business advisor

The Partnership Analysis

When you consider a partnership, understand the ICE issues.

JERRY HAYES, O.D.

If you're about to form a practice partnership as either the senior or junior doctor, you should negotiate for three main reasons:
► Income
► Control
► Equity

While most principals focus on equity, it's my opinion that income and control are actually more important factors. Here's why:

The selling price of a typical dispensing practice is generally 60% to 80% of the annual production. Therefore, a solo practice with $500,000 in annual collected revenue will typically appraise for $300,000 to $400,000 cash. In addition, the seller has to pay taxes on his proceeds after the sale.

Compare equity to income

Now, let's look at how that potential equity compares with annual income. If the practice nets the national average of 30% ($500,000 × 30% = $150,000), its equity should be worth between two years' earnings ($300,000) to a high of almost three years' earnings ($400,000).

When compared with large privately held businesses, which might sell for five- to 10 times the annual earnings, two to three is a pretty low multiple. That tells me that a well-run optometric practice is more valuable to the owner for the generated cash stream than the equity for which it can sell.

For that reason, I would advise most young O.D.'s about to enter a long-term deal as a junior partner to give up a little equity in exchange for slightly higher compensation. For example, let's say that a junior associate is negotiating a junior partnership and is pushing hard to buy 49% of the practice. The senior doctor, however, only wants to sell 39%. How much does it really matter to either side?

Here's one way to look at it. Assuming the practice has two O.D.'s producing $500,000 each and an appraised value of 70% of collected gross revenues, 39% of a $1,000,000 practice would be worth $273,000 cash pre tax ($1,000,000 × 39% ownership × 70% value = $273,000).

Using the same methodology, 49% of the same practice would be worth $343,000 ($1,000,000 × 49% ownership × 70% = $343,000). That's a difference of only $63,000 on a pre-tax basis in today's dollars. The thinking here is that the junior partner could easily make up that $63,000 differential by earning an extra $5,000 to $10,000 per year through the life of a 20- to 30-year partnership.

Senior partner

The reverse applies to the senior partner, but to a lesser degree. He should be willing to give up more equity to the junior partner in exchange for the junior partner taking a slightly lower annual compensation. This is particularly true if the senior partner is nearing retirement and operating on a shorter time frame than the junior partner.

Analysis

These examples aren't intended to be cookie-cutter formulas for determining practice value or partnership percentages. They are designed to help buyers and sellers create better partnership agreements through a better understanding of the dynamics between practice equity and personal income.

But, what about 51% controlling interest? Isn't that all important? The answer is NO, if you structure your partnership agreement properly. Next month, I'll tell you why I think that bit of conventional wisdom is misguided. OM

Disclaimer: The content of this article is for general information only and is not intended to substitute for or serve as legal, financial or management advice.