How are non-compete agreements valued and amortized as intangible assets in an acquisition?

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AcadiFi · Accepted Answer

Non-compete agreements (NCAs) are recognized as **finite-lived intangible assets** in a PPA when the acquirer obtains contractual rights to prevent key individuals from competing. The valuation uses the **with-and-without method**.

**The With-and-Without Valuation Approach**

The fair value of a non-compete equals the difference in enterprise value under two scenarios:

- **With the NCA in place:** Full expected cash flows assuming the founder cannot compete
- **Without the NCA:** Reduced cash flows reflecting the probability and severity of competition

**Worked Example — Redstone Capital acquires Hargrove Analytics:**

Hargrove's founder, Dr. Claire Hargrove, signs a 5-year non-compete. The valuation team models:

| Scenario | Year 1 CF | Year 2 CF | Year 3 CF | Year 4 CF | Year 5 CF | PV @ 16% |
|---|---|---|---|---|---|---|
| With NCA | $8.2M | $9.0M | $9.5M | $10.1M | $10.8M | $30.4M |
| Without NCA | $6.9M | $7.1M | $7.8M | $8.5M | $9.2M | $25.7M |
| **Difference** | $1.3M | $1.9M | $1.7M | $1.6M | $1.6M | **$4.7M** |

The NCA intangible is recorded at **$4.7 million** and amortized over the 5-year contractual term.

**Amortization Pattern**

Most NCAs use **straight-line amortization** because the competitive threat is assumed constant each year. However, if evidence suggests the competitive threat is front-loaded (e.g., founder most likely to compete in years 1-2), an accelerated pattern reflecting the economic benefit consumed may be appropriate under IAS 38 / ASC 350.

**Impairment Considerations:**

- NCAs are finite-lived, so they are tested for impairment only when **triggering events** occur (not annually like goodwill).
- If the founder dies or becomes disabled during the non-compete period, the remaining value would likely be impaired to zero.

**Exam Points:**

1. NCAs derive value from a contractual right — they always meet the identifiability criterion.
2. The with-and-without method captures the incremental value of preventing competition.
3. Amortization creates a tax shield if the NCA is recognized for tax purposes (common in asset deals).
4. NCAs are typically small relative to customer relationships or technology — often 2-5% of deal value.

Explore complete PPA breakdowns in our CFA Level II Financial Reporting course.

How are non-compete agreements valued and amortized as intangible assets in an acquisition?

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