Get a clear picture of practice value

Get a clear picture of practice value

Practice valuations keep you from inflating or underestimating the value of your practice—a key investment in your portfolio
Mar 01, 2005

Cynthia R. Wutchiett, CPA
I first met Dr. Barry, the owner of an ambulatory practice in Virginia, in 1998 at a management conference hosted by the American Association of Equine Practitioners, where I was speaking on valuation and transition issues. Over the course of the next year, I found that Dr. Barry, while receptive to changes in his fee schedule, inventory management, and staff and associate compensation levels, couldn't understand why another veterinarian would pay good money to buy his practice when he retires in 2008.

After I explained the two main factors that determine whether or not a practice has value to a successor owner—the owner's return on investment (ROI) and the transferability of that ROI—Dr. Barry became more receptive to this idea. We even came up with some ways to improve his practice's value, so he could watch his investment grow. Here's what we looked at to determine Dr. Barry's practice value, how we could improve it, and how it could prosper with its next owner.

The ROI The compensation you receive for the risk you take in owning a practice is your ROI, otherwise known as the earnings remaining after you pay operating expenses, including fair market compensation to owners and associates for their veterinary and management services. As a working owner, you may be compensated quite well for your services. But if there's no investment return left after the bills are paid, a potential buyer may decide to invest in another practice.

In the valuation of a veterinary practice, the owner's ROI, or expected earnings, is the primary component of goodwill value. And goodwill typically represents 70 percent to 80 percent of a practice's total value. So expected earnings are critical to anyone who is buying or selling a practice.

To calculate expected earnings and goodwill value, start with taxable income for the prior three years. Then make adjustments for:
  • Income or expenses listed on the tax return that aren't included in the earnings calculation such as the gain on equipment sales and local income taxes
  • Nonrecurring expenses such as repairs due to natural disasters, employee theft, and litigation costs
  • Expenses not listed on the tax return that we include in the calculation of profit such as nondeductible entertainment expenses and owners' health insurance premiums
  • Rent expense, if the amount paid isn't the fair market rent
  • Underspending on facility repairs and maintenance, continuing education for all team members, and the true cost of services provided by the owner or the owner's family at little or no cost to the practice
  • Economic depreciation as a cost of maintaining the current level of investment in medical and office technology and equipment
  • Veterinary pay and owner-level management pay, if current compensation doesn't reflect the fair market value of the services provided.

The adjustments for the fair market value of veterinary and management services are two of the most critical. A potential buyer will want to know what it would cost him or her to provide the same medical and management services you offer. So we don't count bodies or even full-time equivalents. Instead, we look at the total dollar value of medical services provided at the doctor level and determine the fair market cost for providing these services.