27 November 2023: Selling a Business – Non-Competes: Pt 2
Last week’s post – about the possibility of non-compete agreements being outlawed in the United States – became even more relevant with the developments in New York State this past week. It appears that the Grand Poobahs in Albany have moved quickly to get a jump on the feds.
The following is excerpted from an editorial in the 21st November edition of The Wall Street Journal:
“As lousy as New York’s business climate is, it can get worse. Democrats in Albany are reminding businesses of this by passing legislation that would ban so-called non-compete agreements in employer contracts. Call it another gift to Florida.”
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The opinion piece continues…
“Opposition to non-compete agreements has become a new cause celebre on the left. Businesses use these contractual restrictions to prevent employees from going to work for competing employers for a specified period after leaving a company. The agreements safeguard a company’s intellectual property and investment in worker development.
Such restrictions are especially common in finance and tech, where high-earning workers have knowledge about business strategies and trade secrets. You could understand why, say, Amazon wouldn’t want its cloud-computing engineers quitting to take their know-how to Microsoft or Google.
But progressives claim the agreements suppress worker pay and limit labor-market competition—even as they complain that bankers and tech bros make too much money and need to be taxed more.
The Federal Trade Commission has proposed banning non-compete agreements, but its rule would be unlikely to survive legal challenges” (emphasis added) …because Congress never gave the agency authority to do so. Some states have recently passed or are considering legislation that would bar non-compete agreements from being applied to lower-paid workers.“
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“Legislation passed by Democrats in Albany that is headed to Gov. Kathy Hochul’s desk is more sweeping than the FTC proposal. It would outlaw non-compete agreements statewide with few exceptions. It also creates a private right of action siccing plaintiff attorneys on businesses. This might buy another yacht for plaintiff attorneys, but it would hurt most workers.
Two-thirds of businesses surveyed by the U.S. Chamber of Commerce said a non-compete ban would hurt their talent or compensation strategy. Employers claimed they would respond by cutting compensation and reducing the sensitive information they share with employees.
Democrats in Albany claim non-compete agreements have a “negative effect on the labor market and economy of New York State” and “detrimental impact on consumers.”
Sorry, non-compete agreements aren’t why unemployment in New York City is 5.4%—more than three times higher than in Miami. Nor why nearly 160 Wall Street firms with nearly $1 trillion in assets have moved their headquarters out of the state since the end of 2019. Nor why New York state and local tax revenue for the first seven months of this fiscal year is running $9 billion lower than last year.
The legislation is one more reason for firms to move employees to other states. Mayor Eric Adams and Gov. Hochul can’t afford to lose more high earners. The top 2% of taxpayers in New York City pay about half of the city’s income tax.”
The Impact
So, how might this move impact us? Well, it would specifically impact business owners – who are the vast majority of our clients.
Many strategic buyers – especially private equity firms – don’t necessarily want to operate the businesses they acquire. They are often most interested in the management team the business has in place. This, therefore, is a big part of the business’ value. As a result, employment agreements are an important component of their due diligence. Such buyers want to see that management teams and other key employees are tied to the company in a manner that will ensure, to the extent possible, the business will continue to run smoothly and continue to grow.
The problem with any prohibition of non-compete clauses is that such language was always a key component of most employment agreements. Any rule or legislation that eliminates or restricts these protections will likely give pause to many strategic buyers.
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Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches you how to accurately value and successfully sell businesses.
Often, potential buyers, especially financial buyers, feel that a non-compete clause preventing the seller from opening up a competing shop down the street is sufficient to protect them from the significant competition that an unethical seller would present. And as outlined last week, those types of non-competes are exempt from the rule proposed by the FTC. (We’ve not seen the NY legislation but presume that such non-competes are exempt in that language.)
But if a buyer’s decision to buy is, to whatever extent, predicated on the continuance of the existing management team’s operational knowledge and skills, the potential that a key employee would leave – granted, at some short term cost to the employee for breaking an employment contract – for a juicy role at a competitor, knowing that the employee could take with them all the knowledge they’d gained while employed at the target business, is likely to dampen the potential buyer’s ardor for that business.
And when a buyer’s ardor is so dampened, it is manifest either as passing on the opportunity or in the acquisition price and terms that reflect this new risk.
The Bottom Line
If you’re a business owner – or a business broker advising owners as clients or potential clients – this is an issue that may impact you and your business. If the subject business is domiciled in New York – or California or Nevada or elsewhere where non-compete agreements are prohibited or endangered – buyers may begin to raise concerns about how secure the business’ proprietary information – its intellectual property – is. Such a concern could manifest in fewer buyers or lower valuations; or both.
Check with your legal team to see where your company stands on this. And don’t wait until you’re ready to sell. As we wrote last week, “non-compete agreements have been important aspects of selling a business for years and these proposed rules, if formally adopted, will impact our clients to some greater or lesser degree.” The potential for this rule to effect the sale of some businesses is essential to understand before bringing the business to market.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at jo*@Wo*******************.com