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When Should You Value Your Practice?
We have seen an increasing number of deferred transitions over the last several years. Whether you are recruiting an associate to become a partner or want to find a candidate to purchase your practice in one to two years, the question always asked by the Associate or Owner is “When does the practice get valued?”
For many associates who intend to make a financial commitment, they need to know what their potential investment might be. Therefore, determining a value at the outset or within the first year of employment is not unreasonable. We’ve often heard complaints from associates who have worked at a practice for several years who are offered a partnership opportunity, but at what price? If no valuation had been prepared at the outset, does the associate want his/her contributed production to be included in the valuation calculations? The answer is a resounding NO! If you want to value your practice prior to a partnership formation or deferred sale and the price is too high in the associate’s mind, they might walk away! Therefore, in order to avoid this problem and to prevent delay in achieving your transition plans, we recommend establishing a baseline early in the relationship, usually within the first year of employment.
Since many owners offer guaranteed salaries for the first three to six months of employment, it is fair to wait for the completion of the first year to conduct this baseline valuation. If you do the math, most valuations include a three-to-four year historical average, so the inclusion of the associate’s first-year collections should not skew the numbers too much for them. By establishing a baseline valuation when it is time for the partnership or sale to commence, you must update the numbers to reflect current economic conditions as well as any additional assets that might have been purchased during the Associate’s employment phase.
Using this approach minimizes any disincentive for your associate to work hard and help your practice grow without being penalized for their efforts. In our experience, if done properly, associate profit margins should be 30% to 35%. If not, there is something wrong with your economic equation. Perhaps overhead is too high or there aren’t enough patients to share. Good economics assure that the owner receives a good profit margin during this employment phase.
We recommend a baseline valuation for solo practitioners who plan to offer their associate a partnership opportunity within a two to three year period after the associate joins the practice.
There is one major exception to this rule. In situations where the owner feels that hiring a Management Consultant at the outset will not only enhance the success of the associate’s integration into the practice, but also increase the potential for the practice to grow, the valuation for buy in or sale should precede the event. The rationale here is simple. If the owner invests from $25,000 to $40,000 for a reputable consultant to improve the practice’s gross revenue, increase new patient flow, fix patient retention, and increase profitability, the new partner or owner will benefit from these changes and be buying into or purchasing a stronger asset! In fact, we have seen instances where the associate’s ability to earn income is enhanced during the employment phase. So everyone wins!
At the time of partnership formation, the valuation is updated in the following way:
As we have discussed in prior articles, all practice valuations consist of two classes of assets—Tangible Assets and Intangible Assets. Intangible Assets include goodwill, restrictive covenant, telephone numbers, namely all things you can’t see, feel, or touch. Tangible Assets include dental equipment, supplies, instruments, sometimes leasehold improvements, and technology. Once the baseline valuation is determined, you can segregate the value into these two asset categories. From our database, we have found that Intangible Assets values, on average, are about 76% of a practice’s value; the remaining 24% represent Tangible Assets. When it’s time to update your valuation, you’ll adjust the Intangible Assets by the CPI over the period of time from the baseline valuation to the current period. For example, if the buy in occurred in 2009, and the baseline valuation was prepared in 2007, adjust the former value of the Intangible Asset Value by referring to the Bureau of Labor Statistics, “Inflation Calculator” to update that number. Tangible Assets are then reappraised to take into account the additional “wear and tear” that has occurred. We assumed some new equipment or technology was purchased during this period, so you add these assets to the mix. Here are examples of how the calculations might work:
Updating Your Valuation
Practice Value 2007
$600,000
Intangible Assets Value (IAV)
$456,000
Tangible Assets Value (TA)
$144,000
Re-Value in 2009
IAV BLS Inflation Calculator
$471,800
Reappraise TA
150,000
Updated Value
$621,800
Summary
In this case, with the various adjustments made to both asset classes, the revised value would be $621,800. This way, by setting a baseline value, you demonstrate that you are trying to create a “win/win” situation for your partner.
Establishing a baseline valuation lets your potential partner or purchaser know you want things to be fair. In my many years of transition consulting, the root cause of most partnership failures has been over money. So start your relationship the right way by putting your economic cards on the table and create a win-win relationship.
Dr. Tom Snyder, consultant, lecturer, and author has consulted with dental practices nationwide in creating “win-win” practice transitions. He is the Director of The Snyder Group, a division of Henry Schein. Dr. Snyder is a graduate of the University of Pennsylvania School of Dental Medicine and has an MBA from the Wharton School of Business of the University of Pennsylvania. His practical approach to the complex and personalized area of dental practice transitions has been well received.