On Jan. 5, 2023, the Federal Trade Commission (FTC) published a proposed rule that would prevent qualifying employers and employees from entering into noncompete agreements. It would further require employers to rescind existing noncompete clauses in active employment agreements. The opportunity to comment ended in April, and (potentially) affected businesses and their employees are awaiting the final rule to be published by the FTC.

In certain circumstances – particularly in the acquisition of small and mid-sized companies in service industries (for example, dental practices, consulting firms, and other industries where employee talent is among the prime factors motivating the acquisition), this proposed rule by the FTC could have a profound influence. And, importantly, this proposed rule – if adopted – would influence both previous and forthcoming M&A transactions.

There are exceptions to the FTC’s proposed rule. Perhaps the most important exception in the M&A context is that noncompete agreements entered into by an individual who qualifies as a “substantial owner” (i.e., an individual owning at least 25% of the total ownership interest in the target entity) would be exempted from the ban in the connection with the sale of a business entity or substantially all of its assets. Put simply; noncompetes would be enforceable against substantial owners in connection with these transactions. Of course, individuals – oftentimes employees – owning less than 25% of the total ownership interest in a given entity could not be subjected to a noncompete agreement. This could dramatically influence the value of an acquired – or targeted – entity.

The value of entities already acquired could also shift dramatically if the proposed rule is adopted. The proposed rule would function with retroactive effect – meaning that noncompete agreements that were previously entered into (and for which there is no valid exception like the one discussed above) would be invalidated – and would be of no force moving forward in the course of the business. Minority owners and other employees choosing to leave would no longer be restricted by their previously valid noncompete agreements. Quite obviously, if these individuals leave, they may take with them a great deal of the value of the business.

When evaluating entities that may be acquired in the future, buyers should consider the value that employees with currently valid noncompetes provide to the business. This is an exceedingly dynamic legal landscape, and no changes are yet definitive – either substantively or temporally. However, steps can be taken now to prepare.

What businesses should do:

1. Take account of the noncompetes that are currently active in already acquired businesses or businesses that are under acquisition consideration.
2. Consider what other tools may be utilized in order to retain employees that may otherwise be retained by a noncompete agreement.
3. Strategize how the business, which is now reliant on employees and minority owners for retaining customers and clients, may be able to efficiently shift toward a model where customers and clients are retained by the business itself, not by individual employees.
4. Discuss this proposed rule with a Taft attorney when determining the value of a business under acquisition or sale consideration.