How to Do a Practice Valuation

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By Janice Mignogna
Consultant Director
Irving Bennett Business and Practice Management Center
Pennsylvania College of Optometry
and Harry Kaplan, OD, FAAO

There is no magic formula for arriving at an equitable sale price, however, there are two widely used formulas for determining the value of a practice. Often, the two different approaches are averaged together and used as a starting point to begin negotiations.

Evaluation Method #1 (Minimum Value)

100 to 120 percent of the weighted average net income of last three years, plus all assets, (may or may not include a percentage of accounts receivable)

1. 100 to 120 percent Value of the Weighted Average of the Last Three Years of Net Income. The Weighted Average is the oldest or first year’s net multiplied by one; the second year’s net multiplied by two, and the most current or last year’s net multiplied by three. The final average is the total of these three years divided by six to give additional weight to the increasing or decreasing net of the practice.

2. Plus the market value of all assets, which includes professional, office and laboratory equipment, office furnishings, leasehold improvements, supplies, inventory, etc. Also included is the present wholesale valueof all current and up-to-date frames, contact lenses and spectacle lenses.

3. Accounts Receivable may or may not be included. They could be evaluated at 40 to 70 percent for private paying patients, depending on age of accounts and 80% of all third party billing that has already been submitted for payment. Another option is that the collections of all receivables for 180 days would be turned over to seller with a 10% to 15% charge of actual collections for the billing, tracking, office overhead, etc. Having the seller keep the entire Accounts Receivable and collected by the buyer is the simplest and easiest method of handling this item.

Evaluation Method #2 (Maximum Value)

50 to 70 percent of the weighted average gross of the last three years, which includes all physical assets, equipment, and inventory.

This method assigns a greater value to Goodwill and varies from 50 to 70 percent of the average weighted gross (similar to average weighted net method described in Evaluation Method #1), depending on a wide variety of factors, including, but not limited to:

• Average Weighted Net Income over latest three-year period.

• Growth Rate – Rising, Decreasing, Level.

• Maturity of Practice – Number of years established.

• Reputation of practitioner plus ability to transfer goodwill

• Staff retention and capabilities.

• Community – quality, stability, raising a family, etc.

• Practice location and geographic area.

• Parking and transportation access.

• Lease transferability.

• Physical plant and need for modernization.

• Equipment–age and need for update and additions.

• Mix of patients and contemplated percentage loss–average 20 to 25 percent.

• Third Party Care percentages and breakdown.

• Services Rendered–exams, therapeutics, contact lenses, pediatrics, low vision.

• Fee schedule & credit policies.

• Working hours.

• Competition.

No two practices are identical in their characteristics (i.e. patient mix, gross, net, staff, fees, equipment, physical plant, location). Therefore, the final sale price usually evolves from negotiations based on the practice appraisal facts, individual needs, and assets and priorities of both the seller and buyer.

The Final Sale Price Must Be Fair to Both Parties and Meet the Following Requirements:

1.Allow a safety factor for a reasonable loss in transfer of patients. This factor can be anywhere from zero to 90 percent. Maximum goodwill and transfer of patients occurs more easily when the practitioners have been associates for approximately two to four years.Less than this may result in an average loss of 20 to 25 percent of the patient load, and therefore affecting the gross and net of the practice. Most practices normally lose 15 to 20 percent of their patient load per year due to patients moving, deaths, job transfers, nursing homes, staff and doctor dissatisfaction, religion, third-party managed care changes or some loss of seller’s personal friends and family members.

2.The practice must be reasonably pricedto insure the purchaser receives sufficient net to fulfill his/her financial obligations. This includes paying taxes on the net income, maintaining a minimum standard of living, meeting the payment schedule of the practice purchase agreement, satisfying any outstanding student debt loans, etc. If the purchaser cannot fulfill these financial needs, there will eventually be a default in payment, possibly bankruptcy and costly legal actions resulting inboth the purchaser and seller becoming “big losers.”

All agreements must be fair so both seller & purchaser can fulfill their individual needs and priorities.

3.Is the practice worth the price?
GENERAL RULE:If the purchaser is able to lose 20 to 25 percent of the patient load (Goodwill), which results in a similar reduction of gross and net and still have enough net income to pay all the financial obligations as previously outlined, then the practice is worth the purchase price. It is the Net that pays all the bills – not the gross.

We have found from experience that a high percentage of good viable practices will sell for 60 percent, plus or minus 5 percent, of the average of the last three years weighted gross. This includes all assets of the practice such as equipment, inventory, improvements, furniture, etc. The practice values have decreased over the last few years because of managed care with its many restrictions, combined with lower fee reimbursements, loss of major insurance contracts at renewal, decreased loyalty of patients and the uncertainty of the future.

PCO As Practice Valuator

The staff and consultant network of the Irving Bennett Business and Practice Management Center conducts practice valuations, and the school is endorsed as a valuator by the American Optometric Association. A fee of $1,600, which is tax deductible, is charged for staff time, overhead and expenses. These fees will accrue to the Irving Bennett Business & Practice Management Center, which will enable the center to continue to expand its functions for the benefit of students and all eye care professionals. This fee also includes two to three hours of follow-up consultation and advice as negotiations proceed. The group also can assist both seller and buyer to creatively construct a viable agreement, and when necessary, help mediate differences.

Janice Mignogna is director of the Irving Bennett Business & Practice Management Center of Pennsylvania College of Optometry at Salus University in Philadelphia. She can be reached at jmignogna@salus.edu.
Harry Kaplan, OD, FAAO, who taught practice management for 20 years and who conducts practice appraisals, consults to PCO. He can be reached at hkaplan@salus.edu.