levitra"> levitra"> Risk Criteria and Valuation Methods for Valuing Covenants Not to Compete, Pt. 1
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RISK CRITERIA AND VALUATION METHODS

Risk Criteria and Valuation Methods

for Valuing Covenants

Not to Compete, Pt. 1

By: Jeff Jones

Covenants 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.

LEGAL ISSUES

One 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.

Anthony Valiulis, author of Covenants Not To Compete, Forms, Tactics, And The Law1[1], 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.

  • Covenants not to compete are most frequently utilized in the following circumstances:

  • In employment circumstances between employer and employee

  • In the sale of a business between the seller and the buyer



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