The buyer wants to allocate a large portion of the purchase price to a personal non-compete covenant rather than goodwill, which would tax that portion as ordinary income instead of capital gains. How do we push back using market valuation benchmarks?

Question

Tyler Smith · Accepted Answer

Buyers often try to shift a significant portion of the transaction value into personal non-compete agreements or consulting contracts. This allocation allows them to write off the cost quickly for tax purposes. However, it is a terrible deal for you as the seller because covenants not to compete are taxed at high ordinary income rates, whereas goodwill qualifies for lower long-term capital gains tax rates.

To defend your proceeds, you must insist on a formal purchase price allocation under Section 1060 that reflects true economic reality. Use the Income Approach to value the non-compete covenant. This involves modeling a scenario where you actually compete against the business compared to a scenario where you do not. If your business has an institutionalized brand, a solid management team running on EOS, and long-term customer relationships, your personal ability to damage the company is limited. Therefore, the economic value of your personal non-compete is low.

Present these facts to the buyer. Show them that the value of the business resides in the company systems, the trademarked processes, and the team, not in your personal relationships. This proves that the vast majority of the purchase price belongs in the goodwill category.

If the buyer still insists on a high non-compete allocation, demand a gross-up in the purchase price to offset the additional tax burden. This forces them to bear the cost of their tax-saving strategy.