RISK CRITERIA AND VALUATION METHODS
Criteria and Valuation Methods
Not to Compete, Pt. 1
not to compete must be carefully drafted not only for their legal consequences,
but also for their accounting and tax treatment.
Covenants must meet the legislative and case law test of reasonableness
to be enforceable. Furthermore,
covenants must pass the U.S. Internal Revenue Code's test of economic reality
and mutual intent for price allocation and amortization.
When the covenant meets these tests, the analysis can then utilize
valuation methodology to determine economic damages due to breaches of a
covenant, or allocation of purchase price to meet legal and/or tax allocation.
This presentation will discuss some of the significant legal cases and
tax codes that have an impact on defining and valuing covenants not to compete. Also, several valuation methods will be reviewed which can be
utilized in determining the value of a covenant not to compete.
of the most litigated issues in the civil courts has been the determination of
economic damages due to breaches of covenants not to compete, and the cases
continue to increase. While these
cases have helped define the necessary elements of a covenant, there have been
many conflicting decisions which have lead to a great deal of uncertainty
regarding enforceability and the value of economic damages.
Being aware of the manner in which the courts have treated covenants in
the past, the valuator can better determine the elements of value that will be
upheld in the courts.
Valiulis, author of Covenants Not To
Compete, Forms, Tactics, And The Law1, states that
there are several trends that support the increasing need for covenants. The change from a manufacturing to a service economy wherein
the relationship between the individual employee who provides the service and
the customer becomes important to the employer's business relationship with the
customer. The growing emphasis on
market specialization to develop market share requires investment in market
research, product development, and long range marketing plans. These trade secrets must be protected from competition when
an employee leaves or the business is sold and the former owner has the ability
to compete. The growing number of
new small businesses are often the result of employees leaving their jobs and
starting their own businesses wherein they take the knowledge obtained from
their former employers to jump start their new businesses.
not to compete are most frequently utilized in the following circumstances:
employment circumstances between employer and employee
the sale of a business between the seller and the buyer
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