Buying a practice? How much is too much?
Use cash flow to determine the fair value of a practice.
By Alissa Wald, O.D. and Scott Daniels

Are you considering buying a practice and afraid you may be paying too much? Are you confused by the maze of formulas or methods for valuing a business? When it comes to buying a practice or any business we always suggest that you follow the cash. Cashflow is really the lifeblood of any business.

Most practices are "owner-operator" businesses, meaning that the owner's discretionary earnings represent the profit of the business. This is true for most small businesses with revenues under $1 million per year. In other words, these practices do not offer enough free cash flow as an absentee owner to pay a salary for a doctor and a manager. (Businesses with little or no profits would be valued differently)

Cash flow is king (or queen)

What does cashflow have to do with the selling price? Using a reverse engineering method, the available cashflow is separated into two categories: salary and debt service. The cash remaining after subtracting a reasonable amount for your salary provides the maximum cash available to service the debt. Most banks will allow a sufficient cushion when providing a loan so as not to overextend the buyer.

The opportunity cost of money

Imagine we are locked in negotiations with a seller over a $30,000 gap. The seller has already reduced his price and will not drop any further. As the buyer, we must decide whether to walk away or compromise. Emotionally, we may believe the price is too high. On the other hand, the consequences of not purchasing the practice include a loss of equity (employees do not build equity in a business) or a possible loss of more income.

The real question is whether I can afford an extra $350 per month in loan payments. Will the existing cashflow of the business support the increased payment? More importantly, how easily can I increase the monthly revenue by at least $350? Can you think of five ways to increase revenue by $350 per month?

Using the opportunity cost of money, buyers can leverage their buying power and help bridge the gap in compromising on a selling price. For example; a 10-year bank loan with an extra monthly payment of about $350 translates to a present value of approximately $30,000. This provides the seller with the additional $30,000 cash up front.

We're not suggesting that sellers should increase the selling prices or that buyers should simply pay higher prices. However, we are suggesting that an extra $350 a month is not going to make any difference in the long run.

Your negotiations will go smoother and the goodwill created with the seller will most likely create an even better transition. It's not always how much you pay, but how much you benefit from the opportunity. There are always risks in every opportunity. However, most people never recognize the loss from a missed opportunity. This hidden loss can be much more substantial than $30,000, or $350 per month.

Scott Daniels is with Practice Concepts and provides consulting and practice sales assistance for eyecare professionals. He has over 14 years experience in business management, financing, marketing, and negotiations.

Dr. Alissa Wald, a graduate of the University of Houston, currently owns and operates a successful 12-year-old optometric practice, including an associate doctor and seven staff personnel. She is also president of Practice Concepts, providing nationwide practice sales and consulting services. Their website is www.practiceconcepts.com and can be reached by email at scottd@practiceconcepts.com or (877) 778-2020