Admittedly I must tread lightly on this topic because there is too much nuance to cover in a single lifetime. However, in my opinion, the recent FTC ban on non-competes does warrant discussion.
The first point that is interesting to me is that transactions are carved out. This means that business owners will still be bound by the non-competes embedded in transaction documents under the logic of protecting the investment that an acquirer has just made. Therefore, if the non-compete ban is to become effective in its current form or substantially its current form, transactions involving businesses where the owners are intimately involved in the operations of the business will largely be unchanged (typically smaller businesses). However, transactions involving businesses in which some key employees are not owners (typically larger businesses) may have some additional risk that needs to be addressed. This may further favor the tuck-in acquisition over certain platform transactions, all else equal, and tuck-in acquisitions have been in favor for quite some time now.
The second point that many have already mentioned is the applicability of such a ban on nonprofit entities which comprise the lion’s share of health systems in the US. Should it be determined that the non-compete ban does not apply in the same way to nonprofits, that could further divide the landscape.
I have heard several investors quip that non-competes are tools rarely utilized in practice, and their enforcement is a signal of larger management issues. Yet many in the healthcare industry still insist upon including non-compete clauses in employment contracts and transactions alike. It is therefore tough to argue, in my opinion, that non-compete clauses have no strategic value in today’s world.
Implications for Business Valuations
Asset-Based Approach
When applying an asset-based approach, to the extent that workforce-in-place is included in the analysis, I think the analysis should consider the recent FTC ban in some fashion. There is a lot of diversity in practice when it comes to workforce valuations. Some firms don’t ascribe any value to a workforce no matter the circumstance. Still others may not ascribe value to workforce in situations where there are not sufficient operating cash flows. Some may consider workforce value but treat owner workforce separately from non-owner workforce value. Still other firms include workforce value in most applications of the asset-based approach. I believe that the consideration for workforce value is dependent on each individual case.
While it is true that there is plenty of diversity in terms of whether workforce is valued as a separately identified intangible asset, I believe most agree that the workforce value is generally attributable to the cost to replicate a similar workforce, by reference to, among other things, the costs associated with recruiting and training staff members. In this valuation method, assuming the non-compete ban is implemented, I could see an argument for some type of secondary adjustment for the additional risk that employees may leave to compete with the business and thus harming the future cash flows.
Market-Based Approach
When applying a market-based approach, I see this as yet another delineating factor when considering the age of comparable transactions. Theoretically, most current transactions are going to have stronger evidence of market value anyway, but the non-compete issue could be another reason to shy away from older transactions as an indication of fair market value. Of course, I use market transactions with great regularity when advising clients on various aspects of valuation in some settings. That said, I am ever more hesitant to rely upon the market-based approach within the context of a valuation/appraisal assignment in which I am adhering to several sets of professional standards.
Income-Based Approach
I believe the income-based approach is best suited to consider the nuances of any ban on non-competes. This is because we have the option to layer in adjustments directly into cash flow projections or to consider the non-compete ban within the discount rate itself. In fact, non-competes are already something that we consider in our valuations via the company-specific risk premium, a component of the cost of equity capital. We try our best to maintain awareness of the state specific minutiae regarding enforceability of non-competes for physicians, APP’s, and other professionals. We have valued companies in states where non-competes are not enforced. In those situations, we have either considered this fact within the discount rate (via company-specific risk premium) or within the cash flows directly (via ever-increasing payroll costs to account for attracting and retaining employees). This is particularly the case with medical provider workforces since other key employees may still be prohibited from competing in ways that exploit trade secrets or other intellectual property, even in the absence of a non-compete.
Conclusion
In my opinion, some circles of the healthcare M&A community seem to be downplaying the impact that a non-compete ban might have on valuations and M&A activity in general. Acknowledging the intricacies of every market, I disagree, and think that the non-compete ban may have a lasting impact on the way healthcare M&A is done, particularly in the lower and core middle market.
About the author
Jarrod Barraza serves as a senior manager in HORNE’s valuation and transaction advisory group, focusing on the healthcare industry. He is skilled in complex transactions and delivering tailored solutions to meet the needs of his clients such as hospitals, dentists, physician practices, pharmacies and investor groups.
