Non-competes: How long is too long?

By |2022-06-29T11:05:11+10:0025-10-21|

896 days. That’s the amount of time my 14-year-old daughter (let’s call her Jess) spent with a mouth full of metal, and yesterday, after 896 days she was finally free. 896 days, you say!?! Why so long? You see, Jess was born missing an adult tooth, so this was not your average orthodontic exercise.

Jess had known for 4 weeks that the braces were coming off, but she and the orthodontist decided to keep that a secret from the rest of the family (except for our dog, Molly – who was apparently briefed regularly, and in detail, across the last 4 weeks). It was quite the ‘welcome home’ surprise.

1,095 days (3 years) is about the average minimum ‘non-compete’ or restraint period which I see clients asked to commit to, in significant commercial transactions. Actually, it’s pretty common to see requests for 1,826 days (5 years), and even for three-year or five-year periods which start on some future date.

My personal record for a (serious) request by the other side to my client, was that we be restrained for over 2,700 days (7 years +). [Spoiler Alert: that deal did not happen; rather, the clients kept the business and are still making a great living].

Why does this matter? Isn’t it normal for investors to ‘protect themselves’ with this sort of thing? Is any of this stuff even enforceable?

You definitely cannot see the future – and if we could, there is about 2,500 years of deep thinking suggesting that it wouldn’t be good for us. When we humans make guesses about the future, we are genuinely awful at considering possibilities which might be suboptimal for us.

Will the company you’re joining still be in the same industry in three or five years? What about after you’ve been there for three years or so, and then exited? It’s common to see over-reaching shareholder agreements which don’t even start counting until you’ve sold all of your shares. What else will change in your life, with your family, and in the world during that time?

Are these really long periods even enforceable?

A lot of people will tell you that they’re not. Unfortunately, those people are often wrong. When clients ask me about enforceability of non-competes, I will typically advise that:

  • If you sold a business, rather than just joining one as an employee or other participant, then that makes it much more likely that a judge will consider enforcing a long restraint. If you throw some confidential information or real intellectual property into the mix – then it’s even more likely to be enforced.
  • Would the buyer pay (or have paid) the same amount, if you didn’t agree to such a long restraint? Would they go through with the deal to buy it at all? [If the answer is no – then you’re in trouble. If the answer is yes – then don’t agree (or you shouldn’t have agreed) to a foolishly long restraint, which obviously wasn’t needed.]
  • It could be very, very expensive to find out the true answer about enforceability – because only a judge can give you a meaningful, binding answer, and a lot of people will disagree with you and try to prove you wrong along the way.

It would be naïve and uncommercial to think that you can just ignore the genuine need for some sort of non-compete or restraint in some circumstances. So, when should you agree to one, and what are the factors for agreeing to a long one?

  • If you’re clearly being paid a serious multiple of the annual return from the business, then this may justify a longer restraint period; [Perhaps you can pass the time by swimming, Scrooge McDuck-style, through your huge pile of gold?]

Minifigure of Scrooge McDuck covered by many coins.

  • If the buyer is paying you a premium above and beyond what you could expect to earn from the business if you kept it, then it may not be fair for you to compete quickly;
  • If you are absolutely convinced that you’ll never, ever work in the same type of business again, then you might be willing to provide a hefty restraint. [However, my straw-poll based on 20+ years’ data suggests you have a pretty strong chance of being wrong, no matter how convinced you are today.]

To counterbalance that: serious buyers understand this issue (usually, better than their lawyers) and can assess it during negotiations in a sophisticated and realistic way. They usually don’t need or want empty or over-reaching commitments from you – they just want to achieve the value they are counting on. However, if you’re silly enough to overpromise to them, then they will probably spend money to enforce your promise – that’s just good business and accountability, from their perspective.

Of course, this issue of restraint and non-compete is not just about ‘how long’ you’re restrained for – what you are restricted from doing, and where you are restricted from doing it are also important – but they’re a topic for another article.

1,095 days of restraint, as I mentioned earlier, is a fairly typical restraint request made to clients. Sometimes the request asks for much, much longer. 1,095 days (or more) is a really, really long time for a creative, entrepreneurial person to be constrained, and it can be really tough to take – Jess (and Molly) will confirm just how tough it can be.

Please, think hard about what your buyer, investor or other counterparty really needs (as opposed to wants) and about what proportionate, realistic, deliverable period you can genuinely commit to – before you agree to excessive or open-ended restraint periods.

If you need help with advice about what’s normal, with negotiating restraint and non-compete arrangements, or with understanding what you’ve already agreed to, then please give me a call.

Stephen can be contacted at sjr@nicholsons.com.au or call him on (07) 3226 3944.

Think Commercial. Think Nicholsons.

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