Estimating the value of the practice
In Part 1, we detailed the basics of how to determine whether your chiropractic practice has a marketable value. This section will discuss how to arrive at a credible estimate of that value by “The Excess Earning Method”.
Value of the real estate
Where the real estate is owned, and is to be part of the sale package, the first step is to subdivide the practice into two separate entities; the real property of land and building, and the chiropractic practice itself. For this purpose, consider your professional practice as a tenant, paying the same rent and with the same lease conditions as if renting from a third party. Value the real estate by the traditional methods. If the practice is leased, this step is not necessary.
Furniture, fixtures and equipment
When considering the furniture, fixtures and equipment, (F.F.&E), you are seeking a value in place and in use, not what you could sell this equipment for on the open market, which would probably be considerably less. A simple way to produce a reasonably reliable value estimate is to first determine its replacement-cost-new, abstract the “book value” from your financial statements, capital assets and depreciation schedule, and third, estimate the in-place value as half-way between these other two.
Assumed replacement cost new – $100,000
Depreciated book value – $46,700
Halfway between $100,000 and $46,700 = $73,350, say $73,500.
This method provides a ballpark global value, which is the total for all items based on replacement cost, adjusted Canada Revenue depreciation, and the “value-in-use” premise. It does not consider that some items depreciate at a faster rate than others, obsolescence, and that the replacement cost of certain items is decreasing.
Value of The Goodwill
In Part 1, we stated that to have value, goodwill must be transferable to another practitioner, and that person must be able to capitalize on it. If it is not transferable, its value is zero. To value the goodwill, take the annual average of your income over the last five years, and expense statements, if the income and profit has been variable, or three years if it has been quite steady. If there is a noticeable trend, which you assume will continue, use the last two years. Determine the annual average net profit after payment of income tax that is attributable to the business portion of the practice. Delete depreciation and long-term debt service, both interest and principal, and anything that has nothing to do with, or is out of the ordinary to, your day-to-day chiropractic practice. If you own the real estate, add to the net profit your annual mortgage payment, but subtract what you would have to pay for rent, were the property owned by another.
(Remember – you are a tenant.) Always assume the real estate and the F.F.&E. to be free of debt, even if this is not true. When you sell, you will have to pay or assign the debt. Where equipment is leased; if rental only, or rental with purchase option, as you must assume the buy-out option will not be exercised, do not take its value into consideration. If the equipment is in a lease with conditional sale, whereby title passes at the end of the lease, consider it as owned, with the unpaid balance treated the same way as all other capital asset liabilities, that is, deducted from the estimated going concern value of the practice.
If not already done so, deduct a fair wage for yourself including bonuses and/or dividends or, if included, adjust to what it should be. This is what you could earn if working for another, or what you would have to pay someone to manage your practice.
When you have reached this point, all financial and capital demands should have been accounted for. Although somewhat an oversimplification, the remainder is an adjusted net profit figure, on which the goodwill value will be based. Professional appraisers may get much fancier, but you will get a good value approximation by doing it this way.
The value of the goodwill is determined by either discounting or multiplying this adjusted net profit. The eternal problem is what that discount rate, or multiplier, should be. Unfortunately, there is little consensus among sellers, buyers, professional appraisers, Canada Revenue and others. In my opinion, if the practice is relatively new, or one with a minimum or anticipated patient retention where there is not too much room for growth, a times-one multiplier would, probably, be about right. If you are in a very well-established, or group, practice, or if you own the real estate, or are in a long-term low-cost lease, a three, or perhaps even four, times multiplier could be appropriate. All other categories fall somewhere in between. If the residual operating profit is nil, which is common, sorry, but that is what the goodwill portion of your practice is worth – zip.
Total practice value
To obtain total practice value, to the goodwill value is added the in-place value of all tangible assets, the F.F.&E, and the real estate, if the real estate is part of the package.
This procedure produces a value estimate from which to begin negotiating. In the real world, because it is not possible to reconcile every value contributor or detractor, the best of appraisal methods come up short. The results are never exact. And, accountants will tell you that any business or professional practice can have several values, depending on how the seller wishes to extract money. Still, this does not change the fact that a professional practice is only worth what someone will pay for it.
Value estimates are always subject to adjustment by other determinants such as non-competition clauses, a loyal continuing staff, low interest rate seller financing, an earn out, (a.k.a., buy-in – where you remain with the practice during an orderly transition period), etc.
On the negative side, the value is somewhat lessened by excessive competition, pending lease termination – where it is relatively easy to start new – or if the practice is largely built on specialized services that are difficult for the new entrant to continue.
As well, if the market is large, and expanding, competitors will soon be on the doorstep. There is an old axiom; Where capital goes and capital is earned, competitive capital will follow. This applies to chiropractic practices as much as general businesses.
In a nutshell, the valuation considerations are:
- The history of the practice; ie, how long has it been established? In this location? By this same chiropractor(s)? The longer each is, the better.
- The size of the practice; ie is it a single person or a group practice?
- The mixture, or blend, of professional services offered.
- The source(s) of the patients.
- Present competition, and ease of starting a new practice.
- Fees charged when compared to other chiropractic practices ie, are the fees and continued patronage dependent upon any specific groups such as sports teams, managed care facilities, or medical clinics, etc?
- The historical growth of the practice and prospects for further growth; ie, past, present, and anticipated level of earnings.
- The level of staff and partner compensation and/or fee splitting arrangements.
- The reputation of the practice.
- Location considerations, occupancy cost, and remaining lease term.
- The number of persons seeking this type of practice, in this locale.
Despite all of the various methods available for valuating a professional practice, it still comes down to one’s personal judgment, which presumably, is an interpretation of the activities of market sellers, buyers, and at times, financiers. What will sellers accept? What are buyers willing to pay? Will a bank lend sufficient money to buy the practice? What are the tradeoffs between cash and terms? What concessions is either party willing to make? In the final analysis, it is the seller and the buyer working in concert who establish what the practice is worth. The final value, or price, is always based on what is present, the transferable portions, and the level of willingness of each party to negotiate and compromise. •
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