A covenant not to compete only has value to the extent that it “protects the value of the purchased assets of the business (both tangible and intangible) by restricting the seller’s competitive conduct after the sale,” writes Gary Trugman (Trugman Valuation Assoc. Inc.), in a new article for the February 2012 BVUpdate. As a result, a CNC’s value depends on factors such as:
- The ability of the seller to compete after closing the sale, which may implicate the seller’s age, health, professional standing, etc.;
- The derivation of the non-compete; and
- The losses the buyer (the company) would suffer if the seller, in fact, competed.
In most cases, the first step in valuing a CNC is to determine its “economic legitimacy,” a concept that courts have attempted to define over the years (apart from a CNC’s legal enforceability, which is a separate issue). For instance, in Thompson v. Commissioner, T.C. Memo 1996-468 (available at BVLaw), the Tax Court set forth an 11-factor test to determine a CNC’s economic reality. “Clearly, the facts and circumstances in any individual case are important to consider,” Trugman writes, but Thompson’s 11-point checklist furnishes a good basis for assessing the CNC’s legitimacy as well as the probability of the seller’s competition. Download a complete copy of Trugman’s article, “Valuing Covenants Not-to-Compete: an 11-Factor Checklist,” at BVR’s free resources page.