Classification: Deal Driver
Negotiation Time: Moderate
Transaction Costs: Insignificant to Intermediate
Major Impact: Deal Value
Employees and Clients
What is This? In addition to limiting the Seller’s ability to compete, this covenant is another way for the Buyer to protect the value of the Business post-Closing. Because non-compete covenants are limited to a certain geographic area, buyers include this covenant to protect relationships with customers and employees in case the Seller decides to compete in a geographic area that is not covered by the non-compete restriction.
The Middle Ground: This covenant prevents the Seller and its Affiliates from attempting to lure employees away from the Business. It may also prevent the solicitation of clients and prospective clients of the Business, if that restriction is not included in the Non-Competition covenant. In regard to employees of the Business, the restriction is typically aimed at employees who have been offered employment by the Buyer, but does not apply to general solicitations, employees terminated by the Buyer, or employees who terminated their own employment with the Business after a specified time period.
Purpose: The Seller has a massive informational advantage over the Buyer in being able to identify the key employees and clients of the Business. If the Seller were allowed to poach them away from the Business, it could easily decimate the value of the Buyer’s investment. Put another way, the Buyer agrees to a Purchase Price based on expectations for how the Business will perform in the future, and the purpose of this covenant is to protect those expectations.
Buyer Preference: Similar to other restrictive covenants, the Buyer wants this covenant to be as broad as possible while still being enforceable. That means any and all restrictions should be rationally related to protecting the Business. The Buyer may also seek to prevent the general solicitation of employees (and will surely want to do so for clients), and it will want the restrictive language to apply to the Seller’s affiliates and to indirect attempts to solicit employees.
Seller Preference: The Seller wants to include all exceptions contained in the middle ground term, and additionally it might try to reduce the waiting period required to hire any employees who leave the Business of their own volition. It may also want to reduce the effective period for this covenant, if there is a logical reason for it to be shorter than the effective period for the non-compete covenant (generally the Buyer wants the time periods to mirror one another for ease of enforcement). An ambitious Seller may want to avoid this covenant altogether, but most Buyers will refuse to make an acquisition without some protection regarding clients and employees of the Business.
Differences in a Stock Sale Transaction Structure: None.
We want The Middle Ground to be an ongoing dialogue for and resource to the lower middle market M&A community. The outline above is generally applicable, but there is always specific case law and nuance around certain industries that can be useful in helping buyers and sellers come together. If you are a lawyer or deal professional, we encourage you to add your perspective below.