What is your practice worth? What will someone who meets those criteria pay for it, and what you are prepared to accept?
What’s There For The Buyer?
The most difficult part of the valuation process is that unbiased determination of what is
offered for sale. We say unbiased, because undoubtedly you have a sentimental attachment built up over the years, extensive patient records, an enviable reputation, oodles of equipment in new condition, and perhaps, an excellent location, which you know has a high value that will be recognized by all prospective purchasers. Regrettably, it will not. Your practice is not the jewel to another that it is to you. Most times, value to the owner, is greater than what the market will bear. You cannot sell your expertise, your touch, or your passion. Thus, you must ascertain what you have to sell and then determine a market value for it. The most common valuation methods are; (1) The Market Comparison Approach, and (2) The Excess Earnings Method.
Each procedure has shortcomings and due to the many variances and contingencies involved with the appraisal of professional practices, all that anyone, including a professional appraiser, can do is provide his or her best estimate.
Using a Professional Appraiser
The question whether to employ a professional appraiser to determine that market value always arises. If you have a well-established practice with high billings, the latest in equipment, and an extensive patient roster, all transferable to a buyer, or if you anticipate problems with the Canada Revenue Agency, the answer is “yes”. If you possess a small, declining practice, the cost may not produce the wanted benefits. Although a professional appraisal will provide a credible value estimate, this does not guarantee you will sell your practice for the appraised value, or sell it at all. As appraisals can be expensive, it’s your call. If hiring a professional, be certain this person is qualified to value professional practices. Not all are, including some who claim expertise. Check their credentials and references. There is a world of difference between appraising a chiropractic clinic and a restaurant.
The Market Comparison Approach
This approach estimates market value by comparing the subject with several other chiropractic practices that have recently sold, or are for sale, analyzing them and making price adjustments for differences in annual billings, operating profit, tangible assets, goodwill, and other value contributors.
This brings up two problems; first, accurately determining the prices obtained for sold practices, and second, determining how that price was established, often an impossible task. Only professional practice brokers and appraisers are privy to this information and only then, if they were involved in the sale, have a good clientele base, or can lean on other brokers and appraisers for reliable data.
In my opinion, the concept of using the prices obtained by others as a benchmark for establishing your practice’s value is wishy-washy. There are too many contingencies and subjective motives. Frequently, attempting to make whole dollar or percentage adjustments in an attempt to rationalize the differences from one practice to another is guesswork. The advertisements for practices for sale offer little assistance.
The Excess Earnings Method
The Excess Earnings Method estimates a value for the tangible assets, usually limited to the real estate (if owned), the furniture, fixtures and equipment, and adding thereto a value for the goodwill, which includes most everything else.
Other than the capital assets, and perhaps a leasehold advantage, all professional practices, including chiropractic, have a measure of what we will classify as “goodwill”. This includes patient lists. Although there are several definitions for this goodwill, the best definition comes from an English law case when in 1910 Lord Eldon said, “Goodwill is nothing more than the probability that the same patrons will continue to patronize the same shop.” This is all that goodwill really is. This is what you have to sell, the probability, not the certainty. Although there is substantial overlap, and some discussions could fit into any, for this purpose, there are three distinct categories of goodwill. They are “Personal Goodwill”, “Goodwill of Establishment” and “ Goodwill of Location.”
Personal Goodwill is exclusive to the practitioner. It was built up over the years by the dedication and perseverance of the individual professional. Goodwill of Establishment, also known as Business Goodwill and Goodwill of Location lie with the practice itself. The value of goodwill is predicated by its unencumbered transferability. If another cannot assume and capitalize on it, the goodwill portion of your practice has a value of zero dollars.
Because it is not transferable, in any professional practice, there is no goodwill that can be considered as personal to the seller. Once you go out the door for the last time any goodwill built up because of your ability, techniques, personality, or procedures, goes out as well. Earlier, we said you could not sell your expertise. However, a successful practice is largely a trust relationship between the chiropractor and his/her patients, and that trust may be, in part, transferable. You have substantial training and expertise. A fair assumption is that no one will buy you out unless he or she also has substantial chiropractic education, training and expertise, which ensures a measure of continuity. From this perspective it is the trust, not the individual, that has a modicum of transferability, hence value. In starting from scratch a chiropractor must build trust from the ground up, often a longer procedure.
Goodwill of Establishment
Goodwill of Establishment is a measure of durability. The longer the practice has been established, the more regular and devoted the patients and the greater the number expected to return, the greater its value. We are back to Lord Eldon, the probability that the same patients will come back no matter who is in charge. This suggests that patient files have a value in and of themselves. However, to assign a specific value to a collection of historical records, many of which will be dated, contain names of cured patients, have died, relocated, or now treated by another, is little other than pure speculation. The measure of value is probable patient retention and the expectation of income to be gleaned from the files. Although formulas exist to calculate the value of past patient files, in my opinion, none are workable and as such no specific value should be attached to this intangible asset.
Goodwill of Location
To value Goodwill of Location, your professional practice must be considered as a service business, which can be location-dependent or location-independent. A location- dependent business is one where its customers are within easy walking or driving distance. It cannot simply be moved across town without having to start fresh elsewhere. Location-independent would describe most professional practices and, many personal service businesses. As their clients and customers seek them out it is unimportant if these are located in this particular building, or on this avenue, or elsewhere. There is no goodwill of location.
Is a chiropractic practice location-dependent or location-independent? It depends on the origination of the patient base and how many patients would be lost were that location no longer available. If very few, any value for the practice must be for reasons other than having a favourable location. The value that can be attributed to a location-dependent practice is based on the patients that this specific location attracts and the remaining term of the lease. If you have a busy, profitable, practice and there are ten years remaining on a low cost lease; if all are assumable, the practice is worth a lot of money. However, that value declines if there is a question of continuing in this location or the lessor has escape clauses that can almost overnight terminate your occupancy. If the lease term is short and the rent high, the location-dependency of the practice adds nothing.
In short, value equals tangible assets plus goodwill.
*Canadian Chiropractor would like to thank Dr. C. Naylor, DC, for writing us to suggest this topic.
Part 2 of this article will be a demonstration of how to calculate the going concern value of your chiropractic practice.