What the Non-Compete You Sign at Closing Actually Costs You

The Federal Trade Commission has formally removed its Non-Compete Clause Rule from the Code of Federal Regulations, closing out a two-year effort to ban most non-competes nationwide. For business owners planning an exit, the practical consequence is not that non-competes became easier. It is that the covenant you sign at closing is once again governed entirely by state law, and that law now varies more than it has in a decade.

The Federal Rule Is Gone, and That Matters Less Than the Headline Suggests

After a public workshop in January 2026, the agency signaled it would not pursue a categorical national ban. The final Federal Register action removing the rule was the closing procedural step. What replaced it is a case-by-case posture: the FTC retains authority under Section 5 of the FTC Act to challenge specific agreements it considers unfair, and it has already finalized a consent order requiring one employer to abandon blanket non-competes across its workforce.

That distinction matters for sellers. Federal attention is aimed at broad covenants imposed on rank-and-file workers who receive nothing in exchange. It is not aimed at the owner who receives eight figures for the goodwill of a business and agrees not to rebuild the same company across the street. Those are different transactions in the eyes of both regulators and courts, and they always have been.

The result is a return to the pre-rule status quo, where fifty state regimes govern and several of them move every year. California voids virtually all employment non-competes under Business and Professions Code Section 16600. Colorado permits them only against workers earning above an inflation-indexed threshold, which for 2026 sits at $130,014, with customer non-solicitation covenants permitted at 60 percent of that figure, or $78,008.40. Montana bars them outside a few narrow exceptions. If your company operates across state lines, your workforce is very likely subject to several of these regimes at once.

Selling a Business Is Not the Same as Signing an Employment Agreement

Courts apply a materially more permissive standard to covenants given in connection with the sale of a business than to covenants imposed on employees. The reasoning is straightforward: the seller received substantial consideration, negotiated at arm's length and usually with counsel, and the buyer paid for goodwill that would be worthless if the seller could immediately compete for it.

Even California, the most restrictive jurisdiction in the country, carves this out. Section 16601 permits an enforceable covenant from a person who sells the goodwill of a business or substantially all of its operating assets, within a specified geographic area where the business was conducted. Colorado, Delaware, and Montana all maintain comparable sale-of-business exceptions. The consideration you receive is precisely what makes the covenant defensible.

That permissiveness has limits, and Delaware has drawn them clearly. In Kodiak Building Partners v. Adams, the Court of Chancery struck down a covenant given by a selling stockholder in the acquisition of a roof truss manufacturer. The court accepted that the buyer had a legitimate interest in protecting the goodwill it purchased. It rejected the covenant anyway, because the restriction reached all four of the buyer's business lines and extended one hundred miles from every one of the buyer's locations rather than the single location actually acquired. Delaware law protects what the buyer bought. It has not recognized an interest in protecting goodwill the buyer already owned.

The remedy is the part sellers should note. The court did not narrow the covenant to something reasonable. It struck the provision in its entirety, and the Delaware Supreme Court has since affirmed refusals to blue-pencil overbroad restrictions. A covenant drafted to protect everything the buyer owns can end up protecting nothing at all, which is a poor outcome for a buyer who paid for protection and an unstable one for a seller who assumed the matter was settled.

The Covenant Has a Price, and the IRS Requires You to Write It Down

Here is where the covenant stops being a legal formality and becomes a financial term. In an asset sale, buyer and seller must allocate the purchase price across asset classes and report that allocation consistently on Form 8594. The IRS uses the matched filings specifically to identify parties taking inconsistent positions.

The allocation to a covenant not to compete is taxed to the seller as ordinary income. The allocation to goodwill is taxed as capital gain. At current federal rates that spread is substantial, and it applies before any state tax layer. A seller who allows $2 million of an $18 million price to land on the covenant rather than on goodwill has accepted a meaningfully smaller after-tax outcome for a term that was likely never negotiated as a price at all.

The buyer's position is worth understanding, because it is not symmetric. A covenant not to compete entered into in connection with the acquisition of a trade or business is a Section 197 intangible, amortized over fifteen years. So is goodwill. The buyer recovers both over the same period on the same schedule, which means the buyer is largely indifferent between the two classifications while the seller is not. That asymmetry is the negotiating point, and it is available to any seller who raises it before the allocation schedule is drafted rather than after.

None of this permits an allocation detached from reality. The number must reflect the economic substance of what the covenant is worth, and the IRS can challenge allocations that appear driven solely by tax positioning. A covenant from an owner who personally held every significant customer relationship is worth more than one from a largely passive holder, and the schedule should say so. The point is not to zero out the covenant. The point is to price it deliberately, with a defensible basis, rather than to inherit whatever number appeared in the buyer's first draft.

Buyers Are Diligencing Your Workforce Covenants Too

The covenant you sign is one exposure. The covenants your employees signed are another, and buyers have grown more careful about them as state law has fragmented.

A buyer paying a premium for customer relationships wants to know whether the salespeople who hold those relationships are actually restricted from leaving with them. If your agreements were drafted once, years ago, from a single template, and your team now works across California, Colorado, and two or three other states, the honest answer is that some of those covenants are unenforceable and at least one may violate a procedural requirement. Colorado, for instance, requires separate written notice delivered in advance of signing. Diligence finds this. It surfaces as a reduced valuation, an expanded indemnity, or a closing condition requiring you to paper the workforce correctly on a deadline you do not control.

The related question is retention. Management continuity is among the first things a financial buyer underwrites, and stay bonuses are the ordinary answer: commonly 15 to 30 percent of base salary paid over the twelve to twenty-four months following closing, and commonly funded by the seller out of proceeds. That is a real cost, and it belongs in your net proceeds model from the beginning rather than arriving as a surprise during final negotiations.

What to Watch Next

Three developments will shape how this plays out. Watch whether the FTC's case-by-case enforcement reaches beyond blanket workforce agreements into narrower covenants, which would sharpen the line between employment and sale-of-business contexts rather than blur it. Watch the state legislatures, since compensation thresholds index annually and several states have active bills that would tighten notice and scope requirements further. And watch whether more courts follow Delaware in striking overbroad sale-of-business covenants outright instead of narrowing them, a trend that raises the cost of sloppy drafting for buyers and sellers alike.