If you’ve just bought a new business, the last thing you want to find when you’ve already signed on the dotted line and handed over the money, is that that your Seller has just started up a new business the very next day, that’s directly competing with the business they’ve just sold to you.
As a Buyer, one of the assets that you’re purchasing, along with the actual business itself, is the right to not have the Seller competing with you, at least for a period of time.
But, Buyers need to realise that this right is not automatic. If it’s not stated clearly (and correctly – see below) in the sale contract, then the right to prevent competition simply doesn’t exist, and there’s little a Buyer can do to stop the Seller from reopening up the following week, right around the corner, selling exactly the same thing.
So, how do Buyers prevent this situation from arising?
The answer is by making sure that your sales contract contains well-drafted and appropriate ‘Restrictive Covenants’.
Restrictive covenants usually focus on three main areas:
- That the Seller won’t compete by starting a new business, or by working for a competitor.
- That the Seller won’t try to poach any clients from the business they’ve just sold.
- That the Seller won’t try to poach any employees from the business they’ve just sold.
But there’s more to enforcing Restrictive Covenants than just putting your requirements in writing, and getting them agreed. As Restrictive Covenants are governed by the courts (not just the wording of the contract) there’s a danger that if you try to extend your restrictions too far, going beyond what the courts call ‘the legitimate business interests of the business owner’, then the covenants can end up being worthless.
The principle factors which the courts will look at when deciding whether or not to enforce Restrictive Covenants are:
- The period of time which they last. If you want to play it safe, the restriction should last no longer than 12 months, (although 18 months is still possible you’d be amazed how many contracts still try for 2 years, despite the fact that courts have repeatedly thrown out 2 year periods as being too long).
- The geographical area to which the restriction applies. The court will weigh-up the need to protect the interests of the business, against the need of the individual to be able to work. For example, if the business being sold is a hairdressing salon, it may be reasonable to prevent competition within a mile of the existing salon(s), but a restriction not to compete within 5 miles could be thrown out for being too restrictive.
There are other factors the court may take into account too, but this is just a general overview, not a detailed analysis, and each case will be judged on its own merits.
The main point is that the drafting of Restricted Covenants needs to be looked at very carefully, to ensure that they are relevant and enforceable. If Buyers don’t include them in their contract with their Seller, or if they try to over-do them, so they wind up being unenforceable, they could be missing out on a crucial piece of legal protection that will enable their new acquisition to flourish.