Your Practice Worth? The Asset Based Approach

Now that we have that done, we can discuss the asset based approach. With this approach, we focus strictly on the assets. The easy part is the tangible assets of the practice. These are your computers, tables, X-ray systems and other equipment in the practice. We can pretty easily determine a market value for the tangible assets. The next and slightly more difficult part is determining a value for the goodwill in the practice. The definition of goodwill is those intangible assets, or “things,” that help your practice generate income. Those intangibles can include your reputation, philosophy, systems, and everything else that makes patients want to come and see you and pay you to be their chiropractor. Goodwill is valued as a percentage of net income. The percentage can range from 50% for those who are struggling (they may not have the best reputation and/or not have good systems in place to derive an income) to the high end of net income, or about 200%. The latter are the rock star practices that have great reputations, great systems, and dream practices. So, we take the value of the physical assets and then add the value of the goodwill to determine the asset based value of the practice. In our examples above, Practice #2 would have a goodwill value of around 200% of the $300,000 plus the value of equipment, say $100,000, giving them a value of $600,000.

The Income Approach

The next approach we use is the income approach. Another name often used is the cap rate method. With this method, our focus is on the adjusted net income of the practice. We start by using the adjusted net income we came up with after taking out the non-operating expenses of the practice, including the doctors’ salary. This is where it gets tricky. We next add back a normalized doctor’s salary based on the production of the practice. We typically take a typical 30% associate pay rate and apply that to the production of the practice. Using Practice #2 above as an example, if we assume all of the production of $500,000 is by the doctor, we would multiply the $500,000 by 30% to get a normalized doctors’ salary of $150,000. We then subtract the $150,000 normalized doctor’s salary from the adjusted net income of the practice to get what we call discretionary income. Others call it normalized dividend, or just adjusted earnings after normalized doctor’s salary. After we have come up with the discretionary income number we divide the discretionary income number by a capitalization (cap) rate. A capitalization rate is what return an investor would expect to get by investing capital in equity. In this case, what a buyer would expect to get in return for buying the practice. This is where nerdy accountants (I am one, so I can say that) have more fun by analyzing what the cap rate should be. We start with a baseline cap rate that most chiropractic practices trade hands. Cap rates on chiropractic practices can have a broad range. They can range from 30% and go up to 65%. From there, we analyze the practice’s intangibles, very similar to what we do with goodwill, but also take into account the practices location, equipment condition, etc. If it has a bad location, bad reputation, old-tired equipment, we will increase the cap rate as any investor or buyer would want a higher return for a higher risk investment.

The Market Approach

Finally, we calculate the market approach. This method is the easiest method. The market approach focuses on historical sales of practices in the area the subject practice is located. We use various valuation industry databases in addition to our own historical valuation and sales history to determine at what rate practices are being sold. For example, a practice in downtown Seattle will typically have a higher market rate than a practice in Forks. No offense meant to Forks, it’s a beautiful area of Washington with great fishing, nice people, and low cost of living; however, practices in Seattle are more desirable and thus sell for a higher percentage of total gross collections. Practices in Seattle sell for 85% or 90% of collections, but the practice in Forks may only sell for 40% to 50%.

After we have all three methods calculated, we take an average of all three and then add them back together. By doing this, we get a global look at the entire practice and not just one aspect of the practice. We get a look at the assets including goodwill, the income producing ability of the practice and the ability of the practice to generate revenue. If we just use one of the methods, we would only get a pin-hole view of the practice. You want to know everything about the practice and not just one aspect.

As you can see, there is a lot that goes into valuing a practice. Valuing it incorrectly can cost you money when you go to sell, insure, or do estate planning with your practice. Having your practice properly valued will earn you more when you decide it’s time for a transition.

Plexus

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