Recently, Tom Parmalee of funeral Service Insider, asked Tom Johnson about his thoughts concerning non-compete agreements.
Parmalee: How enforceable are non-competes?
Johnson: You will always have some people say that Covenant Not to Compete (CNG) agreements aren’t enforceable anyway so why bother. That is a very dangerous logic in my opinion. Funeral service is a very personal profession and oftentimes the business is tied into the person who has been there for years. This is especially true in small to medium size firms. It is one of the reasons that the public companies prefer to buy larger firms in major metropolitan areas. Those funeral homes are more of an institution and not tied to an individual as much. Regardless, to not have a non-compete in either of these circumstances is dangerous and could lead to disaster for the new buyer. It is a must in any transaction. It is enforceable.
That being said, if someone structured a covenant for 100 miles, 30 years and only $10,000 it may not be enforceable. Why, the length of time must be reasonbable, the scope must be reasonable and there must be some real consideration for the contract.
Parmalee: What’s a reasonable time for a non-compete?
Johnson: The time frames vary but for the most part it will be at least ten years. I have seen them as short as five (not preferable for a buyer) and as long as 15 years, although most of those are paid over ten years. The vast majority of what we have seen over the last 30 years would be ten year covenants.
Parmalee: How much should a seller seek to get if he signs a non-compete?
Johnson: How much should a seller seek to get if he signs a non-compete? First of all, the seller will have to sign a non-compete in almost all cases. The amounts of the non-competes does vary all over the board but usually represent 10% to 15% of the overall transaction. Some sellers prefer to have more deferred payments and the buyers would usually agree to higher CNC’s. You need to be a little careful here as the present value of these future payments will actually discount the deal for the buyers.
Parmalee: How much should a buyer be willing to pay for a non-compete?
Johnson: Most buyers want to put as much as possible on CNC’s as it is a way to have a non interest bearing obligation as part of the deal. You have to be a little careful here as once a CNC gets over 30% of a deal, the IRS may come in and ask a few questions!
Parmalee: If you are a buyer and you feel a non-compete agreement has been broken, what should you do?
Johnson: One, they could stop making payments on the CNC but I would not recommend that action immediately. What I would do is secure an attorney and do your best to stop any action that the seller is doing in breach of the contract. It won’t be pretty but it is the right thing to do. If it turns out that the seller will not stop the impropriety, under your attorneys advice, you could obviously stop making payments.