Restrictive Covenants in the Sale of a Business
In almost every sale of a business, the buyer requires the seller to agree not to compete with the business after closing, not to solicit its customers, and not to hire away its employees. These restrictive covenants are central to the deal, because they protect the value the buyer is paying for. Without them, a seller could take the sale proceeds, start a competing business, and draw the customers back, leaving the buyer with far less than it bought.
These covenants are often assumed to work like the non-competes employees sign at hiring, but a restrictive covenant given as part of a business sale generally stands on much stronger legal footing than the same covenant in an employment agreement, and it generally falls outside the growing body of regulation aimed at employment non-competes. Understanding why is useful, because it shapes how the covenant should be structured to keep that advantage.
This article focuses on restrictive covenants in the M&A context and why they are treated more favorably than employment covenants. Enforceability depends heavily on the governing state’s law, which varies and has shifted in recent years, particularly for employment non-competes. For any specific covenant, the governing statute and case law control and should be confirmed rather than assumed from a general description.
What the Covenants Protect in a Sale
When a buyer purchases a business, a large part of what it pays for is goodwill: the customer relationships, the reputation, the trained workforce, and the going-concern value that make the business worth more than the sum of its assets. Goodwill is fragile. It is tied to the people who built the business, and it can leave with them.
The restrictive covenants are what keep the goodwill with the business the buyer bought. A covenant not to compete prevents the seller from rebuilding the same business in competition with the buyer. A customer non-solicitation covenant prevents the seller from drawing the customer relationships back. An employee non-solicitation covenant prevents the seller from rehiring the workforce the buyer just acquired. Each protects a piece of what the buyer paid for.
That protectable interest is the foundation of the covenant’s enforceability. A court asked to enforce a sale covenant can see exactly what it protects: value the buyer paid real money to acquire and that the seller was compensated to leave in place. That clarity is a large part of why sale covenants are treated more favorably than employment covenants, where the employer’s interest is often harder to define and is weighed against the employee’s ability to earn a living.
Why Sale Covenants Are Easier to Enforce
Where sale-of-business covenants are permitted, enforceability generally turns on whether the restriction is reasonably tailored to the interest the buyer acquired, and several features of a business sale push that analysis toward enforcement in ways that are not present in employment.
The first is what the covenant protects. In a sale, the covenant protects purchased goodwill, an interest courts readily recognize as legitimate. In employment, the employer is protecting confidential information, customer relationships, and training investment, interests that are real but weighed against the public interest in labor mobility and the employee’s ability to work. The sale covenant protects a more concrete and readily identifiable interest.
The second is consideration. In a sale, the seller receives the purchase price, and a portion of the value is effectively paid for the covenant itself. The seller is being compensated to step aside. In employment, the covenant is often supported by nothing more than the job offer or continued employment, which some states consider inadequate consideration for a meaningful restriction. The sale covenant rests on a clear and substantial exchange.
The third is bargaining power. Sale transactions more commonly involve negotiated terms, separate consideration, and parties represented by counsel, which reduces some of the bargaining-power concerns present in employment agreements. An employee presented with a non-compete at hiring usually has little leverage and signs what is put in front of them. Courts are more comfortable enforcing a restriction that emerged from a negotiated transaction than one imposed as a condition of employment.
Together, these features mean a sale covenant starts from a much stronger position than an employment covenant. A restriction on duration, geography, or scope that a court would strike as unreasonable in an employment agreement may be entirely enforceable when it protects goodwill the buyer purchased from a seller who was paid to give it up.
Why Sale Covenants Generally Escape the Regulation Aimed at Employment Non-Competes
Over the past several years, restrictive covenants have drawn increasing regulatory attention, but that attention has been aimed almost entirely at the employment relationship. The concern driving it is labor mobility: whether an ordinary employee should be barred from taking a better job in the same field. That concern applies differently to a seller who was paid for the goodwill of a business.
As a result, the laws restricting non-competes generally treat the two settings differently. Many state statutes that limit or prohibit employment non-competes contain an express exception for covenants given in connection with the sale of a business or its goodwill. The restriction targets the employment non-compete, and the sale covenant is left in place. Federal attention has likewise centered on worker non-competes. The FTC’s attempted nationwide rule included an exception for bona fide business sales, but that rule was set aside and is not in effect, and the agency has continued to scrutinize employment non-competes through case-by-case enforcement.
The distinction is not automatic, and this is where drafting matters. The statutory exceptions for sale-of-business covenants generally apply to covenants genuinely tied to a sale, often given by an owner or a substantial equity holder as part of the transaction. Some statutes also impose specific ownership or transaction thresholds before the sale exception applies, such as requiring the person giving the covenant to hold a minimum equity interest in the business being sold. A covenant that is really an employment restriction dressed up as part of a deal may not qualify. The further a covenant drifts from the sale and toward the ongoing employment relationship, the more likely it is to be treated as an employment covenant and subjected to the regulation that governs those.
The practical consequence is that keeping a covenant clearly tied to the sale, rather than to the seller’s later employment, is what preserves its favorable treatment. The advantage is real, but it depends on the covenant actually being what it claims to be: a promise given as part of the sale of a business, supported by the purchase consideration, protecting the goodwill the buyer acquired.
Drafting the Sale Covenant to Hold, Especially When the Seller Stays On
Even with the favorable posture, a sale covenant still has to be reasonable to be enforced, judged along the familiar dimensions of duration, geographic reach, and scope of restricted activity. The difference is that the reasonable range is wider in a sale, because the protectable interest is larger. A multi-year duration, a geographic scope covering the market the business served, and a restriction defined by the business that was sold are all more defensible when they protect purchased goodwill than when they restrict a former employee. The covenant should still reach no further than the goodwill it protects, but that interest supports a broader restriction than an employment relationship does.
The most common complication is the seller who stays on to run or work in the business after closing. That seller signs, or will sign, covenants in two capacities: as the seller of the business and as an employee of the buyer. Which covenant governs matters, because the two may be enforceable to very different degrees. The covenant given as part of the sale, supported by the purchase price and protecting acquired goodwill, is the stronger one and the one that generally falls within the sale-of-business exception. The covenant signed in the employment agreement is weaker and, in some states, unenforceable or barred.
The drafting response is to tie the restriction that protects the acquired goodwill to the sale, not to the employment. The sale covenant should stand on its own, supported by the purchase consideration and running for a period reasonably tied to protecting the acquired goodwill, independent of how long the seller remains employed. If the buyer protects the goodwill only through the employment covenant, it may find that protection far weaker than the deal required, particularly if the employment ends early or the seller is in a state that limits employment non-competes. The employment agreement can address concerns specific to the ongoing role, but it should not be the only thing protecting what the buyer paid for.
Structured this way, the covenant protecting the acquired goodwill keeps the favorable footing the sale context provides.
The Takeaway
Restrictive covenants are central to an M&A deal, because they protect the goodwill that makes up much of the purchase price. They are also stronger and less regulated than the employment non-competes they resemble, because they protect a purchased interest, rest on real consideration, and arise from a negotiated transaction rather than a condition of employment.
That advantage is conditional. It holds for a covenant genuinely tied to the sale, scoped reasonably to the goodwill it protects, and kept distinct from the seller’s later employment. A covenant that blurs into an employment restriction risks being treated as one, and losing the advantages the sale context would otherwise provide. Matching the covenant to the deal, and confirming what the governing state’s law allows, is what keeps it enforceable.
This post is general information only and does not constitute legal advice. The enforceability and regulation of restrictive covenants depend heavily on the specific facts and the governing state’s law, which continues to change. For questions about a particular covenant or transaction, contact Cruxterra Law Group.
