Valuing Healthcare Non-Compete Covenants

Healthcare noncompete laws have been in the news recently as a widespread revision process appears to be underway. In 2022, 30 bills have been proposed across 29 states involving healthcare noncompete provisions. The Federal Trade Commission has held public workshops to assess the best course for limiting non-competes, and the Department of Justice has brought several legal actions challenging noncompete covenants that may have violated anti-trust laws.

Noncompete provisions are a standard component of many types of healthcare deals, including employment agreements, contracted service arrangements, and business interest or asset sales. Typically, when a physician leaves an employment or contracted services arrangement, or sells a business interest or asset, non-compete covenants trigger restrictions that may include non-compete clauses, geographical limitations, protection of confidential information, and non-solicitation agreements. These restrictions exist to protect the employer's business interests and may or may not be enforceable. Occasionally non-compete clauses are 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 positioned to refer patients to each other.

In the case of a surgery center acquisition, for example, a non-compete clause might restrict the selling physician(s) from owning an interest or otherwise receiving remuneration from a competing surgical facility within a certain radius. Note that the clause does not usually restrict the selling surgeon(s) from performing surgeries at a competing facility; it merely restricts his/her ability to benefit financially. Another common example is a management services agreement, wherein the manager is restricted from owning, managing, or otherwise receiving remuneration from a competing business.

In these examples, to be released from the covenant, the selling surgeon or manager would be expected to buy out the covenant, usually at a price that meets the "fair market value" standard.

Since market data are limited - there isn't a public database of prices related to non-compete transactions - appraisers typically use a "with and without" income approach methodology to value the asset in question (with and without the covenant-not-to-compete, using reasonable assumptions). This approach can be highly sensitive to even minor changes to the underlying assumptions, underscoring the importance of reviewing any amount of market data that are publicly available.

With respect to the cash flow impact of a particular physician to a practice, the value of the non-compete covenant can vary based on many factors, including but not limited to:

• The physician's name, reputation, and expertise;

• The physician's role and tenure with the practice;

• The physician's ability and willingness to engage in competition;

• The specialty of the practice, such as primary care, surgical, or hospital-based;

• The practice's location, market position, payer mix, payer contracts, size, and other factors.

Since each of the above-listed factors can vary widely, non-compete covenant values are highly variable. While convenient, a simplified formulaic approach, such as 1 x annual compensation, may or may not be appropriate and may run the risk of over-valuing the covenant in the early years of employment and under-valuing it in later years. However, a reasonable estimate can be determined under an income approach methodology to value the goodwill or other business interest of the specific physician. In addition to capturing the original value intended for protection by the non-compete, the estimate should be consistent with applicable state laws.

One of the few public sources of market data related to non-compete valuations is the intangible asset values reported in business combination accounting (purchase price allocations). Typically determined by an independent appraisal firm, these values are developed to allocate 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 0.3% to 7.0% 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 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.

This article has been updated from its original 2019 publication.