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Considerations in Practice Valuation. A Quick & Dirty Method of Practice Value Estimation John G. McDaniel, OD, MLHR President Waugoo Consulting Group. Introduction. About myself – John McDaniel, OD, MLHR About Waugoo Consulting Group, LLC Contact information:
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Considerations in Practice Valuation A Quick & Dirty Method of Practice Value Estimation John G. McDaniel, OD, MLHR President Waugoo Consulting Group
Introduction • About myself – John McDaniel, OD, MLHR • About Waugoo Consulting Group, LLC • Contact information: • JMcDaniel@WaugooConsulting.com • 614-352-4423
First Question – Why Do It? • The first question that drives any appraisal/valuation is the purpose: • Practice appraisal (implies fair market analysis) • Practice valuation (implies personal consideration) • Quick estimation for comparisons of prospect practices • Execution of the due diligence process • Business plan and/or strategy development • Borrowing – asset determination/statement of net worth • The purpose dictates the extensiveness of the process and reasonable expenditure for the process
DIY Valuations? • Can some of these be done yourself? • In my experience, only one: the quick and dirty (Q&D) method of estimation • A few caveats: • Be prepared to be frustrated; this method is simple but collecting the data can be complex • Incomplete financial records complicate the process • Q&D estimation is a simplified version of the industry market multiplier method used in full blown appraisals
Replacing a Professional Valuation? • No, but why? • Less rigorous and makes too many assumptions • Too much variance in the data/conclusions • It represents about 1/20 of the actual appraisal process • Try to save a few thousand, risk tens or hundreds of thousands (no exaggeration) • Comfort level with the sources of information • Data is not just “found” it is corrected – this is where appraisers earn their fees • Lack of knowledge on industry norms, including the financial industry norms (for borrowing purposes) • What to do with missing/suspect data? Hard questions that require experience to answer • Etcetera - you get the idea, right? • In summary: don’t sell or buy a practice for a price based solely on this method because it is too simplistic and fails to capture a significant amount of the complexity of the process
Purpose: to relatively quickly estimate the approximate range for the selling price of a given practice Usefulness: most useful when comparing prospected practices – you need a minimal amount of data Useful as a periodic business assessment tool Also can be used as a gauge on a professional appraisal – does this appraisal/valuation seem reasonable? Q&D Estimation
Assumptions & Limitations • Business activities are limited to normal practice of optometry • Real estate is not included • All assets used in the practice will be sold • There will be a reasonable covenant not to compete • All patient records will be sold • There will be a reasonable transfer period & process • Etcetera – things have to be pretty typical because this process does not have mechanisms for dealing with idiosyncratic aspects that are part of all sales
Data Needed to Start • Gross Revenue (GR) for 3-5 years a. Get this from income tax docs • Net income (NI) for the same 3-5 years • You have to use a modified corrected NI (MCNI) • MCNI = reported NI plus add backs of OD income, OD pension/benefits • The accuracy of the method does not justify a more completely corrected NI • Usually can get this data from the tax docs
Calculate Weighted Mean GR (GRWT ) • This becomes the figure used in all future estimation calculations, called GRWT • Make a data table to facilitate the process • The table should have these columns/data:
Calculate Weighted Mean GR (GRWT ) • Enter the GR for each year
Calculate Weighted Mean GR (GRWT ) • Enter the GR for each year • Create the weights (WT) for each year • Keep it simple – the rigor does not justify increased complexity (remember significant digits?) • Higher WT on more recent years, in general
Calculate Weighted Mean GR (GRWT ) • Enter the GR for each year • Create the weights (WT) for each year • Keep it simple – the rigor does not justify increased complexity (remember significant digits?) • Higher WT on more recent years, in general • Multiply each years GR x WT
Calculate Weighted Mean GR (GRWT ) • Enter the GR for each year • Create the weights (WT) for each year • Keep it simple – the rigor does not justify increased complexity (remember significant digits?) • Higher WT on more recent years, in general • Multiply each years GR x WT • Sum the weighted GR values and the total WTs used
Calculate Weighted Mean GR (GRWT ) • Enter the GR for each year • Create the weights (WT) for each year • Keep it simple – the rigor does not justify increased complexity (remember significant digits?) • Higher WT on more recent years, in general • Multiply each years GR x WT • Sum the weighted GR values and the total WTs used • Divide summed weighted GR by the sum of WTs • This figure is your weighted mean GR ($111,000)
Calculate Weighted Mean Growth Rates (GrowthRateWT ) Basic idea: comparison of alternative investments • This applies equally to the practice that sells for $30K and another that sells for $2.5M – those purchase dollars could have been invested in similar alternative investment vehicles (real estate, equities, bonds, T-bills, etc.) • Why do you invest an something? For growth and/or income generation; this focuses on the growth aspect of the “investment”, i.e. practice
Calculate Weighted Mean Growth Rates (GrowthRateWT ) • Enter the GR for each year • Calculate the growth rates • Formula: (Year 2 – Year1)/Year 1 • If 5 years of data, can get 4 rates (n-1=# of rates) • Create weights (WT) – similar to before • Multiply the WT x growth rates • Sum the weighted growth rates and WTs • Divide summed weighted growth rate by the sum of WTs • This figure is your weighted mean growth rate (2.97%) • Is this growth?
Determine Estimated Range • Economically, the scale for growth has to be normalized – 3% is equal to no growth (CPI) • Use the following table to determine the multiplier to use for range determination
Determine Estimated Range • Using the multiplier range, calculate the estimated range for selling price: • Multiply the low end of range x GRWT • Multiply the high end of range x GRWT • This is one of the estimations of selling price range • For this example: $49,500 - $60,500 based exclusively on growth rates • Not done! More analysis is required, even for simple estimating
Calculate Weighted Mean Net Income as a % of GR (NetInc%GRWT ) Basic idea: evaluation of income stream • This applies equally to the practice that sells for $30K and another that sells for $2.5M – those investment vehicles each could have the same rate of income return • Why do you invest an something? For growth and/or income generation; this focuses on the income aspect of the “investment”, i.e. practice
Calculate Weighted Mean Net Income as a % of GR (NetInc%GRWT )
Calculate Weighted Mean Net Income as a % of GR (NetInc%GRWT ) • Enter the GR for each year • Enter corrected NetInc for each year • Corrections for this process: add back OD income and benefits • Calculate NetInc as a % of GR (NetInc/GR=NetInc%GR) • Create weights (WT) – similar to before • Multiply the WT x NetInc%GR • Sum the weighted net income% and WTs • Divide summed weighted net income% rate by the sum of WTs • This figure is your weighted mean net income as a % of gross revenue value (40.57%) • How does this compare with the growth rate analysis?
Calculate Weighted Mean Net Income as a % of GR (NetInc%GRWT )
Determine Estimated Range • Using the multiplier range, calculate the estimated range for selling price: • Multiply the low end of range x GRWT • Multiply the high end of range x GRWT • This is one of the estimations of selling price range • For this example: $60,500 - $71,500 based exclusively on net income rates • OK, almost done now!
What To Do When…? • You get two different ranges (as with our example)? • The results are not close to what I thought I would get? • The basis for the overall range of .35 - .65 • Seller has “amazing assets” and they are not even considered • Yup –remember method assumptions • This value doesn’t take the real potential into consideration • Yup, and that is how it should be; price based on past performance • Don’t like it? Take the practice up to its potential before selling! • The building will be involved in the sale – is this still the price? • No – bring in separate appraiser and treat it as a separate transaction • But this doesn’t take into account “______” (AR, AP, staff, location…) • Yup – this is why this is an estimation – still need real/full blown valuation/appraisal
Things to Remember… • All of the “flux” in this simple process are addressed in a full appraisal/valuation • A full appraisal does 10-15 more of these type of calculations as part of 1/3 of the overall process • What is being sold/purchased? The past performance of the assets owned and goodwill • “Potential” does not increase the selling price; but it does increase interest • Is this a useful process if not selling/buying the practice? • Yes – can be done to evaluate the success of the practice
Thank You! • Thanks to EyeCodeRight, the EyeCodeRight Community and John Warren for this fantastic forum and opportunity • My practice uses EyeCodeRight software (no financial interest) and I love it! • How to contact me: • JMcDaniel@WaugooConsulting.com • Phone: 614-352-4423 • Thanks to all of you for taking the time to listen! • Questions???