Non-Compete Agreements and the Sale of a Business

In utilizing a non-compete agreement as a condition to the sale of a business, it is critical to recognize two nuances:  (1) restrictions on competition are enforceable only to the extent they’re reasonable; and (2) a covenant not to compete could have significant tax implications for both buyer and seller.

Typically, non-compete agreements state that in exchange for compensation, which is usually part of the sale price, the seller will promise not to enter a similar business, within a geographic area, for a limited time period. Courts will only enforce such an agreement if it is reasonable in scope and duration. What qualifies as reasonable depends on the industry and the state in which the agreement was entered into, as states have different standards for evaluating reasonableness.

In negotiating the business sale price, buyer and seller must decide upon  the monetary worth of the non-compete agreement.  In a typical asset sale of a business, each sold asset is treated separately for tax reasons. Currently,  assets treated as capital gains are taxed at an appreciably lower rate than those treated as ordinary income. Notably, gains on some intangible assets, such as non-compete agreements, aren’t usually eligible for capital gains treatment.   Thus, they are usually taxed as ordinary income.  It follows that in allocating the business sale price to all tangible and intangible assets, the buyer and seller should be mindful that assigning a portion of the sale price to the  non-compete agreement could lower  the after-tax profit for the  seller.

Because of these tax implications, buyer and seller alike should carefully structure any non-compete agreement and its monetary value.  If you have any questions regarding the structure of a business sale or a non-compete agreement, please feel free to contact us to speak with one of our attorneys at Acumen Law Group.

Authored by  Dominika Szreder Fard, Esq.