How much is the practice worth?
This question is asked by the Senior OD anxiously. The Junior OD asks the same question with curiosity and confusion. It is a question that business consultants hear routinely but is one of the most difficult to answer.
The simple glib answer is "The practice is worth whatever a motivated buyer is willing to pay an anxious seller!" But arriving at the proper asking price is a complicated procedure. There are many formulas that have been established and by utilizing a combination of them combined with creativity and negotiations, a result can be gotten that will be fair to the Seller and please the Buyer.
The valuation issue is not only important to ODs selling and buying but to those in practice with no interest in selling. Your net worth for estate purposes is linked to the value of your practice. Unusual events could force the need for a rapid sale. A formula should be in place to value your practice annually. This is especially true if there are associate agreements in place with emergency buy out clauses in the partnership or corporate agreements.
The Rule of Thumb Method
This is the traditional system that has been used in the profession based on gross or net income. These systems, although simple, have accuracy problems.
Using the percentage of one year's gross income can be deceptive. A practice may have an impressive annual gross income and yet the net profit is low. This could be due to:
1. A high overhead that may or may not be modified by a more cost conscious new owner.
2. Charging excessive expenses to the practice such as automobile purchases and maintenance, frequent "educational meetings" in exotic locations or taking important referral sources out to dinner at expensive restaurants. A cost conscious new owner could bring many of these expenses under control.
3. Not reporting income by the old technique of "two sets of books". This is of no concern to the Buyer. The Buyer should only pay for income that was declared to the Internal Revenue Service as income.
As you can see this simple gross income method is not so simple.
Using a multiple of net income might be a better approach. This too has problems especially if the net income is higher than would be expected. This could be due to:
1. The Seller owning the property where the office is located but not charging adequate rent for the space used.
2. An office manager spouse who is not being paid a salary commensurate with what an office manager working for the Buyer would receive.
3. The practice being understaffed for modern day practice.
4. No debt burden due to using old instrumentation and no new equipment leases.
It would be necessary for the Buyer to determine a realistic net after evaluating these factors.
Cash Flow Method
Another method, which is a favorite of Accountants and Bankers, is the Cash Flow Method. The value of the practice is the profit left over after the principal ODs receive a salary equal to the going rate of OD salaries in the area, with their skill and experience. This profit could then be used to pay off a long-term bank loan. The amount of the loan would then be the value of the practice. This system too has some inherent flaws:
1. It does not take into account the inventory, the equipment or the quality of the Physical plant.
2. It does not consider the value of long-term transferable lease in a valuable growth area.
3. It does not take into account how the new OD could utilize new skills to build value on to the existing practice.
4. Did the bank consider if the managed care and the co-management sources are transferable to the Buyer?
Which method is best?
A combination of all these approaches must be considered. The very least the practice is worth is the cost to the Buyer of building, equipping, purchasing inventory and training staff. In addition the good will of the patient base with immediate cash flow must be considered as added value.
The ultimate decision from the Buyers vantage point is how comfortable will they feel in the practice and the community. If the fit is right, the Seller should be comfortable with the buyer. An agreed sale price, utilizing funds from the bank in the form of a long-term business loan combined with some short term loans payable to the seller should allow for a successful negotiation.
Other issues impacting price
There are many more issues to discuss such as:
1. Should the Senior OD remain with the practice for a fixed length of time?
2. What sort of restrictive covenant should be placed on the Senior OD to prevent opening a practice in a competitive location?
3. If the Senior OD owns the office building, when should the Buyer be given the option to purchase and at what price?
4. Should the Senior OD sell the practice taking back all the notes over an extended length of time as a retirement vehicle and eliminate the bank as the lender?
5. If a spouse was the office manager should the spouse remain employed for continuity?
6. Should the pay out to the Senior OD, be made as a consultant's fee to allow for a business deduction?
These are just a few of the additional questions I have posed that may be discussed in the Forums. The odwire.org community has valuable opinions and experiences. In addition we have experts in many of the areas, if questions arise. I look forward to your comments.