My first in-depth experience understanding non-compete agreements was in graduate school (many years ago). At that time, the examples only included transactions between large, publicly held companies, so when I handed my very first non-compete valuation to the attorney, I was shaking like a leaf in a hurricane. As the years went on, we’ve been asked to value such agreements more and more. I saw that non-compete agreements involving closely held businesses become “standard fare,” with 30 million Americans subject to this restrictive covenant.
However, the landscape has dramatically changed with the Federal Trade Commission’s final rule issued on April 23, 2024, which bans most non-compete agreements. Under the new rule, existing non-competes are no longer enforceable, with narrow exceptions including senior executives earning over $151,164 annually in policy-making positions (less than 0.75% of workers). Employers are also prohibited from entering into any new non-competes, even with this small subset of executives.
The final rule also includes a limited exception that hasn’t been as publicized: non-compete clauses are permitted in connection with the sale of a business entity, a person’s ownership interest in a business entity, or substantially all of a business entity’s operating assets. The final rule eliminates the proposed 25 percent ownership requirement for the seller.
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Prior to the FTC ban, non-compete agreements helped businesses retain valuable employees, safeguard inside information, and prevent unfair competition. When valuing a non-compete, we considered several factors, such as the overall business value, probable damages from a breach, likelihood of competition, and enforceability of the agreement.
In the wake of the FTC rule, the value of non-competes in business sales, financial reporting, or tax purposes is now largely negligible for most workers. Traditional valuation approaches can be applied for the small percentage of existing non-competes that may still be valid for certain senior executives. This includes estimating the differential cash flows with and without the non-compete, assessing the probability of competition, and testing for reasonability in scope and duration. However, even in these limited cases, the value is uncertain and short-lived, as no new agreements can be implemented.
Looking ahead, businesses will need to rely on other protective measures that the FTC still allows, such as robust non-disclosure agreements and trade secret protections. As these changes come into play, we’ll need to focus more on quantifying the worth of these alternative arrangements.