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The FTC’s final rule on non-competes contains a sale of business exception that’s not as restrictive as originally proposed, but as this Mintz memo discusses, there’s still plenty for buyers to think about as they attempt to navigate the rule in M&A transactions. This excerpt discusses some of the issues associated with using equity-based non-competes with continuing equity holders:

Private equity sponsors, in particular, often will require any sellers who are rolling equity into the company or key management employees who may receive equity in the post-transaction company to also be subject to non-competes. This can take multiple forms but typically include (i) non-competes in the operating agreement for the post-transaction company where such person is bound as an equity holder and/or (ii) non-competes in the grant agreement for any options or profits interests such person may receive in connection with their continued employment.

The continued enforceability of non-competes against equity holders will depend, in part, on the context of the particular agreement and whether the equity holder is also a “worker.” Operating agreements or grant agreements with non-competes may not meet the requirements of the “sale of business exemption” and, therefore, could be invalid under the new FTC rule absent another exemption. Equity-based non-competes against individual sellers who are both “workers” post-transaction and are rolling equity into (or will become an equity holder through co-investment or incentive equity awards in) the post-transaction business are at risk of being unenforceable under the FTC rule by virtue of the individual’s status as a “worker” unless another exemption applies.

The memo discusses the rule’s broad definition of the term a “worker” – which encompasses paid and unpaid services as an “employee, independent contractor, extern, intern, volunteer, apprentic, or a sole proprietor” and points out that it is unclear whether this broad definition in intended to encompass board members who may be considered non-traditional “workers.”

The memo also notes other restrictions that may be invalidated by the FTC’s non-compete rule, including punitive equity repurchase terms that come into play following the breach of a non-compete, and the limited ability of companies to maintain non-competes with senior executives.  It concludes with a discussion of strategies for PE funds and other buyers to protect their interests within the confines of the rule.

– John Jenkins