Non-Competes in Acqui-Hire Deals

Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies. The information on this page should not be construed as legal advice.

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When a prospective buyer in an acquisition is primarily interested in hiring the talent of an acquisition target, rather than acquiring their intellectual property/other assets/revenue, deal structure issues may seem more relaxed.  If the target has no assets that the buyer is interested in, and the target is not more valuable to the buyer as a whole, then the buyer could even be tempted to ignore making the purchase and simply hire the target’s cofounders/employees and provide them with a signing bonus and/or compensation package that reflect the acquisition notion.

One significant reason why a buyer in California would benefit from using an acquisition structure for the acqui-hire is that they can prohibit the acqui-hired employees from competing with the buyer.  This might be very valuable, depending on the expertise and field of the employees.

California Business & Professions Code 16600 broadly prohibits non-competition clauses in contracts with individuals.  This is why non-compete clauses in California employment contracts are generally unenforceable.  However, a narrow exception to 16600 exists in 16601, which allows a contract to contain non-competition language if the contract happens in connection with the sale of the goodwill of a business.  This prohibits someone from selling you their business and immediately turning around to start a competing business. In either an asset purchase or an equity purchase, the purchase agreement can easily reflect language that will satisfy 16601 and therefore allow the buyer to restrict competition from the acqui-hired employees after the purchase.  The agreement will often restrict competition for a period of years following the purchase, regardless of the tenure of employment with the buyer.

Doing an acqui-hire transaction rather than a simple hire may allow some portion of the purchase price to be treated as a capital gain.   Depending on the structure of the deal, however, some portion of the purchase price may be taxable as income.  Among other things, the non-compete obligations could justify recognition of payments after the closing as such.  The buyer may prefer to have more of the deal price recognized as income so they get immediate deductibility for tax purposes, rather than simply acquiring the property with the purchase price tax basis.  The target’s stockholders would typically prefer to receive capital gains treatment and be taxed at 15-20% at the federal level, rather than up to ~39.6% for income.