Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How the Non-Compete Trap Blocks Founders from Their Next Move
Transcript
- Lucas: You close your company, you get your payout, you think you're free — and then you realize you can't work in your own industry for the next three years. That's the non-compete trap in M&A. Luna: It's one of those clauses that sellers often skim over because they're focused on the price. And it can be brutal. Lucas: Exactly. I want to talk about a specific case — a health-tech founder I spoke with last year. He sold his company in 2021 for about $40 million. Great outcome. But the non-compete in the purchase agreement was drafted so broadly, it basically said he couldn't work in any software-enabled health services business anywhere in North America for five years. Luna: Five years? That's extreme. And 'any software-enabled health services' — that's almost everything in health-tech. Lucas: Right. He thought he'd take a year off, then start something new. But when he started talking to lawyers about his next idea — a digital platform for physical therapy — they told him he'd be in breach. The buyer would have grounds to claw back a portion of his earnout and sue for damages. Luna: So what was the buyer's rationale? I mean, it's not like he was going to steal trade secrets and build a direct competitor. Lucas: The buyer — a mid-market private equity firm — argued that his knowledge of the market and relationships with hospital systems gave him an unfair advantage. But really, they were using the non-compete as a talent lock-up. They didn't want him competing for deals or talent. And they knew most founders won't fight it because litigation is expensive and time-consuming. Luna: So the non-compete becomes a weapon, not just a protective clause. Lucas: Exactly. And the thing is, a reasonable non-compete can be perfectly fine. It protects the buyer's goodwill. But the trap is when it's overly broad in scope, geography, or duration. In many states, courts will throw out an unreasonable non-compete entirely — but that doesn't help you if you're stuck in litigation for two years. Luna: Let's talk about what a seller should actually negotiate. What are the key levers? Lucas: First, scope. Define the specific business activities you're restricted from. Don't let it be 'any business that competes' — tie it to the exact product lines, customer segments, and geographies of the company you just sold. Second, geography. If your company only operated in three states, the non-compete should be limited to those states, not the whole country. Luna: And duration — five years is a long time. What's typical? Lucas: One to three years is standard. Anything beyond three years starts to look punitive, especially in fast-moving sectors like tech. Also, consider what happens if the buyer doesn't perform — if they cut your product line or lay off your team, you might want a waiver or a reduced restriction. Luna: That's a good point — tying the non-compete to the buyer's actions. There's also the garden leave concept, right? Where they pay you during the restricted period. Lucas: Yes. If they want you out of the market for two years, they should compensate you for that. Some sellers negotiate a 'compensation period' — say, six months of salary — during which the non-compete is active, and after that, it expires. That puts a real cost on the buyer for extending the restriction. Luna: Before we go further — and I realize we're in the middle of this — I want to mention something. We keep these episodes ad-free deliberately, because we think this kind of specific deal knowledge should be accessible without interruptions. If you find value in that, and you want to support the model, the link is buy me a coffee dot com slash fexingo. No pressure, just an option. Lucas: Yeah, it's a small way to keep the show independent and focused on what matters — helping operators avoid costly mistakes. Okay, back to the non-compete. Another trap is the 'non-solicitation' clause that's bundled in. It might prevent you from hiring any of your former employees, even if they reach out to you first. Luna: That's a nasty one. Founders often want to bring their best people along to the next venture. If the clause says 'no solicitation' but doesn't carve out hiring in response to unsolicited applications, you're stuck. Lucas: Exactly. You need a carve-out for 'unsolicited applications' and for 'general public advertisements.' Also, if the buyer later fires those employees, you should be able to hire them. So negotiate that upfront. Luna: What about the earnout interplay? If your earnout is tied to post-close performance, and then you're forced to stay away, you have no ability to influence the outcome. Lucas: That's a critical point. If you have an earnout, you need to be involved — at least as a consultant. So the non-compete should have a 'services exception' that allows you to fulfill your earnout duties. Otherwise, the buyer could argue you're violating the non-compete by even showing up to help. Luna: And the enforceability varies by state. California basically bans non-competes, but other states like Florida and Texas enforce them broadly. So if your company is based in California but the buyer is in Texas, which law applies? Lucas: The purchase agreement usually specifies the governing law — often the buyer's home state. So a founder in California could end up bound by Texas law. That's a huge trap. You need to negotiate the governing law or at least include a 'blue pencil' clause that lets a court modify unreasonable restrictions rather than voiding the whole thing. Luna: Blue pencil — that's when a court can strike or modify specific parts of the clause, right? Lucas: Yes. Some states allow it, some don't. If you're in a state that doesn't, an overly broad non-compete can be thrown out entirely — which sounds good, but you risk litigation to get there. Better to negotiate a clean, narrow clause from the start. Luna: So for founders listening, what's the one thing they should do before signing? Lucas: Map out your next move. Before you sign, have a clear idea of what you want to do after the deal — even if it's just a concept. Then show that to your lawyer. Ask: 'Does this non-compete block me from doing this?' If the answer is yes, negotiate a carve-out. That's your leverage. Luna: Because once you sign, you're locked in. And the buyer has no incentive to let you out. Lucas: Exactly. And remember, the non-compete is just one piece of the 'restrictive covenants' package. There's also non-disclosure and non-solicitation. Treat them all as negotiable, not boilerplate. A good M&A lawyer should be able to craft protections that satisfy the buyer without handcuffing you for half a decade. Luna: It's really about knowing what you're signing away. The price might be great, but if you can't work in your field for years, it's a different calculation. Lucas: Right. And that founder I mentioned — he ended up settling with the buyer after six months of negotiation. He got a narrower scope and a two-year duration instead of five, but he had to give up some of his earnout to get it. He told me he'd pay ten times that legal fee to go back and negotiate it upfront. Luna: A costly lesson. Hopefully this helps someone avoid it. Lucas: That's the goal. Next time, we'll talk about the 'material adverse change' clause — another one that looks harmless until it's not.