A covenant not to compete (CNC), or non-compete clause, places limitations on vendors competing in the same industry after they sell their business. As you can imagine, it can be extremely damaging competing against someone whom has spent many years building (and learning how to build) a business in the same industry. Not only that, but imagine that this same person knows the strategy, tactics and all minutia of your new investment. Imagine, how tough a competitor this person could be.

This scenario is what a CNC attempts to stop. It attempts to restrict the vendors from competing with the business, in similar regions, over a relatively lengthy time-frame. However, in certain regions (such as California) there is a CNC prohibition, and in other regions where a CNC is enforceable, the level of enforceability is open to debate. In some ways, CNC enforceability is similar to garden leave enforceability; courts often rule that barring someone from earning a living is not just. Exceptions exist if there is a blatant intent to operate in competition.

In regions where enforceability can be relied upon, term sheets generally include a CNC as standard. From the perspective of the private equiteer, the vendor shouldn’t expect fair value if they plan on destroying that value later with proprietary knowledge. And, from the perspective of the vendor, they shouldn’t be barred from their field if all doesn’t go according to plan. However, as with most terms, it’s about balancing preferences.