On April 23, 2024, the FTC announced a rulemaking banning noncompete agreements. Noncompetes, which generally restrict employees from working for competitors after leaving a company, have faced increasing scrutiny in recent years. With the new rulemaking in place, how will banning noncompetes (if ultimately implemented) affect valuation litigation?
Noncompetes act as a negative right of the corporate entity – they aim to block competition after an employee or similar leaves an employer. The more so the value of a company is based on its human capital and workforce assets, as opposed to property, plant and equipment assets (or similar), the more so a noncompete ban can affect value.
The healthcare industry is one are where noncompetes are generally common (setting aside jurisdictions that already ban them) and for logical reasons. The healthcare workforce, its experience, knowledge, and stability, often forms the core value of healthcare businesses. Noncompetes remain a controversial topic in the industry.
More generally, a noncompete ban is likely to result in some valuation impacts, including:
- Litigation Over the Impact of the Ban on Pending/Contemplated Transactions. Pending transactions, or contemplated ones, will necessarily have to take into account whether the ban affects their value. Deals agreed to pre-ban but with a likely closing date post-ban may be affected, but so would any deal where the fundamental value premise is based on retention of human capital. This will likely result in valuation litigation over these deals.
- Focus by Parties on the Value of Talent Retention and Recruitment: Noncompete agreements can act as a deterrent for talented individuals considering employment opportunities. Banning such agreements would likely increase the mobility of skilled workers, encouraging them to explore new job prospects without the fear of legal repercussions. In valuing a business focused on human capital, experts will necessarily focus on the value the enterprise is able to gain from that human capital before the ban and after. Similarly, more granular assessment of corporate value may be required when focusing on the specific human capital and goodwill of these businesses.
- Possible Increase in Valuation for Junior Players: Noncompetes have faced criticism for inhibiting innovation, stopping seasoned employees from launching entrepreneurial ventures or moving to junior rivals in an industry. Increased innovation potential could translate into higher growth prospects for companies, positively impacting their valuation metrics.
Any significant rule change can affect valuation and lead to valuation litigation. With that said, the impact should not be over-hyped. Several jurisdictions already ban noncompetes, the rule is currently being challenged in court, and even as written has several significant exceptions (including upon sale of a business). Nonetheless, it always bears note that valuation is a creature of the regulatory, legal, and in some cases cultural landscape of the time. Any change to that landscape can lead to change in value.