Often when companies are purchased, there is an agreement with the former owner, not to compete with the purchasing company. There is potential value to this agreement, depending on the circumstances. For financial statement purposes, the non-competition agreement would be an intangible asset that would need to be valued separately from goodwill. There are two important assumptions that need to be addressed in order to determine the value of the non-competition agreement:1.) How much of the future earnings could the former owner take from the company if he/she decided to compete against the new company? 2.) What is the likelihood that the former owner would compete?
In considering the answer to the first question, you must consider the individual’s contact with customers and the loyalty of the customers to that individual. Also, you should consider the loyalty of the other employees to that individual, especially if those employees have strong relationships with the customers. Factors to consider regarding the second question - the likelihood that the individual would compete - include the following: Is it likely that the individual would be able to start another company and efficiently compete? Is it likely that the individual would be hired by a competitor? Is the individual near retirement age? Does the individual have other skills in a different industry in which he or she could find other work that is unrelated to the purchased company’s industry? Is the individual wealthy and would not need to work to provide for his or her family?
Both assumptions are important and need to be considered together. For example, if the individual could potentially take a large amount of the customers, but the likelihood that the individual would ever compete is zero, then there is no value to the non-competition agreement. Likewise, if there is a great likelihood that the individual would compete, but that individual did not have contact with customers and would not be able to take away earnings, then there is no value to the non-competition agreement.
If you need to value a non-competition agreement or other intangible assets, contact a member of Schneider Downs Advisory Group.
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