If you are a top company executive, salesperson, or are employed in a highly skilled technical field, you likely have a clause in your employment contract that prohibits you from leaving to work for a competitor or starting your own firm for a specified period of time. While commonplace for more senior positions and in certain industries, you may be surprised to find a non-compete agreement (NCA) in your contract if you assemble or deliver sandwiches at one of Jimmy John’s 2,000 restaurant locations.
A Jimmy John’s employment contract provided to The Huffington Post by an employee states that employees may not work at “any business which derives more than 10% of its revenue from selling submarine, hero-type, deli-style, pita and/or wrapped or rolled sandwiches.” The provision extends for two years and includes any establishment within a three mile radius of any Jimmy John’s in the country. The Huffington Post notes that the restricted area effectively covers 6,000 square miles in 44 states and the District of Columbia.
An important issue to consider when discussing NCAs is enforceability. In many cases, the mere threat of litigation or action by a firm is enough to dissuade an individual from breaking the NCA. In the case of Jimmy John’s broad restrictions, some have suggested that it is unlikely that a court would uphold the contract if litigation ensued. Courts have historically held a narrow focus regarding the applicability and enforceability of NCAs, and Jimmy John’s contractual restrictions may prove to be unreasonable.
What is considered to be a valid NCA? Though different states follow different rules regarding non-competes, with some even outlawing the practice all together, several common criteria are generally followed:
- The agreement must be supported by consideration at the time it is signed.
- It must protect a legitimate business interest of the employer.
- The agreement has to be reasonable in scope, geography, and time.
In business combinations, NCAs are identifiable intangible assets (per ASC 805) and require a fair value measurement along with other intangible assets like patents, technology, and customer relationships. NCAs derive value from their ability to reduce the risk in business acquisitions by minimizing the loss of employees, customers, and suppliers.
When valuing an NCA, most analysts use the “with or without” method. Fundamentally, an NCA is only as valuable as the cash flows the firm protects “with” a NCA compared to “without” one. Cash flow models can be used to assess the impact of competition on the firm, multiplied by the likelihood of competition (ability and willingness), and discounted to the present at an appropriate rate. Valuation professionals should consider factors such as revenue reductions, increases in expenses and competition, and the impact of employee solicitation and recruitment.
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.
- Secrets of the Tech Road: The Evolving Status of Non-Competes
- Presentation: Non-Compete Agreements: Valuation Issues in GAAP and Tax Engagements