Valuing Healthcare Non-Compete Covenants

Non-compete provisions are an important component of many healthcare deals and service arrangements, as they provide protection by restricting the counter-party from engaging in competitive activities. Non-compete clauses occasionally have to be valued for business combination accounting, covenant buyout transactions, or disputes related to a breach.

In healthcare specifically, financial consideration for non-compete covenants is further complicated by the healthcare fraud and abuse laws that are intended to prevent payments for referrals. Non-compete covenant buyouts can receive intensified regulatory scrutiny when the parties are in a position to refer patients to each other.

A common example is a surgery center acquisition where the selling physicians are restricted from owning an interest or otherwise receiving remuneration from a competing surgical facility within a certain radius. Note that the clause does not restrict the selling surgeon from performing surgeries at a competing facility; it merely restricts their ability to benefit financially. Another common example is a management services agreement, where the manager is restricted from owning, managing, or otherwise receiving remuneration from a competing business.

In each of these examples, if the selling surgeon or manager wanted to be released from the covenant, they would be expected to buyout the covenant, usually at a price that meets the "fair market value" standard.

Since market data is limited - there isn't a public database of prices related to non-compete transactions - appraisers typically use a "with and without" methodology to value the asset in question both with and without the covenant-not-to-compete, using reasonable assumptions. This approach can be highly sensitive to sometimes even minor changes to the underlying assumptions, making it even more important to review what little market data is publicly-available.

One important public source of market data related to non-compete valuations are the intangible asset values reported in business combination accounting (aka purchase price allocations). These values, which are typically determined by an independent appraisal firm, are developed for purposes of allocating the purchase consideration from a merger or acquisition to the individual asset categories, including identifiable intangible assets such as non-compete covenants. While these asset values are developed for business combination accounting under the fair value standard, they can be used as a reasonable proxy for FMV.

A summary of the healthcare industry segments where non-compete covenants are attributed value, according to our intangible asset database, is presented below.

According to the database, non-compete covenants represent 0.2% to 7.4% of the value of the acquired business enterprise, at the median, depending on the industry segment. We believe that the relatively small amounts allocated to non-compete provisions may reflect the limitations on the ability to legally restrict referral decisions within the healthcare industry – for example, if an ASC non-compete agreement really could effectively restrict the selling physicians from utilizing a competing facility, the non-compete clause might represent much more than 3.5% of the value of the business enterprise, at the median.

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