Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The M&A Non-Compete That Cost a Buyer $12 Million in Lost Revenue
Transcript
- Lucas: We talked a lot on this show about earnouts and indemnification baskets — the financial mechanics that eat equity. But there's a clause that can cost you real revenue without a single dollar changing hands in escrow, and it's the non-compete agreement. Luna: The non-compete. Everyone knows they're in the contract, but I bet most buyers skim it. 'Don't compete for three years, fine, next page.' Lucas: Exactly right. And that's where the trap lives — in the details. I want to walk through a specific case. A private equity firm we'll call Northrock Partners bought a regional HVAC distributor for $45 million in late 2024. The target had about $30 million in revenue, strong margins, a loyal customer base across three states. Luna: Classic bolt-on for a PE platform. Lucas: Right. And the non-compete in the purchase agreement was standard boilerplate: the seller couldn't 'engage in any business that competes with the company within a 50-mile radius of any office location for three years.' Sounded tight. The deal closed in January 2025. Luna: I'm already suspicious. 'Any office location' — what about territories where they didn't have an office? Lucas: That was the gap. The seller, a guy named Tom, had built the company with a small satellite office in one state and a main headquarters in another. But his real customer base extended much further — he serviced accounts across four states, including a big industrial corridor in a neighboring state where he didn't have a physical office. The non-compete only covered 50 miles around those two offices. Luna: So he was free to compete in that corridor. What did he do? Lucas: Within six months, Tom opened a new HVAC parts distributor in that unguarded territory. Same supplier relationships, same playbook. He didn't solicit any existing customers by name — he just set up shop and started calling on the same type of industrial buyers. By the end of the first year, Northrock estimated it had lost about $12 million in revenue from that corridor. Luna: Twelve million on a forty-five million dollar deal. That's huge. Lucas: It's twenty-six percent of the purchase price. And here's the kicker: Northrock sued, arguing that the non-compete implicitly covered any territory where the company did business. But the contract said 'any office location,' and the court held that language to its plain meaning. Tom won on summary judgment. Northrock got nothing. Luna: This is exactly the kind of trap that seems obvious in hindsight but gets glossed over in the heat of negotiation. Lucas: Which is why we're digging into it today. Let me give you a few concrete takeaways for buyers. First, the geographic scope shouldn't just be radial from an office — it should cover any territory where the company derived material revenue in the prior three years, defined by zip code or county. You want a map exhibit if possible. Luna: A map exhibit. That's smart. No ambiguity. Lucas: Second, the definition of 'competing business' needs to be broad. In Tom's case, his new company didn't sell the exact same brand of HVAC units — he sold a different manufacturer's line. The old non-compete said 'any business that sells products or services similar to those sold by the company.' Tom argued his new product line was different enough. The court bought it. Luna: So the definition should include any business that provides goods or services to the same end users or solves the same customer problem. Not just identical products. Lucas: Exactly. And third: the non-compete should be paired with a non-solicitation clause that doesn't just name existing customers, but also prohibits soliciting any person or entity that was a customer during the trailing twelve months — even if they're not on a list. And a non-circumvention clause that prevents the seller from using any confidential information about customers or suppliers to compete indirectly. Luna: Tom knew exactly which industrial buyers to call on because he remembered them from his time running the company. He didn't need a customer list. Lucas: Right. And the non-circumvention clause would have covered that — using confidential information to compete, even without a physical list. Northrock's contract had a generic non-circumvention, but it only applied to 'confidential information' as defined in the NDA, which expired at closing. They didn't tie it to the non-compete. Luna: So the lesson for buyers: don't let the non-compete be a one-liner. Make it a paragraph — or two. Lucas: Now, I want to give sellers a fair warning too. Buyers who come back with a super-wide non-compete can trap you unjustly. We've seen non-competes that cover 'any business in the HVAC industry' anywhere in the United States — far beyond what the company actually operated. That can be unenforceable in many states, but it still creates legal hassle. Luna: Yeah, if you're a seller, you want the non-compete to be reasonable and tied to the actual business you sold. Not a blanket prohibition on your entire career. Lucas: Let's talk about a seller-friendly outcome. In the Tom case, he won. But he still spent about $800,000 on legal fees — which wiped out a big chunk of his earnout proceeds. So even winning can be expensive. The ideal for both sides is a non-compete that is precise enough to protect the buyer's investment but narrow enough that the seller knows exactly what they can and cannot do. Luna: One thing I see in some deals is a 'carve-out' for the seller to invest in or work for a non-competing business in a related field. That can make the non-compete more palatable. Lucas: Great point. Some sellers negotiate a pre-approved list of activities or a right to request a waiver. But even then, the buyer should retain the right to review and withhold consent reasonably. The key is writing it all down in the agreement, not leaving it to handshake understandings. Luna: So the trap is really about vagueness. Vague geography, vague definition of competition, vague duration triggers. Lucas: Exactly. And here's one more nuance: the duration clock. Most non-competes start at closing. But if the buyer discovers the breach months later, the clock is already ticking. Some sophisticated buyers negotiate that the non-compete period is tolled — paused — during any period of breach. That's uncommon but powerful. Luna: And the remedy? In Tom's case, the only remedy was money damages. The court wouldn't grant an injunction because the non-compete was too narrow. Lucas: Right. So buyers should also include a provision that if the seller breaches, the buyer can get injunctive relief plus the right to claw back a portion of the purchase price — often calculated as a multiple of lost revenue. That gives real teeth. Luna: Let me ask you this: in a competitive auction where the seller has leverage, can a buyer really push for all these protections? Lucas: It's a negotiation. If the seller has multiple bidders, they can say no. But a smart buyer frames it as protecting the value of the deal — not as distrust. And they can offer a slightly higher purchase price in exchange for tighter protections. I've seen that work. Luna: Give me a concrete example of the language you'd want in the definition of competing business. Lucas: I'd write something like: 'any business that sells or distributes products or services that are the same as, or reasonably interchangeable with, the products or services sold by the company during the twelve months prior to closing, or provides such products or services to any customer or end user of the company during such period, or is otherwise engaged in the business of HVAC parts distribution in the covered territory.' You want it broad and redundant. Luna: And the covered territory — you'd define it by specific county or zip code, not just radius around an office. Lucas: Yes. And include any county where the company had at least $100,000 in revenue in the preceding fiscal year. That covers the satellite territories without an office. You can even attach a schedule listing the counties. Luna: Alright, so for listeners who are operators thinking about selling, what's the one thing you want them to remember? Lucas: Don't treat the non-compete as boilerplate. Spend ten minutes with your attorney mapping your actual business footprint — geographic and product-wise. And if you're the buyer, assume the seller will find the gap. Because Tom did. Luna: And the cost was twelve million dollars and two years in court. That's the real price of a poorly written clause. Lucas: Alright, that's our episode. Next time, we'll look at another overlooked clause: the 'material adverse change' provision and how a single unexpected regulatory filing triggered it. That one cost a buyer $200 million. Luna: See you next time.