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Optometry practice valuation and tax strategies
By Adam Cmejla, CFP®
Jan. 8, 2025
Practice owners always have the goal of reducing their taxable income and thus reducing their tax bill as much as possible and on an annual basis.
It’s one of the benefits of practice ownership—having more agency around how, when and on which line item of a tax return their income is reported.
But for each and every action, there is an opposite reaction. Sometimes what worked great in reducing your taxable income as a practice owner can inhibit the enterprise value of your practice when you go to sell it.
That’s exactly what happened in a recent transaction that we advised on. In this situation, our firm represented the buyer of the practice. This was a practice that the buyer had not previously worked in and, thus, their due diligence was being done completely at face value without much prior knowledge about the practice or how the seller had been managing the practice.
The seller believed their practice was worth $300,000 more than what the buyer was willing to pay. The sticking point? The seller claimed they had personal and discretionary expenses—“add-backs”—that should have increased their practice’s valuation.
However, due to messy financials and a lack of proof, the buyer could only rely on the tax returns and the financial metrics that were able to be proven. This resulted in a $300,000 delta between what the buyer and seller believed the practice was worth.
How Are Optometry Practices Valued?
Before we get into some of the details of the deal, let’s discuss how practices are valued. Valuing a business like an optometry practice involves several methods, but most fall into three main categories:
- Market-Based Valuation: This method compares the practice to similar businesses that have recently sold, using metrics like revenue and earnings.
- Income-Based Valuation: By examining the practice’s cash flow, this approach uses metrics like Seller’s Discretionary Earnings (SDE) or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), often multiplied by an industry-standard factor. For optometry practices, this multiplier is typically 4–6x EBITDA or 1-2 (sometimes 3) X SDE.
- Asset-Based Valuation: This method focuses on the tangible assets of the business, like equipment and inventory, and subtracts liabilities to determine the net value.
In this case, the buyer relied on multiple valuation methods to determine a fair price for the practice.
However, the income-based valuation—driven by the numbers in the seller’s tax returns and profit-and-loss (P&L) statements—had the greatest influence on the deal. This method is often the most impactful in transactions because it reflects the actual earnings a buyer can expect to take home and is specific to that practice and not generalized by external factors.
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Unfortunately, the seller’s inability to substantiate discretionary expenses, which they argued should have been excluded from earnings, created a gap in perceived value. The buyer could only rely on verified financials, which led to an irreconcilable $300,000 difference in valuation.
Why Clean Books Matter
Sellers often underestimate the importance of accurate and clean financial records, especially when it comes to proving add-backs—those discretionary or personal expenses that a seller claims should be excluded from the practice’s reported earnings.
Add-backs are critical in determining Seller’s Discretionary Earnings (SDE). SDE is often used in business valuations because it is both verifiable and yet discretionary. It’s verifiable to the extent that the seller can prove which expenses in the business personally benefited the owner. They’re also discretionary because the owner can choose how to “harvest” all available dollars out of the business that aren’t related to the normal operating expenses of the practice.
If a $2 million top-line revenue practice had total operating expenses of $1.3 million dollars (assuming they as the owner are also clinically involved in the practice and thus seeing patients), the owner/seller has $700,000 in profits and, therefore, can choose how to report that income.
If the business is filing tax returns as an S-corp, the owner must pay themselves a reasonable owner’s salary as a W-2 wage. Part of being an owner of the practice is having agency over the expenses of the practice, including the gray area of add-backs.
For example, a seller might run personal expenses like a car lease, travel or entertainment through the business. While these reduce net operating income of the practice, and by extension, the annual tax bill for the current owner, they also reduce reported SDE. For these expenses to count as add-backs, the seller must provide clear documentation to substantiate that they benefited the owner personally, were one-time, or non-recurring in nature.
Without this proof, buyers cannot rely on claimed add-backs to justify a higher purchase price.
It’s important to understand that the income-based valuation approach takes a weighted average of the last three years’ financials—weighting the most recent years the most—in the equation.
So, the $300,000 delta in the valuation was actually a multiple of the annual add-backs that could not be substantiated. In the example of the $300,000 delta, the buyer simply couldn’t verify the seller’s claims and had to rely on the practice’s tax returns, assuming that all expenses reported were usual and customary to the operation of the practice.
Messy or incomplete records don’t just create skepticism—they can lead to undervaluation or even cause the deal to fall apart entirely.
Anchor Bias: The Seller’s Dilemma
One major reason this deal was close to falling apart was anchor bias. Anchor bias occurs when someone fixates on an initial piece of information—like a valuation—and becomes unwilling to adjust, even in the face of evidence.
In this case, the seller likely became anchored to a price they had been told their practice was worth, possibly based on anecdotal information, rule-of-thumb multiples or comparisons to other practices. The $300,000 delta arose because their expectations weren’t grounded in the practice’s verified financial performance.
Sellers often hear statements like, “Practices in this area are selling for $1 million” or “Most optometry practices sell for 5x SDE.” While these generalizations may provide a rough starting point, they ignore critical variables such as profitability, patient retention and market demand.
The danger of anchor bias is that it makes sellers resistant to adjusting their expectations. This can result in missed opportunities to sell at a fair and realistic price, as was the case here.
Anchor Bias: The Buyer’s Perspective
Anchor bias doesn’t just affect sellers—buyers can fall victim to it as well. For instance, buyers might become anchored to a “deal-breaker” price or multiple, even when other factors might justify a higher valuation.
In this case, however, the buyer took the correct approach by grounding their valuation in verifiable numbers. By focusing on the tax returns and P&L statements, they ensured their offer was based on reality, not speculation. This approach demonstrates the importance of buyers staying objective and basing decisions on defensible data, particularly when messy books introduce uncertainty.
However, it’s important to note that anchor bias can also blind buyers to opportunities.
For example, if a buyer is overly fixated on a 4x SDE multiple, they might miss out on a well-performing practice that justifies a 5x multiple.
Lessons for Sellers and Buyers
The friction between buyer and seller in this this deal offers valuable lessons for both parties:
For Sellers
- Maintain Clean and Accurate Books: Ensure that all financial records are organized and free from unnecessary complexity. Document discretionary expenses thoroughly.
- Understand the Role of Add-Backs: Be prepared to prove that claimed add-backs are legitimate and directly benefit the owner. Without proof, buyers will discount or ignore them.
- Avoid Anchor Bias: Be realistic about your practice’s value and align expectations with market realities and verifiable financial data.
For Buyers
- Rely on Verified Data: Anchor valuations to substantiated financials, such as tax returns, rather than speculative or anecdotal claims.
- Stay Objective: While it’s important to have a framework for valuation, be open to adjusting your perspective if the financials or market dynamics justify it.
- Communicate Clearly: If discrepancies arise, address them early in the negotiation process to avoid prolonged misalignment.
The Bottom Line
Selling an optometry practice is one of the most significant transactions a business owner will ever undertake. But as this $300,000 delta shows, deals can be close to falling apart when financial records are messy and expectations are misaligned.
For sellers, the key takeaway is this: Saving in taxes each year by running personal expenses through your business may seem smart in the short term, but without proper documentation, it can cost you hundreds of thousands of dollars when it’s time to sell.
For buyers, the lesson is equally important: Anchor your valuations in reality, not promises. A fair price is built on data, trust and transparency—not on what someone thinks their business is worth.
By avoiding anchor bias, maintaining clean financials, and focusing on defensible valuations, sellers and buyers alike can ensure smoother negotiations and successful transactions.
Adam Cmejla, CFP® is a CERTIFIED FINANCIAL PLANNERTM and Practitioner and Founder of Integrated Planning & Wealth Management, LLC, an independent financial planning & investment management firm focused on helping optometric practice owners nationwide “plan life, on purpose” by providing personal and professional CFO services. Check out the “20/20 Money Podcast” to get more tips on making educated and informed financial and business decisions, be the first to know when his new book How to Buy an Optometry Practice is released, and the “20/20 Money Membership,” built to help ODs become brilliant at the financial basics.
