What are restrictive covenant agreements (RCAs), and why do they matter so much when you’re selling—or scaling—a professional services firm? In this session, employment law expert Todd Stanton of Stanton Law will unpack the real-world impact of RCAs. You’ll learn what they are, when to use them, and how they protect the very value buyers are paying for. From avoiding costly legal battles when employees exit, to understanding what you’re signing when you sell your firm, this candid discussion covers what too many founders overlook. Expect practical guidance, sharp legal insights, and hard-earned wisdom for both sides of the deal table.
TRANSCRIPT
Greg Alexander: Hey, everybody. This is Greg Alexander, founder of Collective 54. And you’re listening to the ProServ podcast. This podcast is for founders of boutique professional services firms. So if you’re somebody who markets, sells, and delivers expertise for a living, this is for you. On this show, we talk about how to grow your firm, how to scale your firm, and maybe someday sell your firm. Today we have a guest with us, Collective 54 member Todd Stanton, and we’re going to talk about restricted covenant agreements—what they are, why you need them, how they work, etcetera. So with that, Todd, thanks for being here. Would you please introduce yourself to the audience?
Todd Stanton: Alright. Thanks for having me, Greg. My name is Todd Stanton. I started Stanton Law, LLC in 2011. I had spent nine years in the big law environment, went out on my own, and have built a quality business-side firm over the past 13 years. We currently have 14 attorneys with several support staff, and we are having a good time helping small and medium-sized businesses navigate the legal part, not letting them turn business problems into legal issues.
Greg Alexander: Okay, very good. And again, thanks for being here. Let’s start at a very high level. Would you give us a working definition of a restricted covenant agreement?
Todd Stanton: Great place to start. I use the term restrictive covenant as an umbrella for any of these typical agreements that protect company information and interests. We start from the bottom of this, which is a confidentiality agreement. That’s a restrictive covenant. It’s going to protect employer company confidential information, things that you don’t want disclosed to the general public. We also can talk about non-raiding covenants, the typical no-hire covenant where you promise not to take people with you if you ever leave your employer’s employment. Then we have customer non-solicits, where you’re not allowed to take customers with you or solicit their business if you leave the employ of a particular company. And then the granddaddy of them all, which is what typically gets a lot of the coverage, is a non-compete, where you’re not allowed to engage in this particular business activity, typically within a geographic area. Taken together, from confidentiality all the way to non-competition, those are the specific types of restrictive covenants. They are typically done with a contract. If they’re done right, they’re done at the inception of employment with an employment agreement. Sometimes we see them on the other side in severance agreements, but it’s just a little bit more expensive to buy them from that.
Greg Alexander: Okay, so great definition. Thank you for walking us through the four big buckets of that. I’m going to ask you two questions: one from the perspective of the founder—how to use an RCA to protect him or herself and his or her business—and then also, when the founder sells their firm, they’re often asked to sign an RCA. So I’m going to ask you questions from that perspective as well.
Todd Stanton: Okay.
Greg Alexander: So first, from the founder’s perspective, is this something that you recommend founders have all their employees sign, or is this something that you recommend just for the senior staff?
Todd Stanton: I would grade that response into something different. I don’t think it’s limited to senior staff, but it is not all employees. Certainly, the big case that got everybody up in arms against restrictive covenants was the Jimmy John’s case, where they were having their sandwich makers sign non-competition agreements, and that’s just silly, right? That was an abuse of process. But somewhere between a sandwich maker and somebody who does have access to confidential information, who is customer-facing, who is influential in your organization, all the way up to senior staff, I would recommend that they do have restrictive covenants. It is designed to protect a protectable business interest.
Todd Stanton: If you can allow me to go back for just a quick second, I look at restrictive covenants or contracts in restraint of trade. They necessarily limit market activity, raise prices, and limit customer choice. On the whole, they are not good, but without them, you don’t have protection as a business owner to safeguard your business interests. Think of it like a patent. If we didn’t have patents, I would spend all this money researching and developing a drug, tool, or invention, and then, if someone could just replicate it without all that investment, nobody would ever invent anything or engage in restrictive research and development.
These restrictive covenants, whether they’re non-solicits, confidentiality agreements, or even non-competition clauses, aim to protect what people have invested in. As a founder, you are building something, and you need to protect that with restrictive covenants. If you’re giving people access to your confidential information, employees, or customers, I would recommend putting restrictive covenants in place for those individuals.
Greg Alexander: And I agree with you. It makes a ton of sense. We use them at Collective 54. I used them at my previous firm, SBI. I’m surprised, however, that many of our members don’t have them in place. I become aware of this when people engage in our exit readiness tool. It’s kind of a mock due diligence, and one of the questions is, “Send us your legal documentation,” and on the checklist is the RCAs. They’re usually not there. Why is it that small business owners, founders of boutique pro-serve firms, don’t have this documentation in place?
Todd Stanton: I think it goes to, and maybe you and I had this—I saw a post about this—it’s if you have a libertarian inclination. This seems to run contrary to libertarian inclinations, right? It does limit market choice. That’s one problem. They’re difficult to ask for, and if you’ve got talent, that talent might push back at the beginning, saying, “I don’t want to do this. I’m not restricting my post-separation options.” It’s a difficult conversation to have.
You need to get past that and explain to them that this is a compact within a company. You can say, “Look, I trust you 100%, employee A. That’s not the problem. But it’s employee B over there that I’m concerned about. I need you to sign this so that he’ll sign this, because we all get hurt if employee B walks, and we all get hurt if you walk too. This is a compact that we’re all signing together.” That’s typically the way we get them past that.
A lot of people just don’t understand that these agreements provide value, especially to the buyer. That’s what the buyer is buying—they’re buying your people, your talent, your intellectual property, and your confidential information. Explaining the purposes behind this can help overcome hesitation to put them in place at the beginning.
Greg Alexander: Okay, very good. Let’s say one is in place, and an employee leaves and violates the RCA. What is reality? What happens? Does everybody wind up in court, or what’s happening?
Todd Stanton: Not if we do it right. Nobody ends up in court. I have an employment law axiom: if you’re asking me whether this covenant is enforceable, you’re asking the wrong question. Everything about these agreements is about an enforcement strategy. It goes back to my axiom about not turning business issues into legal problems.
There’s a cost-benefit analysis when someone violates a restrictive covenant. There’s a dollar value attached to that. How much money are they costing you? If they’re costing you $10,000, I’ll tell you to put away your gavel and retainer. I’m not taking that case. We’re not going after that person for $10,000. If they’re costing you $100,000 or $150,000, a material percentage of revenue, then we can decide if this has a legal solution.
Before we get there, I’ll ask how much you’re willing to spend on lawyers to enforce this restrictive covenant. Let’s say you’re prepared to spend $75,000. I’ll tell you that will get you about halfway there. But what could you do with that $75,000 instead of giving it to lawyers? What can you do to go after that customer, protect that revenue, and improve your market position? That’s a lot of money to spend to keep that customer.
I can script out the conversation for you. You can go to that customer and say, “Look, Greg left, and I’m mad at him. He signed a restrictive covenant. I know he’s knocking on your door trying to get your business. I might not have done a great job protecting this relationship, but I’m here to tell you that you’re important to me, and I want to rekindle this. I’ll take you to Europe for three weeks.” It could be anything. Instead of giving that money to lawyers, perhaps we can find a better way. Offer free products for three months while working it out. Tell them, “I need you back in my house rather than letting you go with someone else.”
Todd Stanton: And if you’ll indulge me, I know you want to move on. But the alternative to that shows how impractical this really is. If you do run down the business and the legal aspect of this, your lawyers are going to work around the clock for 3 or 4 days to draft a complaint. They’re going to go to court, file the complaint, and try to get an injunction. All of that is going to be chaotic for everyone. Who is the first person that gets harmed with that? First of all, it’s your wallet, the business’s wallet. Maybe we shut down the salesperson, maybe we don’t. But then the customer is left out there being told by a judge they can’t do business with the person they want to do business with. I’ve never met a customer who likes being dragged into legal disputes. They’re going to get subpoenas, document requests, and you are going to lose that business anyway if you treat this as a legal problem.
I’ve been doing this for 20-something years. I’ve never taken a restrictive covenant issue all the way to trial because both sides, even if they get into a contest at the beginning of this about who has the better lawyers, end up spending anywhere between $40,000 and $80,000. Then they say, “Let’s find a business solution.” My point is, let’s go to that business solution right from the start and solve this on an ROI basis rather than a cost-benefit analysis or legal basis.
Greg Alexander: Unfortunately, that requires rational, logical thought and keeping emotions at bay. But these are moments of great emotion. The owner feels betrayed because the person left, etc.
Todd Stanton: But you pay me to tell you the truth, right? I’m coming in to objectify it. I’m telling you what’s in the best interest of your business and the other people who are not causing you harm.
Greg Alexander: Sometimes people don’t want to hear the truth.
Greg Alexander: When I sold my firm, I was required as part of the sale to sign a restrictive covenant agreement because they were paying me a lot of money and didn’t want to run into me in the marketplace. I had good legal counsel, and I signed it because it made sense. What advice do you give our members? We’ve had 42 members collectively sell their businesses, and to my knowledge, every one of them had to sign an RCA. These are usually heavily negotiated. What advice would you give a founder who is thinking about selling their firm with regards to being on the other side of the desk, signing one that restricts what they can do in the future?
Todd Stanton: Restrictive covenants, no matter what they are, all the way up to the king of non-competition covenants, are, in my experience, the meat of the deal. In a professional services business where relationships are so important, the buyer is going to require that because you already have those relationships. That’s what they’re buying. They’re not buying the business; they’re buying that relationship away from you in many cases. They’re also buying the process and other aspects, but if you could go out the next day and immediately take those relationships back, they won’t pay the same amount as they would if they know they’re protected for a few years.
I would look at it this way: you’re going to be on the bench for a little bit. You’re going to be able to tend your tomatoes, think about moving to Jackson Hole, or getting a ranch in Texas. Capitalize on your good investments of time and resources. The last thing you want to do is take the sales proceeds and turn them around to pay legal fees defending a restrictive covenant just because you couldn’t sit still for a year and a half or two years.
Greg Alexander: Great advice for sure. What I would add to that is to make sure you know what you’re going to do after you sell your firm. If you think you want to go back into the same business because you really enjoy it, then don’t sell the firm. If you know for sure, with great conviction, that your life is going to take you in another direction, then what do you care? Sell the firm, sign the RCA, wish the buyer the best of luck, and adhere to the agreement you signed.
Todd Stanton: Let me add to that. When they come after you on this and drop a complaint, as a former owner, you are spending money immediately. When you’re on the other side deciding whether to prosecute one of these cases, you get to decide whether to start writing those checks. When you’re a defendant, you’re writing checks until the case is finished. So don’t come close to that.
Greg Alexander: Very good point.
Greg Alexander: So, the podcast tries to keep it to 15 minutes. We’ve gone through an overview of the topic, which we have successfully done today: RCAs.
Greg Alexander: For both ends. We’re gonna save the rest, and there’s a lot more to this for the private Member Q&A session, which will happen on an upcoming Friday. So, Todd, thank you for being on the show today and sharing your wisdom with us. We look forward to you taking members’ questions when we have that session.
Todd Stanton: I look forward to it as well. Thank you.
Greg Alexander: All right, I’ll leave the audience with a few calls to action. If you’re a member of Collective 54, and you’ve got questions regarding restricted covenant agreements and even more broadly legal questions as it relates to running your firm, please attend Todd Stanton’s role model session. He’s brilliant on this stuff and can help you a lot, and you’ll be able to ask your questions directly with him. If you’re not a member, and after listening to this, you think you might want to be, go to Collective54.com, fill out an application, and we’ll get in contact with you. If you’re not ready for either of those two things and just want to consume some more content, I would point you to my book, *The Boutique: How to Start, Scale, and Sell a Professional Services Firm*, which you can find on Amazon. But until next time, I wish you the best of luck as you go on your journey to try to grow, scale, and someday sell your firm.
Note: This transcript was generated by Zoom.