Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How the Non-Solicitation Clause Killed an M&A Pipeline
Transcript
- Lucas: Luna, imagine you sell your company for ninety million dollars. You're set. Then six months later, the buyer tells you that your next startup can't hire anyone who worked with you in the last three years — including the janitor. Luna: That's not a non-compete. That's a non-solicitation clause — and it sounds like they stretched it past what most people expect. Lucas: Exactly. And that's the exact story behind a company called Axonify, a Canadian SaaS firm that sold to a strategic buyer — I won't name the buyer, but think of a large enterprise learning platform. The deal closed in 2022 for ninety million dollars, which was a great multiple at the time. Luna: So what happened? The founder probably had a non-compete for, say, two years. That's standard. But the non-solicit went further? Lucas: Right. The non-compete was eighteen months — typical. But the non-solicitation clause had a term of thirty-six months. And here's the killer: it didn't just say you can't directly solicit employees or customers. It said you can't 'encourage, induce, or attempt to influence' any employee, customer, or supplier to leave or reduce their relationship with the buyer. Luna: So even posting a vague LinkedIn job ad that happens to be seen by an ex-coworker — that could be a breach. That's a trap, not a protection. Lucas: Precisely. The founder, whose name is Carol Leaman by the way, started a new company about a year after the deal closed. She needed engineers. Half the talent pool in her region had worked at Axonify. She couldn't even reach out to former employees who had left Axonify before the sale. The buyer argued those people were still 'covered persons' under the clause because they had been employees of the acquired entity. Luna: That's absurd. If someone quit two years before the deal, they're not your employee anymore. But the contract language said 'any person who was an employee of the company at any time during the twelve months prior to closing.' So it captured way more people than she expected. Lucas: Yes. And that's the structural problem with poorly drafted non-solicitation clauses. They often use broad definitions like 'any person who was an employee or customer within the prior X period.' You need specific carve-outs. The best practice is to limit it to current employees at closing, and exclude anyone who left before the deal was signed. Also, customers should be limited to those the seller actually worked with in the last twelve months. Luna: And a time cap. Three years is extreme. Most non-solicits are twelve to twenty-four months. I've seen some as short as six months in competitive markets. Lucas: Right. So let's talk about what the clause actually says. A typical non-solicitation clause in an acquisition agreement has two parts: employee non-solicit and customer non-solicit. The employee part usually says you can't hire, recruit, or solicit any employee of the acquired company for a set period. The customer part says you can't solicit or do business with the company's customers. But the trap is when they add 'or attempt to influence' — that's a low bar for a breach. Luna: And what happens if you breach it? The buyer can sue for damages, but more importantly, they can often withhold earnout payments or claw back escrow funds. In a deal with an earnout, a non-solicit breach can trigger a total forfeiture. Lucas: Exactly. In Axonify's case, the buyer didn't sue — they just sent a cease and desist letter threatening to withhold the remaining escrow, which was about four million dollars. The founder's lawyers advised her to back down because fighting would cost more than the escrow. So she lost the pipeline of her next company. Luna: That is devastating. So what should a seller negotiate for? Specific language that carves out former employees, limits customer scope to active accounts, and caps the term at twelve months. Lucas: And add a passive hiring exception. That means you can hire anyone who reaches out to you unsolicited — like if an ex-employee applies for a job on their own, that's fine. Many buyers will accept that because it's reasonable. Also, exclude any customer who has stopped doing business with the buyer by the time you restart your company. Luna: And one more thing: make sure the non-solicit only applies to you as the seller, not to your new company's other co-founders or employees. Some buyers try to extend it to 'related entities,' which means your new venture's entire team is bound. Lucas: Great point. That's a common expansion tactic. The buyer will say 'the seller shall cause its affiliates to comply.' That effectively handcuffs your new investors too. You need to push back and limit it to just you personally. Luna: And if you have multiple sellers — like founders and key executives — the clause should be separate for each. You don't want one person's breach to poison the whole group's earnout. Lucas: Exactly. Now, the broader lesson here is that non-solicitation clauses are often overlooked because sellers focus on the non-compete. They think, 'I can't compete for two years, but I can start a new company in a different space.' Meanwhile, the non-solicit silently blocks their ability to staff that company. Luna: Right. And the numbers matter. A thirty-six-month non-solicit, like Axonify had, effectively kills a new venture in the same talent pool. Even a twenty-four-month term is tough. Twelve months is usually the sweet spot — long enough for the buyer to stabilize, short enough for the seller to move on. Lucas: And here's another thing: the non-solicit often triggers the same indemnification provisions as a non-compete. So if you breach it, the buyer can demand repayment of a portion of the purchase price. That's a big hammer. Luna: So what's the takeaway for this episode? When you're negotiating a deal, ask your lawyer to flag every non-solicitation clause. Read the definitions — 'covered persons,' 'customers,' 'business relationship.' If any of those are too broad, redline them. Lucas: And don't assume the non-compete is the only restraint. The non-solicit is often tighter and longer. I tell every client: if you plan to stay in the same industry after the deal, the non-solicit is more important than the non-compete. Luna: Before we move on — and this ties in — a quick note on something that keeps these deep-dive episodes coming. This show is ad-free, and that's only possible because listeners who find value chip in a few dollars a month. If these conversations have helped you avoid even one bad clause in your own deal, that's worth something. You can support the show at buy me a coffee dot com slash fexingo. It genuinely makes a difference — keeps us independent and digging into these traps. Lucas: Yeah, and it's a small way to say thanks if you've learned something. Now back to the non-solicit — I want to run through a quick checklist of what to look for in your LOI. Luna: Good. Let's hear it. Lucas: First, what's the duration? If it's longer than your non-compete, that's a red flag. Second, who is covered? Current employees only, or includes former? Third, what about customers — are they defined as those who bought in the last year, or ever? Fourth, is there a passive hiring exception? Fifth, does it apply to your new company's affiliates? Luna: And sixth, what's the remedy? Is it just an injunction, or can they claw back money? That matters for negotiating leverage. Lucas: Exactly. In many deals, the non-solicit is buried in the non-compete section, so it's easy to miss. I've seen sellers sign an LOI that only mentions 'non-compete,' and then the final agreement has a full non-solicit page. Luna: That's a classic bait and switch. The LOI sets expectations, but the definitive agreement is where the traps live. That's why you need a lawyer who reads every word. Lucas: And one more practical tip: if you're a serial entrepreneur, consider asking for a blanket waiver of the non-solicit for any company you start after the non-compete expires. Some buyers will agree if it's limited to a specific geography or industry. Luna: But they'll usually push back, saying they need to protect their investment. So you have to show them the mutual benefit: if you can't hire, your next company fails, and they lose a potential partner or acquirer down the road. Lucas: Right. And it's not just about the seller. The buyer's own interests are served by a reasonable non-solicit. If the clause is too aggressive, it could be unenforceable in some jurisdictions. Courts in California, for example, are hostile to non-solicits that restrict employee mobility. Luna: So a buyer who insists on a thirty-six-month non-solicit covering everyone might end up with a clause a judge strikes down — and then they have no protection at all. Lucas: Exactly. That's the irony. Overreach can backfire. So the smart play is to negotiate a narrow, time-bound clause that both sides can live with. Axonify's founder learned that the hard way. Her next company eventually raised seed funding, but it took twice as long because she couldn't hire experienced people. Luna: And that delay cost her market timing. In a fast-moving space like corporate learning, six months can mean the difference between leading and lagging. Lucas: Right. So before you sign, look at the non-solicit. It might be the clause that determines whether your next venture thrives or just survives.