Valuing Non Compete Agreements
Where the acquirer is a business, generally accepted accounting principles (GAAP)1 require that the financial statements of the parent company be consolidated with those of its subsidiary. According to the legal order, these accounting rules are specific standards2 according to which the purchaser must allocate the total purchase price paid in a business combination to the fair value of all tangible and identifiable intangible assets acquired (including the non-compete agreement). This gives stakeholders more information about the actual nature and cost of the acquisition. Sufficient sales revenue will also be a significant measure. It is also worth considering whether the non-competition clause is legally applicable. In general, non-competition rules can only be applied if the restrictions are appropriate. As a lawyer, you already know that the courts have refused competition bans covering a territory or a long period of time of great scope. The direct approach is to determine the present value of potential future economic damage that would result directly from the non-application of a non-competition clause. The direct approach is a little simpler because it includes estimating direct damages resulting from competition, usually in the form of a percentage of the shortfall. This method is more often used, as only an estimate of future operating results is required, making the analysis less time-consuming. These two methods, if properly applied, should lead to a similar conclusion of value. Non-compete clauses help companies retain valuable staff, protect inside information and prevent unfair competition.
But while they are designed to protect businesses, they can also put them at significant risk if not properly structured and maintained. Once a discount rate is set, apply the present value factors corresponding to the expected losses (determined in Step 2) to quantify the value of the non-compete clause. For accounting purposes, the value of this intangible asset would be amortized over the term of the agreement. . . .