Unlock the hidden risks of hybrid noncompetes in M&A deals where sellers stay on. This essential guide for buyers, sellers, and advisors reveals why combined restrictive covenants often fail in court and how strategic pre-closing legal structuring can protect your investment and prevent costly litigation. Learn from a recent 8th Circuit case how to draft effective noncompetes for private target acquisitions.
M&A Stories
June 05, 2025
It’s common practice in lower middle market acquisitions for the seller-owner to transition into an employee role with the buyer after closing. Frequently, the noncompete covenant, intended to protect the acquired business, is structured to begin running from the later of the transaction’s closing date or the seller-owner’s subsequent termination of employment. This creates what is often termed a “hybrid” covenant, blending aspects of both a sale-of-business noncompete and an employment noncompete.
This blended approach introduces a significant risk for both parties. State laws frequently distinguish between these two types of covenants, generally viewing noncompetes designed to protect the goodwill acquired in a business sale more favorably than those arising solely from an employment relationship. Indeed, in some jurisdictions, such as California, employment noncompetes are broadly unenforceable.
A recent case from the Eighth Circuit Court of Appeals illustrates this very problem. In 2013, a buyer acquired an Arkansas business specializing in video security equipment for school districts, a transaction valued at $1.9 million. As part of the deal, the seller-owner agreed to work for the buyer for an initial year, transitioning thereafter to an at-will employment arrangement. Critically, the noncompete clause stipulated that the seller-owner would not compete in Arkansas for five years, commencing from the later of the closing date or the termination of his employment.
The seller-owner continued working for the buyer for over eleven years. Upon his eventual termination, he promptly began competing with the buyer. The buyer initiated litigation, and an Arkansas federal district court initially granted a preliminary injunction, temporarily barring the seller-owner from competition during the lawsuit. However, the seller-owner appealed, and the Eighth Circuit reversed this decision. The appellate court concluded that Arkansas law applies stricter scrutiny to employment noncompetes than to those integral to a business sale. In the court’s assessment, the covenant in question primarily functioned as an employment noncompete, and under established Arkansas precedent, a five-year term for such an agreement is considered unreasonable and, consequently, unenforceable.
The clear lesson for buyers, sellers, and their advisors is the importance of distinguishing between the sale-of-business and employment relationships when drafting restrictive covenants. What constitutes reasonable terms for protecting the acquired goodwill in a sale may be entirely different, and potentially unenforceable, when applied to a post-closing employment relationship.
To proactively mitigate this risk, parties should consider drafting a separate, distinct noncompete covenant specifically tied to the business sale. If permitted by applicable state law, a second, separate noncompete could then be included within the employment agreement to address the post-employment period. This structured approach allows both buyers and sellers to analyze the likely enforceability of each covenant independently, tailored to its specific purpose and the nuances of state law, thereby avoiding the ambiguity and litigation risk inherent in a single, undifferentiated hybrid noncompete.
See: Progressive Technologies, Inc. v. Chaffin Holdings, 33 F.4th 481 (8th Cir. 2022)
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals..
By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5
and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM
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