There are numerous reasons why a business valuation may need to be undertaken. Some of these are dispute resolution, matrimonial breakdowns and corporate reorganizations. Due to the demographics of society currently, with the aging of the baby boomers, a more prevalent reason is for the sale or purchase of a practice and succession planning.
When performing a business valuation in a Professional Practice, the professional valuator looks at a number of different factors that drive the cash flow of the business, its transferability and its underlying asset value. The asset value may include intangible assets, such as patient lists and geographic location, as well as the more obvious tangible assets, such as equipment. The value of the practice in excess of the tangible and identified intangible assets is attributed to goodwill. The goodwill can then be determined to be commercial or personal in nature. Personal goodwill may be attached to the practitioner, and as a result, would not be transferable. If this were the case, it would be excluded from the value of the practice.
An example of this would be a general medical practice. Since demand for family doctors is currently so great, a new physician could open up a new location and draw in new patients relatively easily. As a result, it is unlikely that the selling family doctor could charge a goodwill amount for the patient list.
There are three main valuation methodologies which the professional valuator uses in determining the worth of a practice. We will look at each of these individually.
The first are asset-based approaches, which calculates the value of the assets less the liabilities. This is done on either a going concern or liquidation basis. If the practice has the ability to continue operations, a going concern approach is used, but if the practice is in distress, a liquidation approach is implemented. This could occur if the practitioner suffered a sudden illness and the practice suffered irreparably as a result. For this reason, it is important to have a plan in place for such an event to still receive value for the practice. Under a liquidation approach, further deductions to the value of the business are made for costs such as legal fees, broker fees and taxes.
An income based approach can incorporate a number of different methodologies. Those used will depend upon the situation surrounding the practice being valued. In the case of a growing or declining practice that is experiencing fluctuating cash flow from year to year, a discounted cash flow approach will likely be used. This is done as there are not stable cash flows to which you can apply a fixed multiple, so the projected cash flow of the practice is discounted to its present value to determine the total worth of the practice at the valuation date.
If the practice has had stable earnings that are expected to continue into the future, a capitalization of earnings, cash flows or earnings before interest, taxes, depreciation and amortization (EBITDA) may be employed. The multiple applied will vary based on certain factors such as industry, geographic region or other practice specific factors. Generally, if there is less risk and/or a greater potential for growth, there will be a higher multiple applied.
The market based approach is used to determine the reasonability of the valuation arrived at under the other approaches. We keep a database of transactions we have been involved in, as publicly available information is hard to come by and will generally be for public practices and different geographic regions.
If you have further questions regarding business valuations, please feel free to contact a member of the DJB’s Professionals Specialty Group.
Article writen by: Corey Miles, CPA, CA, CBV