How to keep a seller invested in a company?

October 30, 2024

by an member from University of Washington in Mount Vernon, WA, USA

Hello all. We're considering acquiring a company where the seller isn't retiring, which could pose a future threat if they ever choose to compete with us after the non-compete expires.

How feasible is it to demand a long non-compete? (~10 years or more)
How large of a seller note should we consider asking to keep them invested?
How much equity should we consider asking them to invest in the acquisition to keep them invested?
Is there something else we can do to try and mitigate this risk?

I'd appreciate any thoughts on this. Thanks!

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Reply by a professional
from Bentley College in Miami, FL, USA

Long Non-Compete: A 10-year non-compete can be challenging to enforce, depending on jurisdiction. In many cases, courts view 5 years as more reasonable. However, structuring an agreement that encourages long-term loyalty through other means could provide additional security.

Seller Note: Asking for a seller note of 15-25% of the deal’s value is a common approach to keep sellers financially invested in the business's future success. This often motivates sellers to maintain goodwill and assist in a smooth transition period.

Equity Roll: Inviting the seller to roll over some equity can also align their interests with the success of the business post-sale. Many buyers find that even a small equity roll (5-10%) can help align long-term goals, keeping the seller engaged without diminishing the buyer's control.

Additional Protections: Consider performance-based earn-outs, consulting arrangements, or advisory roles, as these can often keep a seller engaged without direct competition risk.

If you’re working through these elements and would benefit from tailored expertise, DueDilio could help connect you with M&A professionals experienced in deal structuring and retention strategies. They can guide you through the nuances and help design a framework that aligns the seller’s interests with yours. Good luck!

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Reply by a professional
from Northwestern University in Southborough, MA, USA

I believe you can actually enforce a 10 year non-compete in certain circumstances, but i'm not a lawyer. My understanding is that (in general) non-competes are difficult to enforce for employees, and even in states where they typically stop non-competes, they are still very much enforceable when the ownership sells their interests in a company. As an example, when I sold my business, I had two non-competes, one as an executive and one as part of the Equity Purchase Agreement. The executive agreement had compensation attached to the non-compete period, and the equity purchase agreement was negotiated as part of the sale of my equity. I think if there's a 10 year term in the equity purchase agreement, that sounds like two people came to a business agreement to block her/his competition in the market as part of the sale. Though if you tried to lock up common managers, I think you'd have a tough time enforcing that.

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