If you are planning to buy or sell a business, you are undoubtedly aware that numerous components must be figured into the equation. One of the most important aspects is the valuation of various assets owned by the selling company. Naturally, it is generally easier to establish the value of tangible assets, such as equipment and inventory, than it is to value intangible assets.

For example, the sale of a business may include a noncompetition agreement, or "covenant not to compete," as part of the deal. This type of agreement is often used in sales to outsiders or when co-owners or partners go their parting ways. As a new case points out, the valuation of the noncompetition agreement can be critical.

Background: A valid noncompetition agreement must distinguish between acts that take legitimate profits from the company and those that are essential to the employee's livelihood. For example, an employee usually will be permitted to compete with an ex‑employer on some levels, but prior clients or customers may be off-limits.

Any noncompetition agreement should be worded carefully. Typically, the agreement may call for a former employee to refrain from specific acts at specific places for a specific period of time. The enforceability of these terms depends on whether the restrictions are "reasonable" or not.

When judging the reasonableness of a noncompete agreement, the courts may consider the following factors, among others:

*The length of time the agreement remains in force;

*The scope of the geographic area restricting the individual;

*If the agreement restricts activities not in competition with the company;

*If the agreement prevents the individual from working in his or her chosen field; and

*The reason for the departure of the individual.

Facts of the new case: When a family member decided to leave a family-owned firm, the company structured the buyout as a stock redemption with a noncompetition agreement. The buyers--in this case, the company--intended to allocate part of the $24 million purchase price to the noncompetition agreement, but failed to spell out the terms in writing. Thus, it was left to the Tax Court to determine the outcome.

Due to the lack of a formal valuation, the Tax Court ruled that the allocation was zero. This resulted in a significant tax advantage to the recipient of the buyout. Reason: All of the gain is treated as capital gain, which is taxed at a preferential tax rate. If a proper allocation had been made, the amount attributable to the

noncompetition agreement would have been taxed as ordinary income.

Practical approach: Don't leave valuations of intangible assets to chances. With thousands of tax dollars at stake--or maybe more--it makes sense to consult with an expert analyst.