Building value as you build your practice (Proceedings)
The valuation of a veterinary practice reveals a telling story about the practice and its owners and staff. It is evidence of the practice's ability to pay bills, retain staff and clients, and invest in the future. It is also management's report card and a forewarning of the owners' future financial security.
Practice valuations are mandatory when planning for financial security, buying or selling a complete interest or a partial interest in a practice, writing buy/sell agreements, estate planning, bank financing, mergers, divorce, or for litigation for damages (for example, condemnation, breech of contract, lost profits, etc.).
With so much riding on the outcome, it's alarming to see how many owners have never had their practice valued. If these owners had a similar investment in, for example, AT&T or Microsoft, they would be checking the value of their investment every day! It's time to face the facts – a practice's value is not equal to one year's revenue; and, a practice's existence is, in itself, no assurance of value. So, let's look at how veterinary practices are valued in today's market and what you can do to control the final outcome.Determining Value
The most common method used to value a veterinary practice is the excess earnings method. It has carried a variety of descriptive names over the years, but the basics of the formula are the same. The principal components of value are net assets and goodwill. Other methods are available, (for example, the discounted future returns and capitalization of earnings methods) but they are not often used because of disadvantages inherent with each.
Net assets include working capital assets such as cash, accounts receivable, and drugs, hospital, and retail supplies. Values for these assets are usually first obtained from the practice's Statement of Financial Position prepared on the accrual basis. Then, each asset is adjusted from its stated book value to its appraised fair market value. For example, accounts receivable are adjusted to reflect only the value of the collectible accounts. Working capital assets are reduced by working capital debt such as accounts payable, payroll taxes payable, sales tax payable, and retirement contributions payable.
Net assets also include the practice's tangible assets such as office supplies, office furniture, and medical and office equipment. The practice land and building is included only if the practice owns these assets. Tangible assets are valued at current market value, the price a buyer would pay given each item's age and condition. Market value can be determined in one of three ways:
If real estate is to be valued, obtain an independent appraisal from a qualified appraiser experienced in valuing special use facilities. After all assets have been valued, all purchase debts such as notes, leases, and mortgages payable are listed and subtracted from the asset total to arrive at net asset value.
The intangible asset value, or goodwill, is the value placed on the practice's earnings from operations. To determine the goodwill value, the earnings generated from the normal, ongoing operations of the practice must first be calculated. This calculation begins with practice income as reported on practice tax returns for the prior three years. (Less than three years may be included if major changes have occurred such as the construction of a new facility, the addition of a second practice, severe weather damage, etc.)
Then, practice income is adjusted to reflect the normal operations of the practice. Adjustments are made for: 1) income and expenses that are on the tax return that are excluded from the calculation of value, such as interest expense and the gain on sale of equipment; 2) expenses that are not on the tax return that are included in the calculation of value such as nondeductible entertainment expense; 3) non-recurring expenses, such as those associated with flood damage, litigation, relocation, etc.; and, 4) an increase or decrease in rent expense to reflect the true rental value of the land and building.