Insights From Our Editors

How to Do a Practice Valuation

By Mark Wright, OD, FCOVD,
and Carole Burns, OD, FCOVD

August 8, 2018

Your practice is a business. Your business is either growing in value every year or it is decreasing in value. At some point you will want to sell either part, or all, of your practice. When you sell, you would like to receive maximum value for your practice. This article will help you get ready for that day.

The quick and dirty calculation
The valuation using this method includes all physical assets, equipment and inventory.

A quick and dirty way to get the value of your practice is to take 65 percent of your gross revenue collected. (Definition: gross revenue collected is dollars collected, not dollars billed.) Here’s the math for the quick part:

If your practice gross revenue collected is $1 million, then 65% times $1 million = $650,000.

The dirty part is that number may not be accurate. Consider two practices both bringing in gross revenue collected of $1 million. The first practice has a net of $50,000 and the second practice has a net of $400,000. Should both practices be valued the same even though the net for each practice is radically different? Obviously, the practice with a net of $50,000 should be valued significantly less than the practice with a net of $400,000. So, this formula is not very good.

What is the minimum value of your practice?
To find the minimum value of your practice, go to your practice Balance Sheet. If you close the doors of your practice tomorrow, sell all the assets and pay all the debt of the practice, what you are left with is the equity in the practice. This is the minimum value of your practice.

This is the formula used in the Balance Sheet for your practice. It is: Assets – Liabilities = Equity.

Your practice CPA should be creating a Balance Sheet at least every year for your practice. If your practice is growing in value, then your Equity should be increasing every year. A healthy way to view your Balance Sheet is that it is the value scorecard for your practice.

What is the best calculated value for your practice?
The valuation using this method includes all physical assets, equipment and inventory.

To find the best calculated value for your practice requires that you understand what you are selling. You are selling an engine that produces a net. The core question that every practice owner should be constantly thinking about is: How effective and how efficient is the practice in producing a great net?

Let’s consider some numbers to help us answer the core question.

How effective are the optometrists at producing a great gross revenue?
Gross revenue does impact net. The easiest way to show this is that net cannot be larger than the gross revenue collected for all the business done in a given year. It can also be easily shown that the money you receive for a 30 percent net in a $1 million practice is significantly higher than the amount of money you would receive for a 30 percent net in a $500,000 practice, as $300,000 is twice as much as $150,000.

Let’s consider how effective a practice is at producing a great gross revenue. According to the MBA numbers collected over approximately 2,000 practices, the median annual gross revenue collected for a one full-time equivalent optometrist is about $700,000. If a practice has two full-time equivalent optometrists, then in a median practice the annual gross revenue collected would be two times $700,000, which equals $1.4 million.

For the optometrists in the top 5 percent revenue producers in the country, then one full-time equivalent optometrist would be generating an annual $1.4 million gross revenue collected. This optometrist is twice as effective at generating revenue than the median optometrist. (You need to know that there are optometrists in the top 1 percent revenue producers in the country who generate an annual $2.5 million per one full-time equivalent OD.)

The primary difference between the one full-time equivalent optometrist, who produces $700,000 gross revenue collected, and the one full-time equivalent optometrist who produces $1.4 million, is the $700,000 optometrist is doing many of the tests that could be delegated to staff members, and the $1.4 million optometrist delegates most of the testing to staff members.

Here’s the calculation to determine how effective the optometrists in your practice are at producing the annual gross revenue collected:

Gross Revenue Collected divided by the number of Full-Time Equivalent Optometrists

Let’s put numbers to the formula. For a practice that generates an annual gross revenue of $1.1 million with two optometrists, one working 40 hour per week and the other working 30 hours per week, the formula would look like this:

$1.1M / ((40+30)/40) = $628,571

The two optometrists in this practice are functioning less effectively than the median optometrist who produces $700,000.

The effectiveness of your optometrists to produce a great gross revenue will affect the practice value.

How efficient is the practice at producing a great net?
The average net for an optometric practice for the country has hovered around 30 percent for over 30 years.

We need definitions here because, for some strange reason, the optometric literature uses the word “net” different than every other business in existence.

True Net = Practice revenue – Total practice expenses including total costs for all ODs working in the practice including owner ODs
Optometric Net = True Net + Total costs for all ODs working in the practice including owner ODs

Adjusted Optometric Net = Optometric Net + Depreciation + Any personal expenses that the owners are running through the practice
For purposes of clarity, we will use the above three definitions in this article. With those definitions in mind, to restate the first sentence of this section of the article: The average “Adjusted Optometric Net” for an optometry practice for the country has hovered around 30 percent for over 30 years.

Now that you know how to calculate your Adjusted Optometric Net, here is a good Practice Valuation calculation based on this number:

PRACTICE VALUE = Weighted EBITDA x 4.25

EBITDA is Earnings before Interest, Taxes, Depreciation and Amortization.

To get to EBITDA, take your Adjusted Optometric Net and add to it Interest, Taxes and Amortization. (You already added back Depreciation to get your Adjusted Optometric Net.)

This formula uses a three-year-weighted EBITDA. Here’s the formula with the understanding that Year 1 equals the oldest year and Year 3 equals the nearest year:

(((1 x EBITDA Year 1) + (2 x EBITDA Year 2) + (3 x EBITDA Year 3)) / 6) x 4.25

This formula rewards a practice that has a growing EBITDA, and punishes one that has a decreasing EBITDA.

Where does the 4.25 come from? After evaluating a lot of practices and comparing results with other practice evaluators, the 4.25 with a weighted EBITDA is the number that hits the sale price of practices the majority of the time.

Looking back at the formula, what two things increase the practice value the most? If your optometrists are producing a great Gross Revenue, and your practice has a great Adjusted Optometric Net, your practice value will be high. Likewise, if your Gross Revenue and Adjusted Optometric Net is low, then your practice value will be low.

OTHER FACTORS TO CONSIDER
There are other factors that need to be considered in a practice valuation. Here’s a list.
Electronic Health Record level
HIPAA-compliance level
Need for additional equipment
Full-scope practice
Competition
Current local economy
Lease terms and transferability
Turn-key operation
Need for major renovation
Patient profile
Practice fee structure
Community demographics
New/former patient ratio
Office management system
Completeness of patient records
Present employee retention
MIPS
MACRA
Parking and transportation access

Each of these factors can either increase or decrease the value of the practice.
There are even more sophisticated practice valuation formulas that build upon this base and add: capitalization rate, capEx rate, and taxation rates.

Other practice valuation methods
There are other practice valuation methods, but they are not as good in predicting practice value as parts of the formula are highly subjective. Examples of these are:

• 100 to 120 percent of the weighted average of adjusted optometric net income of last three years + current market value of all assets + adjusted accounts receivable

• Weighed Average Net + Current Market Value of Assets + Goodwill

• Discounted Cash Flow Method

The Final Sale Price Must Meet the Following Requirements
1. It is most important for the price and terms to be fair to both the seller and the buyer. If this step does not happen, most often the deal does not complete. (Here’s an example of bad terms: A practice supporting one full-time equivalent doctor cannot sell the practice to a buyer and expect the buyer to hire the seller back for three days per week.)

2. The buyer must be able to buy. It can be the best deal in the country, but if the buyer’s cash flow after the purchase does not work with the buyer’s current debt load and the additional debt of the practice purchase, then the bank will not lend and the deal will fall through.

3. Allow a safety factor for a reasonable loss in transfer of patients. Most practices normally lose 5-10 percent of their patients each year due to patients moving or dying. With a practice transfer, another 5-10 percent of patients may change where they go for eyecare. The question becomes, can the buyer survive a 20 percent loss of patients?

The Practice Management Center As Practice Valuator
The Practice Management Center (PMC) is owned by the Association of Practice Management Educators. The PMC conducts free verbal practice valuations combined with a free consultation for buyers and sellers of part, or all, of optometric practices. We do this to assist buyers and sellers in creating successful transitions of optometric practices. You can learn more about us by going to optometrybusiness.com/pmc.

If you’re ready to take that first step to either buy or sell part, or all, of an optometry practice, then go to optometrymatch.com, click on REGISTER, and enter your contact information. After you’ve registered, if there is a specific practice, then click on PRACTICE INFORMATION, use the password you received when you registered to upload the practice information. We are happy to help you.

 

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