Non-compete when buying a business: what to ask the seller to sign
Short answer
When you buy a business, you're paying for its goodwill: customers, reputation, relationships. A non-compete stops the seller from taking that goodwill back by opening a competing business or calling old customers. Ask for one covering the seller's realistic competitive reach (the geography where your customers are and the services you sell) for a period long enough for relationships to transfer to you.
Courts generally treat sale-of-business non-competes more favourably than employee ones, but they still have to be reasonable, and state law varies.
Picture buying a dental practice, a landscaping company or an insurance agency, and six months later the seller opens up across town. Most of the customers knew the seller, not the business name. A non-compete is the only thing standing between you and that outcome. Not legal advice; enforceability is a state-law question for your attorney.
What a seller non-compete covers
| Term | What to think about |
|---|---|
| Activities | The services and products the business actually sells, plus close substitutes. Too broad (any business at all) invites a court to strike it. |
| Geography | Where customers come from. Map them. A local service business might need a radius; an online business might need customer-based terms instead of geography. |
| Duration | Long enough for relationships to move to you. Relationship-heavy businesses justify longer terms. |
| Non-solicitation | No contacting customers or hiring away employees, regardless of geography. Often easier to enforce than a broad non-compete. |
| Non-disparagement and confidentiality | No badmouthing the business; no using its information. |
| Who signs | Every selling owner. Consider spouses or family members who held key relationships. |
Worked example: a non-compete and a seller note together
Illustrative example, not legal advice
The price includes a $150,000 seller note paid over five years. The purchase agreement says that if the seller breaches the non-compete or non-solicitation clauses, the buyer may offset its documented losses against the remaining note payments, in addition to seeking a court order. In year two, the seller begins serving two former customers worth $40,000 a year. The buyer's attorney sends notice and withholds the next payment under the offset clause. The clause doesn't replace the non-compete; it gives it teeth. Note that in SBA deals, standby notes have their own terms; agree offset rights with your lender and attorney.
Why sale-of-business non-competes are different
Employee non-competes face growing restrictions across the US. Sale-of-business non-competes rest on a different footing: the seller was paid for the goodwill, and without a promise not to compete, the buyer can't get what was paid for. Many states recognize this distinction. California, for example, generally voids non-competes but has a statutory exception for a person who sells a business's goodwill (Business and Professions Code section 16601). A broad federal ban on employee non-competes proposed in 2024 did not take effect, and it excluded sale-of-business non-competes anyway. State law is what governs, and it changes, so have your attorney confirm the current rules.
Practical points
- Agree it in the LOI. Raising it for the first time in the purchase agreement can feel like a new demand.
- Coordinate with the transition. The seller may consult for you (up to 24 months in total in SBA deals). Make sure the consulting agreement and non-compete fit together.
- Mind the tax allocation. Any price allocated to the non-compete is reported on Form 8594 and taxed differently for each side. Decide it with your CPA.
- Back it with something. If you have a seller note, a right to offset damages against it gives the non-compete teeth.
The non-compete protects goodwill; for how goodwill is valued and why some of it is personal to the seller, see valuing goodwill.
Worked example: setting the area from the customer list
Illustrative example, not legal advice
A pool service company's customer list has 310 accounts. Mapping them shows 280 within 25 miles of the yard and 30 scattered up to 45 miles away. A non-compete covering 25 miles protects 90% of the accounts (280 ÷ 310) and is easier to justify as reasonable than a statewide ban. Adding a non-solicitation clause that covers every customer on the list, wherever they are, protects the other 30 without stretching the geographic restriction. For duration, ask how long relationships take to move: if customers deal with the owner directly and the transition is six months, a term of several years after closing gives you time to make the relationships yours. Courts in different states judge reasonableness differently, so let your attorney set the final terms.
Tax note: the non-compete has a price tag
Any part of the purchase price allocated to the non-compete is reported on IRS Form 8594. For the buyer, a covenant not to compete entered into in connection with buying a business is generally amortized over 15 years, like goodwill (26 U.S.C. 197). For the seller, amounts allocated to a non-compete are generally ordinary income rather than capital gain, which is why sellers usually want the allocation kept small. Agree the allocation in the purchase agreement with both CPAs involved.
Clause checklist
- Parties: every selling owner, and any family member or entity they control.
- Restricted activities: defined by what the business actually does, not every business in the industry.
- Area: based on where customers are, from the customer list.
- Duration: long enough for relationships to transfer.
- Non-solicitation of customers and employees, separate from the non-compete.
- Confidentiality and non-disparagement.
- Remedies: injunctive relief, and a right to offset damages against any seller note.
- Consideration and tax allocation stated in the purchase agreement.
Red flags in non-compete negotiations
- A seller who won't sign one at all, or wants exceptions for "a few old clients".
- A family member with key relationships who isn't a party.
- A consulting agreement that lets the seller serve customers directly after the transition.
- A restriction so broad it's unlikely to be enforced where you operate.
- No remedy: no right to offset against a seller note, no injunction language.
Non-solicitation and confidentiality: the clauses that do the work
Even where a broad non-compete is limited by state law, two narrower promises often carry most of the protection. A non-solicitation clause stops the seller approaching the business's customers and employees for a set period. A confidentiality clause stops them using the customer list, pricing and methods. These are usually easier to enforce than a ban on working in the industry, and they target what you are actually paying for. Ask your attorney to draft all three, so that if one is cut back by a court the others still stand. This is general information, not legal advice.
Finally, check that the non-compete covers everyone who could compete: the seller, their spouse if active in the business, and any company they control. A covenant signed only by the selling entity may not stop the person behind it.
Keep a copy of the signed covenant with your closing documents, and diary when it expires so you can plan for the seller being free to compete.
Frequently asked questions
Are non-competes enforceable when you buy a business?
Generally more so than employee non-competes, because the seller was paid for the goodwill being protected. They still need to be reasonable in scope, area and time. California, which voids most non-competes, has a statutory exception for sellers of a business's goodwill. Your attorney will apply your state's law.
How long should a seller non-compete be?
Long enough for customers and staff to transfer their loyalty to you, and in line with what's considered reasonable in your state. Your attorney will know the usual range; the right answer depends on the industry and how relationship-driven it is.
Should the seller be paid separately for the non-compete?
Sometimes part of the price is allocated to the non-compete. That has tax consequences for both sides (the allocation is reported on Form 8594), so decide it with your CPA.
What about the seller's family members or key employees?
A seller non-compete binds the seller. If a spouse or child was central to customer relationships, consider asking them to sign too. Key employees are a separate matter, governed by employment law.
Do employee non-compete rules affect a seller's non-compete?
Rules restricting employee non-competes have been changing in many states, but most treat non-competes given by the seller of a business as a separate category, because the seller was paid for the goodwill. State laws differ on scope and enforceability, so have your attorney draft it for the states involved.
Should family members sign the non-compete?
Anyone who holds key customer or supplier relationships, or who could easily compete, should be considered: a spouse who ran the office, a son who managed the main accounts. Your attorney will advise on who can be bound and how.
Sources
- IRS Form 8594 (non-compete is part of the asset allocation)
- California Business and Professions Code section 16601 (sale-of-business exception)
- Cornell LII: 26 U.S.C. 197 (covenants not to compete entered into with an acquisition are amortized over 15 years)
- SBA SOP 50 10 8.1 (seller consulting up to 24 months)
Related guides
General information, not legal, tax, financial or investment advice. Rules and lender practices change; check the linked sources and talk to your attorney, CPA and lender about your deal. Examples with named numbers are illustrations, not real businesses. OKtoBuy's Deal Check does not value businesses or give price opinions.