Over the past 15+ years, I have defended approximately 150 non-compete cases and advised more than 1,000 clients on non-compete issues. These days, I routinely represent clients who sold their business for a substantial sum of money, then in relatively short order began work on a new venture that potentially implicated the operative non-compete restrictions. To many folks, this sounds absolutely crazy. But with serial entrepreneurs, it is incredibly common.
Serial Entrepreneurs: Founders Who Get New Ideas and Want Back In
Consider it like this: We are talking about the type of person who spends 8 years building a company, sells it for $80 million, pays off the debt and bonuses out key members of their team, and then walks away with $40 million. As a condition of the sale, they agree to an extremely broad 5-year non-compete agreement. If they sold an energy drink company to Pepsi, then they are out of beverage, completely. If they sold a supplement and wellness company to Proctor & Gamble, then they are out of supplements and wellness as broadly as that market can be defined.
But the type of person who pulls this off is not the type of person who can take a 5-year vacation. In fact, I rarely see these people take off five months. I recently had a situation where a guy had sold his company for more than $40 million. He clears about half of that. He took two weeks off. Went to the beach. Disconnected. Went surfing. Zenned out. He had been working 70+ hours a week for years. This was the first true vacation he had taken in at least a decade. And, somehow, while he was surfing he came up with a brilliant business idea. It did not involve direct, head-to-head competition with the venture he just sold. It was in an adjacent market. But the non-compete he signed in connection with the sale was extremely broad. If we go strictly by the terms of the operative non-compete as written, his pursuit of the new concept probably violates the non-compete. But: We do not go strictly by the terms of the non-compete as written. Yes, courts are highly deferential to business sale non-compete agreements. They are presumptively enforceable and evaluated much differently than non-competes in employment. But even business sale non-compete agreements have limits.
So, this guy calls me. Literally two weeks after the sale closed. Virtually the entire $40 million was paid at closing, with only about $500,000 held back for adjustments. And, as noted above, he cleared about $20 million. He does not need to do anything. He could go sit on the beach for years. He could disappear off the face of the earth. But this is just not the type of person who is going to go post up in a luxury eco lodge in Patagonia, take day hikes with a native guide, drink Lagavulin by a fireplace, and write a novel. At least not for any significant period of time.
He had an idea while surfing and totally zenned out. And now he wants to know: What is the risk and can I start this new venture? I get this sort of call all the time. But it usually takes them a bit longer than two weeks. Three to six months is more common. And regardless of the exact situation, they all have the same basic questions: What is the risk? Can I really do this? If so, how?
To be clear: None of these people are proposing jumping right back into a competitive business and going head-to-head against the acquiring company. That would be the dumbest thing ever and basically invite existential risk. If you do that, you are basically asking to get tagged for disgorgement of the entire sale price and more. So that is not what we are talking about. Instead, we are talking about nuanced situations where the founders / sellers have a broad, 5-year non-compete and a new venture concept that is in a grey area.
Typical Scenarios that Invite Challenges to Sale of a Business Non-Compete Agreements
Here are some of the most common scenarios I see that exist in the grey area vis-a-vis business sale non-compete restrictions.
Extremely broad non-compete, non-solicitation, and confidentiality restrictions. The buyer is a massive corporation and insisted upon a restriction that covers any business or venture that competes with the buyer, period. So the restriction is not based on the market scope of the acquired venture. Instead, it is based on the buyer’s entire global footprint. New venture is in an adjacent market, but not competitive. Possible challenge to scope of competitive restrictions.
Conflict or inconsistency in the terms of applicable restrictions. I see this one all time. Many people incorrectly assume that just because a team of BIGLAW transactional lawyers papered up the deal, the terms of the deal will be air tight. That is just not true. A brief aside to illustrate the point: When I started my career at Boies, Schiller, & Flexner, I spent a significant amount of my time working on the Barclays / Lehman Brothers litigation. Barclays had purchased substantially all of Lehman Brothers’ assets in a bankruptcy sale. Those assets ended up being worth roughly $10 billion. This was during the 2008 financial crisis. Lehman had a huge team of BIGLAW transactional lawyers that billed millions of dollars for papering up the deal. A year after the sale, Lehman filed a lawsuit challenging the sale. Their argument: Barclays got too good of a deal. They’d had no idea what assets they were selling and how much those assets were worth. They wanted the sale unwound, or, at least a portion of the profit Barclays had made since the sale.
So consider that. Even in a multi-billion dollar transaction with a massive team of deal lawyers, big companies still make mistakes. Over the past 15+ years, I have seen at least a dozen situations involving (a) the sale of a business for at least $10 million and (b) the transaction documents contain conflicting or unclear terms governing the post-sale non-compete restrictions. Let’s consider a few specific sub-variants of this category. Example: The asset purchase agreement has numerous exhibits. One exhibit is the post-sale Restrictive Covenant Agreement. The APA mentions the restrictive covenant and how that agreement is a material part of the deal. Although the APA itself contains a Delaware forum selection clause and choice of law provision, the RCA contains a totally separate forum selection clause and choice of law. Instead of Delaware, the RCA says that the forum and choice of law shall be that of where the restricted persons (the sellers) resided at the time of the sale. Well, suppose the sellers resided in Canada and Canadian courts are notoriously strict about striking down overly broad non-compete agreements even in the sale context.
Or, there is confusion over who is bound by what. The sellers are technically two LLC’s that own all of the membership interests in the company being sold. They sign the APA on behalf of the LLC’s, not in their personal capacity. There is an exhibit Restrictive Covenant Agreement just like in the example above. But the buyer’s deal lawyers were sloppy. The sellers never actually signed the RCA in their individual capacities. The RCA is a blank, uncompleted, unsigned standard form agreement. Seller says: Yes, we agreed to that as our LLCs and not in our individual capacities. Buyer says no, we obviously meant for that to apply to you in your individual capacities.
Dispute over a carved out line of business. Seller sells Company A and agrees to a broad, 5-year non-compete. But the seller owns multiple other businesses, including some that are close to the relevant market, or, that even overlap with the relevant market. The sale agreement includes a specific carveout for Company B and the relevant line of business. The seller wants to expand the operational and market footprint of Company B. This potentially violates the non-compete. But the non-compete and the carveout are clearly in conflict. I’ve seen this several times.
Seller abandons the line of business or the region. This is self-explanatory. Two years after the sale, the acquisition has turned into a disaster. The buyer mismanaged everything. Eventually, the buyer decides to cut their losses and either exit that line of business, or, exit that line of business in a specific geographic region (if it’s a service business). The seller wants to know: Can I get back in?
The breach of contract scenario. Seller takes a sale of the business non-compete, but also agrees to go work for the buyer for a year to facilitate the transition and integration. This almost never ends well. The seller is not used to having a boss. The seller and corporate buyer are constantly in conflict. Ultimately, the buyer holds back a significant payment that is due on an earn out schedule. Call it $5 million. The buyer says: You are in breach of your obligations because staying on and cooperating in the transition was a material part of the deal. You breached XYZ provisions in the Sale Agreement. We aren’t paying the remaining $5 million unless you do XYZ for us. The seller says: Fuck you. I’m done. You breached the Sale Agreement. The seller’s immediate question: Can I get back in?
The “I need my team” scenario. The seller has a great new concept that is not competitive with the old venture. But he needs several members of his old team to build the new venture. The sale agreement prohibits him from soliciting or hiring any of his former employees for 5 years. Here, we are getting away from a core non-compete issue and, instead, are considering the reasonableness of a lengthy, post-sale restriction against hiring former colleagues for a business that does not compete with the buyer in any fashion. Where as the core non-compete has a reasonable, legitimate, and even pro-business justification, the justification for the employee non-solicitation restriction is not nearly as legitimate. As always, the outcome here depends heavily on choice of law, forum, and even the state or jurisdiction where the employees reside.
The preparing to compete scenario. The seller has a new concept that absolutely would compete with the sold business and acquiring company. The ultimate question: How much work can be done on the new concept / new venture that constitutes preparing to compete, not actual competition. And are their any applicable agreements that might implicate intellectual property that is created within, say, 2 years after the sale.
Understanding the Landscape: Identifying the Operative Restrictions and Choice of Law
In situations like this, the possibilities, risks, and appropriate guidance all come down to the exact language of the restrictions, the applicable choice of law and forum, and the market scope of the contemplated new venture. Often, there is not just a single provision or a single agreement that applies. In many instances, there are multiple agreements, and sometimes the terms of those agreements conflict. Likewise, these situations often give rise to parallel legal proceedings: (a) a TRO or preliminary injunction case in court and (b) a separate arbitration proceeding to decide the merits. The analysis doesn’t just turn on the language of the restrictions. It also hinges on both the substantive law that will apply and the forum or forums where the dispute will be resolved. And sometimes variables are not clear cut.
I spend a significant amount of my time these days doing analyzing these exact situations and creating a playbook or roadmap that entrepreneurs can use to move forward in their new venture. Sometimes there is a viable pathway forward. Other times, the risk is simply too high. I typically advise my clients that these are extremely high risk situations, regardless of the merits and the legal landscape. Any time you sold a business for $50 million+ and are possibly in a non-compete grey area, that is high risk. As such, contemplating a new venture that is in a grey area only makes sense if the potential upside is literally multiples of what they cleared on the first sale. And in spite of this risk, I perpetually have a roster of clients who are serious enough about launching a new venture that they want to thoroughly evaluate the risk landscape and consider their options. Because depending on the specifics, there may be some extraordinary tools in the toolkit. If the facts and the law are clear enough and our position is strong enough, that is where we consider options like pursuit of a declaratory judgment and demand for expedited proceedings. But that is for another day.
Over the past 15+ years, Jonathan Pollard has defended approximately 150 cases in litigation or arbitration, resolved more than 500 non-compete disputes outside of court, and advised more than 1,000 clients on non-compete issues. Pollard has represented dozens of individuals who sold their businesses in connection with non-compete issues. In many instances, the individuals have sold their businesses for in excess of $20 million, sometimes significantly more. Jonathan Pollard a high stakes litigator and the founder of Pollard PLLC. Pollard routinely represents clients in non-compete, trade secret, and unfair competition cases. Pollard has been recognized by Super Lawyers and the elite lawyer ranking organization Chambers & Partners (of London). Pollard has appeared in or on the New York Times, the Wall Street Journal, Bloomberg, PBS News Hour, Law360, NPR, Inc. Magazine, and more. His office can be reached at 954-332-2380 or info@pollardllc.com.