Definition
Restrictive covenants are promises, usually in the purchase agreement, that limit what the seller can do once the business is sold. The common types are a non-compete (not running or working for a competing business), a non-solicit (not approaching customers, suppliers or staff) and a promise not to use the old trading name. Each is limited by time, geography and the activities covered. Whether a covenant can be enforced depends on local law and on whether it goes no further than needed to protect what the buyer paid for.
Worked example
Silverbirch Physiotherapy is a fictional Canadian clinic sold for C$1,200,000. The seller agrees that for three years she will not open or work in a physiotherapy clinic within 10 kilometres, and will not approach the clinic's patients or staff.
A year later she is offered a role at a clinic 40 kilometres away. That falls outside the covenant, so she can accept.
Why buyers care
Much of what you pay for is often goodwill, and a seller who opens a rival business nearby can take it straight back. Covenants are the main protection.
Courts in many places treat covenants given by the seller of a business more favourably than those in ordinary employment contracts, but a covenant that is too wide in time, area or scope risks not being enforced at all. Keep them tied to the business as it actually operates.
Think about who else should give them, such as co-owners, family members in the business and key staff. Rules differ by country and, in the US, by state, so take advice from a qualified lawyer where the business operates.
Goodwill is the part of a purchase price above the value of a business's identifiable assets, less its liabilities. It reflects things like reputation, customer relationships and trained staff.