Selling a Practice: Valuing a Non-Competition Agreement

Several accountants and lawyers who specialize in advising clients in the dental profession often share valuable information from their industry-specific newsletters and journals. One such person is Allan Garber, a chartered accountant, who recently forwarded to me a detailed analysis explaining how a Non-Competition Agreement (NCA) may be employed in the sale of a dental practice and how it may help to minimize the taxes payable when selling professional goodwill. I am always seeking industry-accepted methods to minimize my clients’ tax burden when selling a practice, and this is certainly one worth mentioning.

Dentists who have not initiated the process of professional incorporation may find this strategy of interest, as it apparently has little or no effect upon the purchaser’s future tax planning. In a traditional asset sale, a seller seeks to structure the transaction such that the tax burden is minimized. This approach is permitted under the new professional incorporation regulations and it usually benefits the seller while penalizing the purchaser. The seller can reduce his or her tax burden, while the purchaser suffers a loss in future tax relief, also known as the “lost tax shield.”

However, the introduction of a value for the NCA, or restrictive covenant – an item included in almost every agreement of purchase and sale – appears to be a win-win situation; a rare occurrence in today’s complicated tax environment. The Federal Court of Appeal ruled on this matter in Manrell (2003 DTC 5225). Your accountant should know where to find the written decision.

A professional appraisal does not normally include an allocation of fair market value for a Non-Competition Agreement, but an Agreement of Purchase and Sale can include such a clause. To determine the value and allocation of an NCA, many factors need to be considered, such as: Does the seller have the ability to compete against the purchaser?; Does the seller possess any unique or proprietary skills that may damage the sustainability of the business if such skills are employed after the sale?; and, What specific business practices will the seller cease from performing after the sale?

Other issues such as the non-solicitation of staff, referring sources, financial capacity, age, health and the stated intentions of the seller should also be considered.

The steps needed to determine the value of an NCA are complex. First, the entire practice should be professionally appraised on an asset basis in order to produce individual tangible asset figures. The capitalization of earnings appraisal method, a commonly accepted approach, often fails to produce a separate value for the goodwill. Next, in the event the seller does not provide an NCA, the potential loss in future revenues is estimated. Added to this estimate is the notational loss in goodwill value. This series of sophisticated calculations and assumptions will result in a value for an NCA. It is essential that both the seller and buyer agree on the value figure. This process may be difficult, but with the help of a knowledgeable accountant and lawyer, it is worth investigating when pursuing the sale of a dental practice.

Ontario Dentist – December 2003