The missing link to fast, accurate, and affordable professional practice valuations.
- Blog -
Your practice closed for Covid-19… is your practice worth less?
Board certified business appraisers begin the process of valuation by reviewing the income producing ability of the practice. One advantage of small businesses are the “perks” of expensing optional and allowed items to minimize profits. Each owner personalizes these options upon their personal preference and their accountant’s advice.
The appraisal standard that guarantees uniformity is a process called normalization or recasting of the income statement. This is necessary because there are extra-ordinary and/or one-time expenses that must be considered. The evaluation process normalizes these items to get an accurate representation of the practice’s true cash flow. Examples are: 1) Legal fees from lawsuits; 2) Accounting fees from audits; 3) If office real estate is personally owned, paying an above market rent to yourself; 4) Paying yourself a below market salary and taking draws against profits for the balance to minimize FICA taxes.
These examples pale in comparison to the devastation of closing your practice for Convid-19 but there’s precedent for normalization. Every city unintentionally closes businesses from roadway summer construction. Professional practices, retail stores, restaurants are affected from the difficulty of getting to the business. Some are effectively closed for weeks.
There are acceptable normalization techniques to use for Convid-19 shut-downs. 1) If the practice is down 4-8 weeks, an add-back proportionate to lost business revenues will be made to the NOI. 2) If the practice is shut-down for more than two months, the preceding year’s income statement should be normalized and all the value weight be given to it. Assuming year to year performance consistency, there should be no value penalty due to Convid-19 closures.
Therefore, there is no reason to wait to list and sell your practice. Just make sure the appraiser of your practice is aware of and uses these techniques.
Ted See, President, The TASCON Group
You’ve Worked your Whole Life Building the Value of Your Practice…
It’s time to retire, don’t bet the value of your life’s work on multipliers or rules of thumb. Some believe business valuation an art and multipliers and rules of thumb are adequate methods to value your practice. The multiplier, a value nobody can quantify, is multiplied against some arbitrary value such as gross sales, gross profit, adjusted net profits, etc. A small variance in the multiplier can cost you $100,000 or more.
Here’s how to avoid it. Most dental practices are worth more than the market value of their assets. Banks usually won’t lend the difference between the selling price and down payment and/or the buyer needs additional down payment. Therefore, to maximize the value, the dentist holds some of the paper from the purchase price. A practice is worth: 1) That price at which it must pay the debt, at market conditions, structured from the sale. 2) It must pay the owner a fair market salary. 3) It must pay the owner a return on investment. At any "snapshot" in time, mathematically there is only one value that can simultaneously meet all three criteria.
Remember, a buyer wants to know that he/she will be paid appropriately and also receive an appropriate return on investment. Since the dentist will be holding part of the debt, it is critical that debt be considered as part of the valuation process. These three criteria are the key issues determined in future due-diligence reviews by the buyer and seller. Having this information up-front saves professional fees, time and deals.
The only methodology that considers these three criteria is called the ‘Optimism” method. It optimizes the value for a win-win to both the buyer and seller. Insist upon it!
Ted See, President, The TASCON Group
Learn the basics of the professional practice valuation process!
- Ten Minute Read -
Hi, I’m Ted See, the president of The TASCON Group and the author of two business valuation books. Today I am going to give you an overview of the business valuation process and how it applies to your practice so you can make an informed decision concerning your choice of a valuation provider.
Confusion and misunderstanding seem to surround business valuation more than virtually any other business topic. Everyone seems to have a different multiplier or rule-of-thumb to value your practice. You have worked your whole life growing your practice. Now that it is time to exit from yours or buy one, why risk it on a crapshoot? The need to accurately price your practice is paramount to successful acquisitions, divestitures, and exit strategies.
All of us who are certified in business valuation are required to work to the same industry standards. Beware of others who are not certified as there is no national requirement to be so. As a licensed business appraiser, we are required to consider all of the 10 to 15 (some say more) conventional valuation methodologies for each appraisal. These valuation methodologies include market approaches, asset approaches, and income approaches. Income approaches are considered the most accurate. Let’s compare them.
Market approaches are similar in concept to the Competitive Market Analysis (CMA) that is provided by your real estate agent when you sell your home. The real estate industry has done an accurate job of tracking the sale of homes, their price, location, size, and the details of each home. Having this information, a CMA is accurate and meaningful in the marketing of your home. Unfortunately, this is not the case with businesses. Efforts have been made to try and track the sale of businesses to replicate the real estate industry’s success but to no avail. The sale of a business is a private transaction and the information is just not available.
There are three primary asset approach methods. The liquidated value method, the book value method, and the adjusted book value method.
The liquidated value method is used only for business in distress. This method estimates the liquidated value of the assets on a “forced sale” bases where the values are less than the fair market value of the assets and subtracts the liabilities. This method is not appropriate for a successful practice due to the risk of understating it value as a going concern.
The book value method is calculated by subtracting your practice’s total liabilities from its total assets as listed on the balance sheet. The value of the assets may have been reduced faster than the true economic loss of their fair market value. Therefore, the book value of a business is not used because it does not consider the income-producing ability of the assets to produce a fair market value of the practice as a going concern.
The adjusted book value method adjusts the book value of your practice’s assets to their estimated fair market values and subtracts the liabilities. If the adjusted book value is worth more than the fair market value of the practice, it would be better to sell the assets outright, not the practice as a going concern. Therefore, your practice is never worth less than its adjusted book value. This method is usually rejected because its adjusted book value is not an indicator of the income-producing ability of the assemblage of all of the assets.
There are numerous income methods. The two that are primarily used are the Discounted Cash Flow method and the Capitalization of earnings methods. Historically, income approaches carry the most weight and the capitalization methods used the most frequently.
The Discounted Cash Flow method is based on an estimate of the future net income your practice is expected to generate in the future. Sales and expense projections are made from 5 out to 10 years in the future. A present value is subjectively determined and the future estimated income stream is discounted back to a present value. Due to the subjectivity of making income, expense, and present value projections out for such a long period, this method is rarely used to value professional practices.
The Capitalization of Earnings methods (Cap rates), is also known as “multiples of value” and are the most frequently used to value a professional practice. There are many methods in this category including those developed by the IRS to compensate brewers and distillers for their businesses during prohibition. Although there are many different methods, they are all similar in that the business’ annual income stream is normalized to adjust it for extra-ordinary income and expenses. The resulting value is multiplied by a capitalization rate multiplier. Unfortunately, should the subjectively of calculating the cap rate varies by only one half of one percent, it could under-state or over-state the practice’s value by $100,000 or more.
Since all of these methodologies are considered to be relatively inaccurate when used individually, the appraiser is to select the most appropriate methods that he/she thinks will most accurately represent the size, type, and market location of the subject practice. Ultimately, five to seven methodologies are used in a valuation.
The resulting value of each method is subjectively weighted, and the weighted average result determines the final opinion of value. Unfortunately, weighting the results of individual methods that are individually considered inaccurate, doesn’t make the weighted values any more accurate. For this reason, the appraiser is supposed to perform a “sanity check” or “test of reasonableness” to assure that the final opinion of value makes sense. Unfortunately, most evaluators skip this step and you are left with a weighted average or range of values for your practice that can’t be quantified and can only be negotiated during the buy/sell process.
What sets The TASCON Group apart from other valuation companies is that every effort is made to provide our valuation clients with an accurate and quantifiable valuation result. In 1989 we developed a proprietary software platform known as The TASCON® Business Analyst that perfected the “test of reasonableness” to become what the industry now calls the “Optimization” method. It is considered the most accurate and quantifiable valuation method in the industry today.
It is based on the fact that a fair market transaction must be a “win-win” for all parties. It uses only non-subjective, third-party data and is based on the fact that a business is worth that price at which:
1. It must be able to pay the structured debt that the sale creates at market terms and conditions.
2. It must pay a fair market salary to the owner, commensurate with the size, type, and location of the business and
3. It must pay the owner a fair return on their investment, commensurate with the risk of a similar business.
In any market, at any snapshot in time, there is only one mathematical value at which a business can simultaneously meet these three criteria. All valuations performed by The TASCON
Group are performed to these standards and are therefore quantifiable.
Our valuation reports give you more than others can provide. Besides an accurate and quantifiable result, our report also provides you with the important information needed to get deals done quickly. Since a business’s value is different from its stock value, our report includes a stock/equity valuation for tax purposes and partnership deals. Also included is an estimate of the seller’s post-sale proceeds for tax and other planning purposes. Since a buyer wants to know what their annual salary will be should they purchase the practice at the fair market value, also included is an estimate of the buyer’s income both during and after the payment of debt service. All of these items would require additional time and fees to determine and having these answers upfront speeds up the sales process.
The efficiencies of our proprietary software allow us to perform “the test of reasonableness” upfront and eliminates the time and your expense that would be needed for us to perform the calculations for the many methodologies that we already know are inaccurate and wouldn’t be used.
I invite you to see for yourself that our valuation report is everything we say it is and more. Just select “Download a Free Sample Valuation Report” below.
CALL US WITH YOUR QUESTIONS OR SELECT THE “ORDER NOW” LINK BELOW TO GET STARTED!
How to Prepare Your Practice for Sale
If you are planning on selling your practice in a year or so, please consider the following to minimize negotiations and to maximize your selling price. Appraisers certified in business valuation all work to the same standards. The most accurate business valuations use the income producing ability of the practice as the base standard. One advantage of owning a business is the owner’s ability to legally reduce their tax liability by using the “perks” afforded the owner of expensing optional and allowed items to minimize their profits. Each owner personalizes these options upon their personal preference and their accountant’s advice.
The appraisal standard that guarantees uniformity is a process called normalization or recasting of the income statement. This is necessary because there are extra-ordinary and/or one-time expenses that must be considered. The evaluation process normalizes these items to get an accurate representation of the practice’s true cash flow. Examples are: 1) Legal fees from lawsuits; 2) Accounting fees from audits; 3) If office real estate is personally owned, paying an above market rent to yourself; 4) Paying yourself a below market salary and taking draws against profits for the balance to minimize FICA taxes; 5) Paying a spouse an above market salary for services that can be replaced in the market for a lower cost. To name a few of the most typical.
However, although these adjustments are allowed and proper, there is a disadvantage to using all of these “add backs” in a valuation. Although you feel your practice’s appraisal is an accurate representation of its true market value, the single thing you can do to minimize the process of giving potential buyers the ability of negotiating the price is to minimize the perks until the practice is sold. This will eliminate or certainly minimize those things that a potential buyer can reference and challenge during the negotiation process.
As an example, defending extra-ordinary legal fees, or an accounting audit can easily be defended. Unfortunately defending paying a spouse more than a market salary or reducing rent to a market standard is much more difficult. After all, the buyer and spouse would also like to get the higher salary, or if they become the building owner as part of the sale, they will also want to pay themselves more rent.
Ted See, President, The TASCON Group