the presence of a non-compete with the owner. This risk can either be mitigated or simply factored into the price the buyer is willing to pay for the equity. In any event the amount that a buyer will be willing to pay for the firm equity will clearly be impacted by the expected response of non-owner employees to the ownership change.
There is much case law involving the enforceability of covenants not to compete. Overly restrictive provisions have been deemed to be unenforceable. Generally, such agreements should be limited to set time periods, reasonable geographical areas and not cause a permanent impairment on the employees’ ability to ply their trade. In some states statutes have been enacted to prohibit the enforcement of covenants to lower skilled employees. For a state by state chart that is somewhat dated but still useful click here.
Certain Florida appellate courts have adopted the misplaced notion that the requirement of a covenant not to compete as a condition of sale for a professional practice demonstrates that goodwill is personal and not subject to division in divorce cases. This misunderstanding has caused grave inequities for divorcing spouses living in these jurisdictions. For a complete discussion of this issue you can download this article.
Copyright 2018 Michael Sack Elmaleh