Mercer Capital's Financial Reporting Blog

Non-Compete Agreements: The Good, the Bad, and the Ugly

Non-compete agreements are increasingly in the news, though not always in the most favorable of contexts. Proponents argue that such agreements protect firms’ intellectual property and prevent the loss of key employees, customers, suppliers, and trade secrets. Others would suggest that non-competes stifle innovation by limiting competition and employee mobility.

In recent years, non-compete agreements have become more widely used, although as shown in the recent case of Instant Technology LLC, the enforceability of such agreements is highly dependent on the specific facts and circumstances. Instant Technology is a tech-focused staffing firm. The company filed suit after five employees left to form a competing firm, Connect Search, alleging that they violated the terms of their employment agreements. One of the former employees, a VP of sales and operations, had signed an employment agreement which included a non-compete clause. Instant Technology sued on the basis that this individual poached its employees and also solicited business from its clients, which were provisions included in the above mentioned individual’s non-compete agreement. The former employee argued that the non-compete clauses were unreasonable, and the judge agreed. The basis for the ruling concluded that the commoditized nature of the staffing industry meant that clients routinely worked with multiple staffing firms at once. Further, information about those clients’ job postings were publicly available on numerous websites and so such information was not confidential. Lastly, the judge struck down the employee solicitation claim, noting the high employee turnover rate in the industry.

In a previous post, we discussed the prevalence of non-compete agreements for more senior positions, executives, salespersons, or highly-skilled individuals in a technical field, throughout certain industries. However, non-compete agreements have also been included in employee contracts at over 2,000 Jimmy John’s restaurant locations for employees assembling and delivering sandwiches. These noncompetes prohibited former employees from taking jobs at any other sandwich restaurant nearby for two years. While several former employees have sued the Company, a federal judge last year ruled that the case lacked standing because the Company indicated it was not planning to enforce the agreements.

Labor experts have suggested that non-compete agreements and related contracts are aimed to prevent turnover, though courts and the public appear to not favor incidents in which contracts are not created to protect proprietary information like intellectual property, formulas, trade secrets or business strategies.

In another example, a recent Wall Street Journal article described a young journalist’s recent experience of being asked to leave her new job at Thomson Reuters as a result of disclosure of a prior non-compete agreement. Her previous employer, Law360, sent a letter to Thomson Reuters citing a non-compete agreement she signed when she started her first full-time job with Law360 two years before at the age of 25. The journalist recalled signing this agreement, though she made reference to former colleagues leaving for other publications without incurring dismissal from their next employer. In industries where people change jobs frequently, these types of provisions can negatively impact the career development of those who may not realize that they are covered by restrictive covenants.

The value of an individual’s non-compete to a corporation can become important in the context of acquiring a business or in matters of calculating economic damages. In purchase price allocation, the value of a non-compete agreement is typically calculated as the difference between entity value on an “as is” basis with present employees intact and a hypothetical firm value, assuming that the acquirer is unable to obtain assurances that key employees would remain active and, further, would not seek to compete with the acquired company for a specified period of time.

Mercer Capital regularly values non-compete agreements and other intangible assets in the context of financial reporting and tax-related engagements. Please contact us to discuss your valuation issues in confidence.

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