Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Non-Compete Trap That Cost a Buyer 25 Million
Transcript
- Lucas: So Luna, let's talk about a $25 million mistake that happened because of a single sentence — or rather, the absence of one — in a non-compete clause. Luna: Oh, I love a good non-compete horror story. Was this in the software space? Lucas: Exactly. OmniCorp, a mid-market tech roll-up, bought DataSync, a B2B data integration platform, for $150 million. The seller's CEO, John Miller, signed a two-year non-compete saying he wouldn't engage in any 'business that is competitive with the acquired company.' Standard boilerplate. Luna: Standard and dangerous. What was the loophole? Lucas: The definition of 'competitive business' was limited to companies that derived more than 50 percent of their revenue from data integration services. So Miller, six months after closing, launched a new company that offered data integration as a free feature — monetizing through analytics. Zero revenue from integration itself. Technically, he wasn't in violation. Luna: And OmniCorp's lawyers had signed off on that? That's a massive oversight. Lucas: Right. They assumed the non-compete covered the entire business, but the carve‑out was so narrow that Miller could essentially do the same thing, just with a different revenue model. Within a year, he'd poached three of DataSync's top engineers and two major clients. OmniCorp's projected synergies — they'd counted on keeping that team and cross‑selling — evaporated. Luna: So they sued, I assume? But by then the damage was done. Lucas: They did sue. And the court applied a 'blue pencil' doctrine — they can strike unreasonable parts but not rewrite the contract. The definition was clear; it wasn't ambiguous. The judge said, 'You wrote this. It's your fault.' OmniCorp spent another $3 million in legal fees and got nothing. Luna: That's the thing with non-competes — you can't always rely on a court to save you. What's the lesson here for buyers? Lucas: First, never accept a competitor definition that uses a revenue percentage. Instead, tie it to the actual products and services the target offers — and any that are in development or planned. Second, include a 'garden leave' clause: if the seller is going to compete, you pay them a fraction of the salary to stay out for an extra six months. It gives you time to retain relationships. Luna: I've also seen deals where the non-compete doesn't cover affiliates. The seller starts a company through a spouse or a trust. Did that happen here? Lucas: Not in this case, but that's another common trap. You need to explicitly name affiliates, related entities, and even 'passive ownership' exceptions. If the seller can own 5 percent of a public competitor, that's usually fine — but you want to define 'passive' as no board seat, no management role. Luna: And geography. A lot of non-competes limit to a specific region. But if the business is digital, geography means nothing. You need a worldwide scope. Lucas: That's exactly the next point. Digital targets should have global non-competes. OmniCorp's was limited to North America — Miller's new company operated out of Ireland, serving US clients remotely. Totally allowed. Luna: So the trap is essentially a mismatch between the non-compete's scope and the actual competitive threat. And you need to draft it with the seller's future behavior in mind. Lucas: Right. One thing I've learned: get the seller to define, in their own words, what they think they won't be allowed to do. Then have your lawyers expand it. You'd be surprised how often sellers try to carve out 'consulting' or 'board service' as exceptions. Luna: Let me throw out a quick honest thing — a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many episodes. These deep dives take a ton of research, so thanks if you're one of them. Lucas: Yeah, it really does keep us independent and ad‑free. Alright — back to the non-compete. There's another dimension: the interplay with earnouts. In OmniCorp's deal, they had a $30 million earnout tied to revenue retention. Miller's new company made that impossible. Luna: So the non-compete failure also killed the earnout? That's double jeopardy. Lucas: Exactly. The earnout was based on 2024 revenue from existing clients. Miller took three of the top five clients. OmniCorp paid zero earnout, but they'd already paid the base price. Total value destruction: $25 million in lost future cash flows, plus the legal costs. Luna: I remember a case from 2018 — a HubSpot competitor called something like 'Inbound Systems' — where a similar oversight cost the buyer $12 million. The non-compete allowed the seller to work for a 'consulting firm' without defining what that meant. Lucas: That's the 'consulting carve‑out' trap. Some sellers try to add a phrase like 'except for providing advisory services.' That's a gaping hole. You need to specify: no services to any company that competes, even if it's consulting. Luna: Or they say 'except for serving on boards of non‑competitive companies.' But what's 'non‑competitive'? If it's vague, you're back to square one. Lucas: Right. So your non-compete should include a list of prohibited activities: owning, managing, operating, controlling, financing, consulting to, investing in, or participating in any way. And then define 'competitive business' broadly — any business that provides similar products or services to any customer or potential customer of the target. Luna: And don't forget the 'potential customer' part. OmniCorp's definition only covered actual clients. Lucas: Exactly. Another fix: include a 'right of first refusal' for the buyer if the seller wants to start a new business. The buyer can say, 'We'll buy that new business too' — or at least get a non‑compete on those new activities. Luna: I've also seen deals where the non-compete is tied to a specific list of competitors attached as an exhibit. That's a good practice, but you need to update it annually. Lucas: And make sure the list is non‑exclusive — 'including but not limited to.' Otherwise the seller can argue that if a competitor isn't on the list, it's allowed. Luna: Let's talk about jurisdiction. Some states, like California, basically ban non-competes. How do you handle that in an acquisition? Lucas: Good point. In California, post‑employment non-competes are void, but in the context of a business sale, they are enforceable for the seller. So you can still get a non‑compete from a California seller. But you have to be careful about choice of law — choose Delaware or New York law. Luna: And don't forget that if the seller moves to a non‑enforcing state, you might have trouble. So consider a 'forum selection' clause: any litigation about the non‑compete must be in a friendly jurisdiction. Lucas: Another trap: the non-compete doesn't explicitly state that the buyer can assign it to a future purchaser. If OmniCorp later sells itself, they want to assign the non‑compete to the new owner. Without that language, the seller might argue the non‑compete dies with the original buyer. Luna: So the lesson is: don't treat the non-compete as a boilerplate checkbox. It needs to be custom‑drafted for the specific target, the industry, the seller's personality even. Lucas: And always talk to the seller about their plans. If they're planning to retire, great. If they say, 'I might do some consulting,' that's a red flag. Dig into what 'consulting' means. Luna: So what's the forward‑looking takeaway for our listeners? If you're buying a company today, on July 28, 2026, what's the one thing you should check in your non‑compete? Lucas: Pull out the definition of 'competitive business.' If it uses a revenue percentage, a geographic boundary, or a vague term like 'materially similar,' rewrite it. Go to the target's business plan, see where they planned to expand, and make sure the non‑compete blocks that too. Luna: Good advice. And have your lawyer review it alongside the earnout and retention agreements — you want the three to be consistent. Lucas: Exactly. The $25 million mistake was avoidable. It just took someone asking the right questions about the non‑compete scope before signing.