As valuation practitioners, we are increasingly called to assess the fair market value of intangible assets, including non-competition agreements, particularly in the context of mergers and acquisitions. With the shifting regulatory landscape around non-competition agreements, valuation firms must stay informed of developments and adapt their methodologies to accurately reflect current laws and tax requirements. The Federal Trade Commission’s (FTC) proposed restrictions on non-competition agreements—and the ensuing legal battles—add new layers of complexity to valuation practices under IRC Section 280G, which governs golden parachute payments. Here, we explore the implications of these changes, key considerations in valuing non-competes, and state-level factors that valuation professionals should incorporate.
Current Legal and Regulatory Landscape
The FTC’s attempt to restrict non-competition agreements, aiming to protect worker mobility and reduce barriers to competition, represents a seismic shift. While the rule would permit existing non-compete clauses for senior executives earning more than $151,164 annually to remain, new non-competes are barred, except in limited cases. This move has faced resistance, with a federal court ruling against the FTC’s ban and an ongoing appeal. As this regulatory ambiguity unfolds, valuation practitioners must navigate these uncertain waters, particularly when performing valuations under IRC Section 280G for executives facing potential golden parachute taxes.
Impact on IRC Section 280G Calculations
IRC Section 280G plays a critical role in determining whether compensation received by executives in M&A transactions qualifies as excess compensation, thus subject to additional tax. Non-compete agreements are often considered in these calculations, as they can reduce the total parachute payment by the fair market value of the agreement. However, the FTC’s evolving stance on non-compete enforceability complicates these calculations. If the FTC’s ban on non-competes for all but a narrow subset of executives succeeds, it will limit the applicability of these deductions, adding complexity for valuation professionals when advising clients on compliance with Section 280G.
Valuation professionals will need to determine if an executive’s position qualifies as “policy-making”—a designation that affects whether the non-compete can be included in 280G calculations. This ambiguity necessitates careful scenario planning, often valuing the agreement under two conditions: one where the executive is assumed to be in a policy-making position and one where they are not. Such dual analyses provide flexibility and clarity for clients engaged in M&A transactions, allowing them to address tax planning needs in an environment of ongoing regulatory flux.
State-Level Considerations and Valuation Implications
Valuation practitioners must also account for variations in non-compete enforceability at the state level, which could be more restrictive than federal standards if the FTC’s appeal is unsuccessful. Certain states already have stringent guidelines on the enforceability of non-competes, including duration and geographic limitations. For example, a non-compete that restricts competition for three years in a contract may need adjustment if the state’s regulations only permit two years.
Such adjustments are not limited to duration. For example, non-compete agreements often specify a broad geographic scope, which may conflict with a state’s narrower parameters. In these cases, valuations must adopt the more restricted geographic scope required by state guidance, potentially resulting in a lower valuation of the agreement. These state-level complexities require valuation firms to stay informed on jurisdiction-specific regulations, as each state’s authoritative guidance significantly influences the value of non-competition agreements.
Strategic Considerations for Valuation Practitioners
The evolving landscape around non-compete agreements poses challenges and opportunities for valuation firms. With multiple jurisdictions enforcing varying levels of restrictions, and the FTC’s stance still uncertain, valuation practitioners must approach the valuation of non-compete agreements with a strategic, informed perspective. Staying updated on federal and state legal precedents is critical, as is collaborating with legal counsel to ensure comprehensive due diligence in transactions.
For valuation firms, adopting robust methodologies that consider potential legal outcomes can enhance client confidence and compliance. As we evaluate non-competes for M&A transactions, our expertise will play a vital role in navigating these complexities and providing actionable insights that support informed decision-making, even as the regulatory environment continues to evolve.
