Our thoughts . . . 2-23-09
ASSET AND AVOIDED COST SALES
Past articles on this site have discussed the more commonly used valuation methods based on financial calculations and market data. That would include such hopefully familiar terms such as: capitalization of earnings, excess earnings to retire debt, summation of assets, discounted cash flow, and market comparables. This time, however, I would like to discuss a couple of less familiar sale and valuation processes that might occur more commonly than you think. While by some stretch of the imagination you might consider these concepts very distant cousins of the summation of assets method, they are used in very different types of practice situations.
By way of review, a practice sale generally consists of two basic categories of assets: tangible and intangible. The tangible assets include those things that can be touched and/or seen such as: furniture, fixtures and equipment, computer and electronic hardware, instruments, software, and supplies. Intangible assets, which are often incorrectly all characterized as "Goodwill" or "Blue Sky", are less touchable but none the less very identifiable. The list would include:
| 1. Recognizable business location 2. Trained and available work force 3. Published, advertised, and recognized phone number 4. Presumption of a lease and the use of existing leasehold improvements 5. Benefits of market branding 6. Established patient base 7. Established base of specialists, laboratories, suppliers, and vendors 8. Goodwill |
While the first seven items are somewhat self-explanatory, Goodwill is often the most debated. It means a lot more than just warm fuzzies. Roger Hill of the McGill and Hill Group defines Goodwill as the expectation that the financial benefit enjoyed by the owner of a business will survive a transition and become the benefit of the new owner. I think that says it about as well as I've ever heard. Most traditional sales have a mix of Tangible and Intangible Assets identified by contract in an allocation. In most cases the Tangible Asset total will be less than the Intangible, often less than a third of the total sale price.
In the case of what is generally referred to as an Asset Sale, the practice is most commonly going out of business and being liquidated. This can be for any number of reasons including:
| 1. Owner's decision to retire immediately 2. Loss of location or lease termination 3. Undesirable location for a future owner 4. Outdated facility and equipment 5. Minimal patient base and revenue |
There may be an attempt to sell some of the equipment but the negotiations generally center around the patient base. Many have recognized that incorporating another practice into theirs can be a very cost-effective way to increase revenues and profitability. Custody of patient records can be purchased outright, on a "pay per see" basis or some combination of the two. The retiring doctor's phone number along with a letter of introduction will help facilitate the merger. In some cases, the retiring doctor may even work in the new office for a short while to further help seal the deal. These opportunities are usually very modestly priced and can be very profitable for the new owner.
A slightly more abstract but interesting concept of valuation is known as the Avoided Cost Method. Simply stated, if you can buy it for less than you could build it, and all other factors are relatively equal, this might be a golden opportunity. This could even be true if the practice in question does not have sufficient patient base or cash flow to be evaluated by any of the traditional valuation methods.
Let's consider for a moment what in today's market may be the riskiest method of getting into practice, the start up. (Let me say right here, before there is any perception of "Broker Bias" against start-ups, that I have personally scratch started from bare space three practices and rehabbed three others that were not far from a clean start.) Most sources will agree that a modest build out at $125/sq. ft. along with the necessary equipment, instruments, supplies and working capital will cost between $350,000 and $500,000 in 2009 dollars. After all of this, there is no staff, patients, or revenue. While I will save a more complete analysis of Buying vs. Start-up for another article, wouldn't you wonder why a bank would even consider a loan like this? The fact is, very few will. If, however, an opportunity was available in the general area you wish to practice that was equipped, functional (and perhaps as a throw in would have some patient base and revenue), and could be bought for less than the financial costs and time value spent in building a new location be something worth considering?
These opportunities come to the market for a variety of reasons. Maybe the owner's interest in owning a satellite practice nosedives after the loss of an associate or perhaps the owner wants to return to graduate school before the practice really got a chance to get going. The three "D's", death, disability and divorce can create opportunities for the new owner to avoid significant costs. These situations differ greatly from strictly asset sales because there can still be a significant Intangible component to the allocation of assets. As a matter of fact, some portion of just about every item on our earlier list could still be counted towards the value.
One final note: many lenders have programs just for these types of opportunities. Qualified buyers can borrow significant funds because the lenders realize that the borrower has reduced the overall risk of ownership. If the buyer is also able to bring any existing patient base to the new location, so much the better. While we at EMA still believe that cash flow is "king", these opportunities deserve consideration in today's markets.
Steve Wolff, DDS
UMKC Class of 1977