There is a version of this conversation that starts with the purchase price. That is the wrong version.
You agreed on $1.8M. The LOI is signed. Diligence is moving. Then your attorney flags the non-compete clause and suddenly two people who shook hands three weeks ago are arguing over restriction radius and tax allocations. Neither of you thought to negotiate what happens if the covenant gets challenged in court.
Non-compete consideration in a business sale is one of the most misunderstood pieces of deal structure. Get it wrong and you end up with either an unenforceable agreement or a tax problem you did not see coming. Sometimes both.
What Non Compete Consideration Actually Means
Non-compete consideration is the specific value exchanged in return for the seller agreeing not to compete with the business you just bought. That definition sounds clean. The reality is not.
In most states, a non-compete agreement is only enforceable if something of value changes hands in direct exchange for that promise. And “value” here does not mean the purchase price of the business itself. It means the portion of the purchase price specifically allocated to the non-compete covenant in the Asset Purchase Agreement.
If you pay $2M for a business and the purchase agreement never allocates any dollar amount to the non-compete, courts in several states will treat that covenant as unenforceable. The seller walks away and opens a competing business across the street. You have no legal recourse.
Not a hypothetical. We have watched this play out.
How Consideration Gets Allocated in the Purchase Agreement
The APA breaks the total purchase price into buckets. Each bucket carries different tax consequences for both buyer and seller, and one of those buckets is the non-compete covenant. This allocation is not optional paperwork. The IRS requires both parties to report these allocations consistently on Form 8594, which means whatever you agree on in the APA, both buyer and seller are locked into it from a tax standpoint.
Typical allocation categories in an asset sale:
- Tangible assets (equipment, inventory, vehicles)
- Goodwill and going concern value
- Customer lists and relationships
- Non-compete covenant
- Training and transition services
For the non-compete allocation specifically, the buyer gets to amortize that amount over 15 years. The seller reports it as ordinary income, not capital gains. That distinction matters enormously to a seller who was expecting most of the sale proceeds to be taxed at the lower long-term capital gains rate.
Which brings up why this negotiation gets complicated fast.
Why Sellers Push Back on High Non Compete Allocations
When you propose allocating $300K of a $1.5M purchase price to the non-compete, the seller’s accountant is going to push back. Hard.
Here is the math they are running. If that $300K is allocated to the non-compete, the seller pays ordinary income tax on it. In most states, that runs 30% to 40% combined federal and state. If that same $300K had stayed under goodwill or equipment, it might qualify for long-term capital gains treatment at 20% or less. On $300K, that tax difference can be $30K to $60K out of the seller’s pocket. Real money. Not theoretical.
So when you are trying to get a broad, well-funded non-compete allocation and the seller keeps dragging their feet, it is usually a tax issue, not a trust issue. Knowing that lets you solve it correctly rather than escalating into an argument about whether the seller “plans to compete.”
Sometimes you can split the difference by adjusting the overall purchase price upward slightly to compensate the seller for the tax hit. Sometimes you trade on other terms (a slightly shorter restriction period, for instance, in exchange for a cleaner allocation). Your attorney and both parties’ CPAs need to be in that conversation early, not three days before closing.
What Courts Consider Adequate Consideration
“Adequate” is where things get legally nuanced, and the answer depends entirely on your state.
Some states treat the purchase price itself as sufficient consideration, as long as the non-compete is contained within the purchase agreement. The court views the whole transaction as a single exchange. Other states require that a specific, separate dollar amount be called out and actually exchanged for the covenant. No allocation, no enforcement. A few states go further and require the consideration to be “reasonable” relative to the burden placed on the seller. A seller restricted for five years across a large geography may need more allocated to their covenant than a seller agreeing to a 12-month, single-county restriction.
General markers of adequate consideration by deal size:
- Deals under $1M: typically $25K to $75K allocated to the non-compete
- Deals in the $1M to $3M range: commonly $75K to $200K
- Deals above $3M: varies widely by industry, geography, and restriction scope
These are rough market ranges from what we see across our deal flow, not hard numbers. Your attorney needs to advise on what courts in your target state have actually upheld. State-level case law on non-compete enforceability (which you can often find referenced through your state bar’s resources or the FTC’s published commentary on non-compete agreements) varies more than most buyers expect.
Non Compete Scope and Enforceability
All of that is about money. Now the part that kills more deals than the allocation conversation ever does.
Consideration alone does not make a non-compete enforceable. Courts also scrutinize the scope of the restriction itself. And here is the part that catches buyers off guard: an overbroad non-compete can void the entire agreement in some jurisdictions, even if you paid fair consideration for it.
The three dimensions courts examine:
Duration. Two to five years is standard in most business acquisitions. Three years is the most common. Courts are generally comfortable with restrictions under five years. Anything beyond seven years faces real scrutiny, and in our experience, lenders do not love seeing long restrictions either because they suggest the seller’s involvement was harder to replace than the financials indicated.
Geography. The restriction should match where the business actually competes, not where you hope to expand someday. A regional HVAC company with customers in three counties gets a three-county restriction. Not a statewide one.
Activity. The covenant should restrict the seller from working in the specific business they just sold, not from working in any business ever. “You cannot own or operate a competing HVAC service company” is reasonable. “You cannot work in the trades in any capacity” is likely unenforceable.
SBA lenders pay close attention to this. On SBA 7(a) financed acquisitions, lenders want a properly structured non-compete in place before closing. They are financing the goodwill of the business, and the non-compete is part of what protects that goodwill. A covenant that is too narrow or poorly constructed can raise flags in underwriting. We have seen it delay deals by weeks.
How Non Compete Consideration Fits Into SBA Deal Structure
If you are buying with an SBA 7(a) loan, the non-compete clause is not a legal formality you tack on at the end. The SBA treats it as an element of deal quality.
SBA SOP guidelines require that the seller (and in some cases, key employees) execute a non-compete as a condition of loan approval. The lender needs assurance that the goodwill they are partially financing does not walk out the door with the seller after closing. What this means in practice: the non-compete needs to be in the purchase agreement, properly allocated, and reviewed by the lender’s counsel before closing. Do not treat it as boilerplate that gets drafted the week of close.
Side note: this is also where working capital planning intersects with deal structure. You should have 2 to 6 months of working capital reserved post-close (which is non-negotiable on any deal we advise on), and the last thing you want is a closing delay caused by a poorly drafted non-compete eating into that runway before you even take the keys.
Draft the non-compete structure early. Agree on the allocation number during LOI negotiations if possible, or at minimum address it explicitly during diligence. Your attorney should have a template that aligns with what SBA lenders expect to see. If they do not, that tells you something about how many SBA deals they have closed.
Negotiating Non Compete Terms Without Blowing Up the Deal
The non-compete conversation gets emotional. Sellers often feel like you are accusing them of planning to compete against their own life’s work. That framing does not help anyone.
Here is a better frame: the non-compete is not about distrust. It is about protecting the asset you are both agreeing has value. The seller priced goodwill into the sale. A non-compete is what makes that goodwill real. Start by agreeing on scope before you agree on allocation. If the seller is comfortable with the geographic and duration terms, the allocation conversation becomes easier because the seller already bought into the concept. You are just putting a number on something they already agreed to.
Do not lowball the allocation in the APA just to save the seller on taxes. An under-allocated non-compete may be challenged or found unenforceable. Pay the fair amount. If needed, gross up the purchase price slightly to cover the seller’s incremental tax cost. Structure matters more than price on deals like this, and a well-structured non-compete is worth more to you over ten years than a $30K savings on purchase price.
If the seller pushes for a narrow geography, think about whether the business actually extends beyond that area. If their customer base is genuinely local, a tight geographic restriction is reasonable, not a concession. But document the consideration clearly. The APA should state the dollar amount allocated to the non-compete, the duration, the geographic scope, and the specific activities restricted. One unambiguous paragraph is worth more than pages of vague protective language.
Frequently Asked Questions
What is non-compete consideration in a business sale?
Non-compete consideration is the specific value exchanged for a seller’s promise not to compete with the business being acquired. Without adequate consideration allocated directly to the non-compete covenant, courts in many states will void the agreement entirely. In an asset purchase, this is typically a dollar amount called out in the purchase agreement and reported on IRS Form 8594 by both parties.
How much should be allocated to a non-compete covenant in an acquisition?
There is no universal number, but common market practice for deals in the $1M to $3M range is $75K to $200K allocated to the non-compete covenant. The right amount depends on your state’s legal standards, the scope and duration of the restriction, and the tax implications for the seller. Work with your attorney and CPA to arrive at a defensible figure that courts in your state have upheld.
Does an SBA 7(a) loan require a non-compete agreement from the seller?
Yes. SBA guidelines require the seller to execute a non-compete as a condition of loan approval when goodwill is being financed. The lender needs assurance that customer relationships and business reputation cannot be immediately undermined by the seller opening a competing operation. The non-compete must be in place and reviewed by lender counsel before closing.
Is non-compete income taxed as ordinary income or capital gains?
The IRS treats payments for a non-compete covenant as ordinary income to the seller, not capital gains. This is why sellers often resist high non-compete allocations in the purchase price breakdown. Ordinary income rates are typically 10 to 20 percentage points higher than long-term capital gains rates, meaning the seller nets materially less on that portion of the proceeds. This treatment applies regardless of how the agreement is worded.
What happens if the non-compete consideration is inadequate or missing?
In many states, a non-compete with no specific consideration or inadequate consideration is simply unenforceable. The seller can open a direct competitor the day after closing, take customers with them, and recruit your employees. Your only remedy would be a breach of contract claim that is unlikely to succeed if the court finds the consideration deficient. Getting the allocation right in the APA before closing is non-negotiable.
Working Through a Deal? Start Here.
Getting non-compete consideration wrong is the kind of mistake that does not surface until it is too late to fix. It is one of dozens of structural details that separate acquisitions that hold together from ones that fall apart after closing.
Regalis Capital runs a done-for-you acquisition advisory service. We source deals, run the financial modeling, manage SBA lender relationships, and work through deal structure details like non-compete allocation with your legal team from LOI to closing. We review 120 to 150 deals per week and our team has seen every version of this conversation.
If you are serious about acquiring a business with an SBA 7(a) loan and want a team that handles the structural work, start here.