Continued from Part I, Non-Competition Clauses and Valuing a Business in a Divorce.
Part I of these posts addressed general issues in business valuations, and some of the special issues in valuing a business for a divorce. Which brings us to the main topic of these posts, how a buyer’s requiring a non-competition clause as part of the purchase of a business, affects and relates to calculating personal goodwill and the value of the business.
Generally, when someone buys a business, they don’t want the new owner opening up right down the street and siphoning away business. So, a non-competition clause prohibits a seller from doing that for a certain period of time, within a certain geographic area.
Non-Competition Clause and Personal Goodwill
As this relates to the marital value of a business, generally an argument that will be accepted is that if a seller requires a non-compete clause, it must mean that there is at least some component of personal goodwill, i.e. people coming to the business because of that particular person. One issue I am not sure about, and have not discussed this yet with a business valuation expert, is whether this conclusion is always necessarily true. For example, if there is an existing business, and a new business with an owner 100% completely unknow in the area, i.e. 0 personal goodwill, opens next door, some people will probably just randomly go into that store not because of any particular person working there. There would be a good reason to not want a competing business next door even if there was no personal goodwill for the owner of the competing business.
Based on Florida caselaw, however, the former conclusion is generally accepted – i.e. that if a non-competition clause is required, then some portion of the value of the business must be personal goodwill. Often the assumption accepted is that the value, therefore, must be all or almost all personal. Most of the reported appellate cases addressing this issue involved a professional practice, where in reality the value of the business was all or mostly all personal goodwill.
Valuing Non-Competition Clauses and Personal Goodwill
From talking with valuation experts, one appropriate way to look at the extent to which a non-competition clause is an indicator of personal goodwill, or more specifically the dollar value of the personal goodwill as a component of value, is how much business would leave, and income and therefore value would be reduced if the seller leaves the business. A related perspective is how much a buyer is willing to pay for the non-competition clause. I have seen it stated simply in valuation reports that the value of the non-compete clause is the present value of the income for the buyer that would be lost, if the key person (here the spouse) leaves.
Collaborative Divorce and Valuation
Bottom line, business valuations are complicated, which is another reason I believe a Collaborative Divorce approach to family law cases is far better than a litigated, adversarial approach. I was in a meeting recently where a financial expert colleague described a collaborative process of spouses talking together with him regarding the methodology and approach for a valuation, and subjective decisions along the way, so that everyone was involved at all times, and understood how the value in the report was determined. This as compared to a scenario in litigation where each spouse retains a valuation expert, with the experts often coming in with far different values, and each spouse ending up with limited trust that the other side is seeking a fair result.
It reminds me of talk I heard once by the Administrative Judge for the Miami Family Court, regarding research results showing that something called procedural justice was more important to litigants in walking away from court thinking and feeling that things had been fair, than substantive justice – i.e. people want the result they’re seeking and that is important to them, but even more important than the decision in the case and the substantive result on the issues, was whether the process seemed fair.