business advisor
Setting a Price for Your Practice
Selling your practice? Cash flow is key in determining value.

A client called recently to inform me that he was putting his practice up for sale. When I asked him how much he wanted for it, he replied, "I've decided to let the buyer make an offer and then negotiate from there. Do you think that's a good approach?"

Although the response, "sounds pretty dumb" crossed my mind, I politely told him that the seller is the person who should set the asking price. Because only he knows the ins and outs of the practice, it's his job to justify the price to prospective buyers, and most of all, the seller has the final say over whether the deal actually takes place. Considering that, how does an optometrist determine the asking price of his practice when he gets ready to sell?

Working the numbers

Contrary to popular opinion, there is no simple formula that tells you how to price a practice and for how much. However, you can work within certain ranges. At the low end, a practice (not including real estate) should never sell for less than the value of its hard assets.

For example, if the appraised value of all the inventory, equipment and furnishings is $100,000 and the owner owes $10,000, then it's difficult to envision a scenario in which this practice isn't worth at least $90,000.

On the high end, appraisers determine the ultimate value of a practice by how much net income is available to pay the cost of purchasing the practice and to provide the buyer with a decent income during his pay back period.

Using a simple example that doesn't factor in a down payment or the impact of tax deductions, let's assume that you're considering the purchase of a practice that has a "true net" of $150,000 each year. That would allow enough cash flow to produce an annual income of $80,000 to a buyer and leave $70,000 to repay the loan on the practice. According to optometric appraiser Marilee Blackwell, M.B.A., $70,000 would pay off a loan in the amount of approximately $400,000 at 6% interest over seven years.

Understanding the catch

That's basically the way appraisers assign value to a professional practice or small business. However, there is one small catch: You can't use the profit number shown on the Profit & Loss Statement. That's because deductions for depreciation and equipment purchases, plus any personal expenses that are run through the practice will artificially reduce the net and in turn, lower the appraised value.

Even with the best appraisal, buying a practice isn't without risks. If the practice net improves, then the buyer's net income increases while his loan payments will remain constant. On the other hand, if the buyer does a poor job of managing the practice or if the local economy falters, then the net income could go down, but the payments won't.

Cash flow is king

If you want an accurate valuation, you need an experienced appraiser to determine the true net of your practice. Without that, you don't really know how much cash flow is available to pay off a purchase loan and to provide the buyer with a reasonable salary. And that's the best basis for determining the true value of a practice.

A frequent writer and speaker on practice management issues, Dr. Hayes is the founder and director of Hayes Consulting.  You can reach him at (800) 588-9636 or JHAYES@HAYESCONSULTING.NET.