Does a non-competition agreement have value? And if so, how much? How do you determine the value of a non-competition agreement if a director-shareholder leaves the company and no agreement on competition has been reached?
If the seller remains active in the company's market segment after the transfer, the question of whether specific agreements were made about competitive activities, employees and customers comes into play.
Unfortunately, it happens that there is no clear agreement on this in the shareholder agreement or management agreement. What to do?
A non-compete agreement is a collective term for several agreements:
- Activities (re-enter business, employed by a competitor, strategic consulting, an executive or management position with a competitor, developing new products or services in the same market)
- Employees or interns (do not actively approach, do not hire)
- Relationships (customers or leads, not making contact or offers)
- Investments & holdings in competitors
- Geographic scope & duration of the non-compete agreement.
- Fines, measures & penalties
The non-competition clause limits the clout of the departing director-shareholder. A person is unable to conduct business in the agreed-upon sector during the term of the clause. In practice, the term varies between one and three years. After that time, contacts are usually diluted and it takes a lot of time and effort to set up a new business again.
The seller will therefore want a higher price for its shares in order to make a fresh start in another sector or to bridge the term of the clause.
Damage calculation
But how do you calculate that additional price? There is no formula because it involves future scenarios. In order to make an estimate anyway, we need to make some kind of damage calculation.
Suppose the selling shareholder starts a new directly competing business immediately and then removes:
- The largest relationship
- A key-employee
- 10% of revenue
* Gross margin is discounted over future years by the legal interest rate.
** Human Capital is another name for the value an employee brings to the business (business, organizational or management).
In this example, no weight is given to other factors. The gross margin in this case is the economic approximation of damages to the company.
Case law shows that the duration of a non-competition clause is capped at 3 years within the limits of reasonableness and fairness. After that, the company must be able to cope with the competition associated with a free market.
Compensation
The value of a new non-compete clause is important part of negotiating price and terms of exit. The price of the clause can be as much as 20% of the purchase price. If you want to avoid that, it's better to negotiate agreements in advance than to have to haggle over them later.
If buyer and seller do not come to an agreement, it does not mean that the seller is allowed to do as he pleases. If there is demonstrable economic damage to the company, the seller can be ordered to pay damages.
