One of the first considerations is to know why you want to sell a part-interest, thus forming what will probably be a partnership of some type, and why the associate wants to buy in. Whatever they may be, the objectives of both will affect the price paid and received but not the value. Value is what something is worth to an average willing buyer acquiring the practice or asset from an average willing seller. Price is what a specific buyer will pay and what a specific seller will accept. Price is affected by individual seller-buyer motives – value is not.
The value of a professional practice, including a chiropractic one, is the summation of the value of the real estate, if owned, or the leasehold interest, if not; the in-place value of the capital assets of furniture, fixtures and equipment; the working capital; and finally the goodwill. Determining the value of the first four inputs and distributing those values between seller and buyer is seldom problematic. It’s the goodwill value that creates the difficulty.
Probably the best definition of goodwill comes from an old English law care when in 1910 Lord Eldon said: “Goodwill is nothing more than the probability that the same customers will continue to patronize the same shop.” In a chiropractic practice, this can be narrowed down to the present value of returning patients and the potential to acquire new ones.
Before attempting to pro-rate the value of the goodwill between the selling senior and buying associate, the following are to be taken into consideration:
- If the associate left the practice what would he/she take along?
- If the associate left the practice, what would be lost by the senior chiropractor?
- Has the associate received fair compensation or was (s)he being subsidized by the senior?
- Was (s)he subsidized during his/her early years, but is not now?
- If there were excess earnings by the associate, were they created by low take-home pay by the senior?
- Was the associate properly rewarded for his/her contribution? What is the associate’s contribution worth in relation to the value of the entire practice? How is that contribution valued? Was the associate underpaid, or perhaps overpaid, to ensure that (s)he remained with the practice?
- Does the associate consider him/herself as indispensable, that is, the practice would suffer materially if he/she left?
- Has the associate generated new patients or relied on the senior to bring them in?
- Has the associate created a measurable value to the practice that is realizable on the market?
- What incentives were used to attract this chiropractor to your practice?
- Have you considered the basics for exit by either party? Few of these arrangements last indefinitely.
- Has the fact that you cannot subdivide the value of the goodwill from the remainder of the practice been considered? That is, you cannot sell the goodwill to one party and the tangible assets to another.
- Was the possibility of a future buy-in given any consideration when the associate was first hired?
- How will the associate’s purchase be paid for? Is seller financing a consideration? Is the price adjusted because of it?
- What percentage is the associate acquiring? What are the options for the associate to acquire the remainder?
SUBDIVIDING THE GOODWILL
In professional practices, there are two distinct types of goodwill: first, personal or professional, and second, practice goodwill. Personal or “professional goodwill” is attributable to the person who created it and is what the U.S. courts classify as “Non Realizable.” That is to say, it cannot be sold, traded or encumbered. It is exclusive to the professional who created it. If that person leaves the practice, it leaves too.
The second type, “practice goodwill,” is what the same courts define as “Realizable Goodwill.” It is part and parcel of the entire practice – it is not attributable to any one person or value generator, but was created by the blending of several influences. If the practice is sold, provided that it goes with the package, and although not separable therefrom, it has a marketable value if it is transferable to a buyer. However, there is no proven formula or template by which subdivisions of this form of goodwill into its various contributions or ownerships can be determined.
The Associate’s Position
The normal custom in the sale of a fractional interest in a professional practice is that the realizable goodwill is the sole property of the seller. (S)he will want full value for it while the buyer may expect a discount based on the fact that (s)he has materially contributed to the viability and present market value of the practice. The pitch goes, “It would be worth substantially less without my contribution and as I created part of it, a portion of the goodwill value should be deducted from the practice’s purchase price. The position of the seller is that (s)he doesn’t want to lose the associate, or the sale, but is not Santa Claus. This then raises the question: does the associate have a valid argument?
Division of Expenses
That the associate generated, say 40 per cent of the gross revenue to the practice does not mean that (s)he also contributed 40 per cent to the after-tax net profit. Irrespective of billing differences, each participant consumed an equal amount of the fixed expenses of rent, taxes, property insurance, etc. Thus the fixed expenses are divided 50-50 between the senior and the associate. Variable expenses are based on the percentage of the billings or gross income generated by each chiropractor as (s)he who bills more also consumes more. The division of the goodwill estimate between the chiropractors would be the percentage of the net profit that each contributed to it.
However, as mentioned, there is no formula or template by which the respective value of each contribution to the goodwill can be calculated. Attempts were made by this writer to do this mathematically, but on each occasion no defendable answer was produced. The only conclusion that can be drawn is that the realizable goodwill of the practice must be attached to it as a single entity. It is an integral part of the value of the practice as a whole and it cannot be segregated into identifiable portions that can be individually valued.
It all boils down to the fact that all professional practices must be sold as working units in place, that is, with all value-contributing components working together in a harmonious relationship. That one claims that because of past labours and dedication (s)he owns a certain percentage of the goodwill does not imply that this person can extract it. It all belongs to the firm, which in the case of a one-person owned chiropractic practice, is the senior chiropractor. That the seller may juggle selling price on account of the associate’s contribution to the goodwill is a question of personal proclivity. It is not a fact of the market.