Non-Compete Agreements in a Business Sale: A Guide

When a private company changes hands, the buyer is not just purchasing equipment, contracts, and cash flow. A large share of the purchase price often reflects goodwill, the intangible value of customer relationships, reputation, and market position built by the seller over years. A non-compete covenant is the mechanism buyers use to protect that goodwill from the one person best positioned to erode it: the departing owner. Sale-of-business non-competes are legally distinct from employment non-competes, and they are treated far more permissively, even in states that broadly prohibit non-competes in the employment context.

Sale-of-business covenants differ from employment non-competes

An employment non-compete restricts a worker from taking a competing job after leaving an employer. Courts scrutinize these closely because they can limit a person's ability to earn a living, and the bargaining power between employer and employee is often unequal. A sale-of-business non-compete arises from a very different transaction. A seller who has received substantial consideration for a company, including its goodwill, agrees not to turn around and start a competing venture that would strip value from what the buyer just paid for.

Because the seller is a paid participant in an arms-length deal rather than an employee accepting terms as a condition of a job, courts apply a more lenient reasonableness standard. The rationale is straightforward: a buyer who pays for a business should not have the seller open a competing shop across the street the following week. This distinction is why sale-of-business covenants remain broadly enforceable across all fifty states, subject to reasonableness limits.

Why buyers insist on them

Goodwill is frequently one of the most valuable assets in a lower-middle-market transaction, and it is inseparable from the relationships and know-how the owner controls. Without a covenant not to compete, a seller could theoretically sell the business, collect the proceeds, and immediately solicit the same customers and rehire the same key staff under a new banner. Buyers require these covenants to:

• Protect purchased goodwill so the customer base and reputation they paid for remain with the acquired entity.
• Preserve continuity during the transition period when relationships are being handed off.
• Prevent talent and client poaching through companion non-solicitation covenants covering employees and customers.
• Support financing, since lenders and equity investors often view enforceable covenants as a condition of the capital structure.

The value at stake is real. In many small and lower-middle-market companies, the founder personally embodies much of the enterprise value. Customers may buy because they trust the owner, key referral partners may route work through a single relationship, and institutional knowledge about pricing and operations may live in the owner's head. A buyer underwriting the deal is effectively betting that this value can be transferred and retained. A durable covenant not to compete is a central part of protecting that bet, which is why the absence of an enforceable restriction can affect not only price but whether a transaction closes at all.

Non-compete versus non-solicit

These covenants often travel together but do different work. A non-compete bars the seller from engaging in a similar line of business within a defined territory for a set period. A non-solicitation covenant is narrower, prohibiting the seller from actively pursuing specific customers, prospects, or employees of the business, without necessarily barring the seller from the industry altogether. Non-solicits are generally viewed as less restrictive and can be enforceable in some jurisdictions that limit broader non-competes. In practice, purchase agreements commonly include both, along with confidentiality and non-disparagement provisions, as part of the restrictive covenant package.

Non-solicitation covenants themselves often split into two categories: customer non-solicits, which prevent the seller from courting the acquired company's clients, and employee non-solicits, sometimes called anti-raiding provisions, which prevent the seller from luring away the workforce. A related no-hire provision may go further by barring the seller from hiring those employees even if they apply on their own. Because these narrower covenants restrain less than a full ban on competing, they are frequently the fallback where a broad non-compete would be vulnerable, and they are sometimes the primary protection negotiated in industries where a wide non-compete is impractical.

State law governs, not a federal ban

Non-compete enforceability is a matter of state law. There is a common misconception that a federal rule now bans non-competes. In April 2024 the Federal Trade Commission issued a rule that would have banned most employment non-competes nationwide, but a federal court in Ryan, LLC v. FTC set the rule aside in August 2024, and it never took effect. The FTC later moved to dismiss its appeal, and the agency has signaled it will pursue case-by-case enforcement rather than a categorical ban. Notably, even the FTC rule as drafted contained an explicit carve-out for non-competes entered into pursuant to a bona fide sale of a business.

The practical result is that state law continues to control. Several states broadly bar employment non-competes, including California, North Dakota, Oklahoma, and Minnesota, with Washington having enacted a broad ban in 2026 that takes effect in 2027. Yet every one of those states preserves an exception for the sale of a business. In California, for example, Business and Professions Code section 16601 permits a seller of business goodwill or ownership interest to agree not to carry on a similar business within a specified geographic area, so long as the buyer continues to operate a like business there.

What makes a covenant reasonable

Enforceability turns on reasonableness across three dimensions. Even in permissive sale-of-business contexts, a covenant that overreaches on any of these can be narrowed or struck by a court.

• Duration. Sale-of-business non-competes commonly run two to five years. Two-year and three-year terms are widely enforced; some states have statutory presumptions, and Florida, for instance, presumes durations of up to several years reasonable when tied to a business sale. California courts have generally treated roughly three to four years as an outer boundary.
• Geography. The restricted territory should track where the business actually operated and served customers. A nationwide restriction is difficult to sustain for a business with a regional footprint.
• Scope of activity. The prohibition should map to the line of business being sold, not lock the seller out of unrelated fields.

Courts also weigh whether goodwill genuinely transferred. Recent California case law has distinguished full sales from partial sales of ownership, applying a reasonableness review to partial exits and questioning covenants tied to sales that do not actually convey goodwill. The amount of consideration a seller receives also matters, since substantial payment supports a broader restriction than a court would tolerate in an employment setting.

States also differ on what a court does with a covenant that reaches too far. Some jurisdictions apply a blue-pencil approach, striking the offending words while leaving the rest intact, while others will reform or rewrite an overbroad term to what the court considers reasonable. A minority of states refuse to save an unreasonable covenant at all and instead void the entire provision. This variation is one reason the drafting is jurisdiction-specific and why a covenant that is routine in one state can be unenforceable in another. Choice-of-law and choice-of-venue clauses are commonly used to point toward a jurisdiction whose standards the parties prefer, though courts do not always honor them when a different state has a stronger public policy interest.

Tax and purchase-price allocation notes

A non-compete covenant can also carry tax consequences, because the purchase price in an asset deal is generally allocated across the assets acquired, and a portion may be assigned to the covenant itself. For the seller, amounts allocated to a non-compete are typically treated as ordinary income rather than capital gain, while amounts allocated to goodwill may receive more favorable capital-gains treatment. Buyers, by contrast, generally amortize an acquired non-compete over a fixed statutory period. These competing preferences mean the allocation is often negotiated, and it should be consistent across the parties' tax filings. This is a general description of common treatment and not tax advice; the specifics depend on deal structure and current tax rules, which a qualified tax professional can address.

Where covenants fit in a prepared sale process

Restrictive covenants are typically negotiated alongside price, structure, and the transition plan, and they interact with earnouts, consulting arrangements, and any equity rollover the seller retains. A seller who plans to stay on as an employee or consultant may face layered covenants, one tied to the sale and another to continued service. Because scope, duration, and geography are negotiable and jurisdiction-specific, these terms are often addressed early in a well-organized process rather than left to the final drafting sprint. Platforms such as Bankerly.ai organize the diligence and documentation workflow that surrounds a sell-side transaction, within which covenant terms are one component among many.

Educational note

This article is general education, not legal advice. Non-compete law varies significantly by state and continues to evolve through legislation and court decisions, and the enforceability of any specific covenant depends on the exact language, the transaction structure, and the governing jurisdiction. Anyone evaluating a covenant in a business sale should verify current state law and consult a qualified attorney licensed in the relevant jurisdiction.

Sources

• Federal Trade Commission - Noncompete Rule
• California Legislative Information - Business and Professions Code Section 16601
• Morrison Foerster - Non-Compete Round Up: FTC, NLRB, California and Delaware
• LegalClarity - Non-Compete Laws by State: What's Banned, What's Allowed
• Littler - Washington Bans All Noncompetes, With a Sale-of-Business Exception