The Federal Trade Commission (FTC) recently significantly changed the landscape of non-compete agreements in the United States. These clauses, often included in employment agreements, restrict workers from taking jobs with competitors for a certain period after leaving their current employer.
While the FTC permits non-compete agreements during business sales, applying them to acquisitions is trickier. It can involve complex negotiations and revisions to management employment agreements.
FTC's Non-Compete Ban: Impact on M&A
The FTC recently banned most non-compete agreements, arguing they stifle worker mobility and hinder economic growth. Let's unpack the FTC's reasoning and explore the claimed downsides of non-competes:
Reduced Competition: The FTC argues that non-compete agreements limit worker mobility, preventing workers from taking their skills and experience to competing businesses. This reduces competition in the labor market, potentially leading to lower wages and fewer job opportunities for workers.
Stifled Innovation: Non-competes can also discourage workers from starting their own businesses or pursuing new ventures, hindering innovation and economic growth.
Scope of the Non-compete Agreement Ban
New Non-compete Agreements: The FTC's rule prohibits employers from entering into new non-compete agreements with almost all workers, regardless of position or industry.
Existing Agreements: The FTC takes a different approach for existing non-competes:
Senior Executives: Existing non-compete agreements with senior executives are generally allowed to remain in place.
Other Workers: Employers cannot enforce existing non-competes agreements with most workers.
M&A Transactions and the Sale of Business Exception:
The FTC's rule includes a sale of business exception, which allows non-compete agreements entered into during a bona fide sale of a business. However, this exception may not be as straightforward for certain situations in M&A transactions, as discussed in a legal memo by Mintz.
Key Considerations for M&A Deals:
Equity-based Non-competes: Private equity firms often use equity-based non-competes with sellers rolling over equity or key employees receiving equity in the acquired company. These non-competes may be in the operating agreement or grant agreements for stock options.
Enforceability of Equity-based Non-competes: The enforceability of these non-competes depends on whether the equity holder is also considered a "worker" under the FTC's broad definition. This definition includes paid and unpaid services provided as an "employee, independent contractor, extern, intern, volunteer, apprentice, or a sole proprietor." The memo raises uncertainty about whether this extends to board members.
Other Restrictions Impacted: The FTC's rule may also invalidate punitive equity repurchase terms tied to non-compete breaches and limit the ability to enforce non-competes with some senior executives.
Strategies for M&A Deals:
While the FTC's final rule allows non-compete agreements during business sales, a recent memo by Mintz highlights potential complexities for buyers in M&A deals, particularly when using equity-based non-competes with existing shareholders who will retain ownership after the transaction.
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 Mintz memo concludes by discussing strategies for private equity firms and other buyers to protect their interests while complying with the FTC's rule.
It's important to consult with an employment attorney to understand how the FTC's ruling may impact specific M&A transactions.
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