Anyone who owns a professional services practice sometimes wonders what their business is worth. They may have a specific reason, such as a prospective merger or acquisition, near-term retirement plans, estate and gift tax planning, or pending litigation.
Often, practice owners think they know their practice’s value because they have used a rule-of-thumb method. Rules of thumb may state that a business’s value is “x times revenue” or “x times cash flow.” These methods may be good for a ballpark estimate of value, but they omit a major factor: future worth.
Formal business valuations
Having a current valuation for your practice allows you to be better prepared for the unexpected, such as a partner’s departure due to a sudden illness.
Often, when you are approached by a buyer, the offer is based on a rule-of-thumb valuation. But that number can be $1 million or more less than the practice’s actual value. That is a lot of money to leave on the table, especially if your practice is the biggest asset in your portfolio.
A formal business valuation uses best practices to establish a value for your practice. It includes tangible and intangible information such as gross income, net income, fee schedule, number of patients, types of insurance accepted (if any), number of new patients each month, location and goodwill.
At least one of these three generally accepted valuation approaches is used to calculate a practice’s value:
- Asset (or cost) approach. The asset or cost approach derives value from the combined fair market value (FMV) of the business’s net assets. However, this method relies on historical costs.
- Fair market value (FMV) approach. This approach uses sales of comparable assets to determine a practice’s value. Each comparable transaction is further analyzed to develop pricing multiples (e.g., net income or operating cash flow) and further adjusted for discretionary items, such as expenses paid to the business’s owners.
- Income approach. The income approach converts future expected economic benefits (e.g., cash flow) into a present value. Adjustments are made for discretionary expenses, nonrecurring revenue and expenses, unusual tax issues or accounting methods, and differences in capital structure.
Part of the valuation process is an assessment of the risks the practice is facing. Risks might include use of obsolete technology, nearby competition, impending changes in insurance reimbursements, potential changes in business structure (e.g., taking on a partner), and the strength of goodwill toward the practice.
Having a formal valuation gives you negotiating power
Medical practices look very different today than they did just two years ago. Most dramatically, the use of telemedicine and similar technologies have accelerated. Whether the business owner has invested in the necessary technology may affect the value of the practice. In addition, hospitals continue to buy practices, which makes staying independent more expensive in certain practice areas.
No one knows what the future holds. But having a true valuation for your business allows you to understand what improvements would increase its value and puts you in a better position to negotiate should the unexpected happen.
Call Edwards, Ellis & Associates to schedule a professional consultation.
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