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From the VetPartners Experts: All Valuations Are Not Created Equal

May 29, 2019 at 5:22 pm
Lorraine List

Suppose you are an associate at ABC Animal Hospital and you’re considering the purchase of 20% of the practice from the owner. She hired a veterinary valuation expert two years ago to value the practice for planning purposes. The expert determined a value of $2.4 million, and the owner has given you a copy of the report. Using that report, she has determined that your price for a 20% interest will be $480,000, or 20% of $2.4 million. She says it’s not worth getting another valuation to update the report for the last two years of activity, and even though the practice has grown, she’s willing to “throw in” the increase in value for free.

Should you agree? No. Read on to understand why.

What every buyer needs to know about a practice’s valuation report

Your considerations as a buyer are not just about the passage of time. There are other major issues that significantly impact the price you should pay. Those relate to the purpose of the existing valuation, what you are specifically purchasing, and your status as a buyer of a non-controlling interest. Here’s what you need to understand:

  • The purpose of the existing valuation, according to the report, was to help the owner plan for the future. If you review the actual report, you should be able to determine if the value was based on historical figures or on projections for the future. If projections were used, were they (and are they) reasonable? If historical figures were used, how did the valuation analyst arrive at the value?
  • Does the report reflect the practice’s debt, and does the value reflect the fact that you will be assuming a portion as an owner?
  • The valuator may or may not have assumed that the owner’s compensation would stay the same. How is the owner paid? Did the valuator add back part of the owner’s compensation because it represented profit, not compensation for the owner’s production or management services? What will be both the current owner’s and your compensation if you buy in?
  • Was part of the owner’s compensation paid in lieu of rent on the practice’s facility (which she owns) so that she could contribute more to a retirement plan? Or is rent artificially high to save payroll taxes for the owner? What rent will the practice pay after you buy in?
  • Does she have family members on the payroll and, if so, is their compensation reasonable? Or was part of it added back to the bottom line because it represented a method for taking profits out to help support a family member?

The valuator may have added back these kinds of expenses, thereby increasing profits on paper and the resulting practice value. Was the purpose of the planning to know what the practice was worth on the open market for someone who would be buying the entire practice and would have total control? Your situation is different. Someone buying 100% is likely buying only assets (equipment, goodwill, patient records, perhaps client accounts receivable, etc.) but not assuming the seller’s debt. You, however, will be buying only an undivided 20% interest in the assets and effectively assuming 20% of the practice’s debt. Therefore, unless the practice is debt-free (rare in this profession), your price must be lower than for someone buying just the assets.

In addition, you need to know if these changes on paper will actually be made (i.e., will the owner’s salary be reduced, will family members’ pay be at market rates, will practice rent represent fair market rent on the facility, etc.?). Because if these dollars are still paid as in the past, actual profits when you’re an owner will be less than those shown in the valuation report. That means your 20% share, after servicing the debt and paying these continuing expenses won’t be enough to service your debt to buy in at $480,000. And, since you’re buying only 20% of the practice, the owner still will have control to make these decisions. That’s why you should ask these questions now and be sure you have a signed owners’ agreement in place to document these decisions before you buy in.

A practice valuation can vary depending on its purpose

The moral here? Valuations are done for a variety of purposes, and depending on the reason, the value of the practice can vary significantly and still be correct. Valuations are done for purposes of buying and selling all or part of a practice, but also for strategic planning, estate or gift purposes, partner conflicts arising from bad owners’ agreements, liquidating a practice, etc. Depending on the purpose, the report might be valuing only assets (the things of value) or equity (which is the assets LESS the existing debt). Without knowing the purpose and how the figures in the report were determined, you can’t be sure the bottom line is appropriate for you.

Ask questions and/or hire your own expert before relying on any valuation report.

 

Interested in learning more about practice valuation? Check out VetPartners’ valuation resources.

 

 

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Lorraine List
Lorraine List is a distinguished lifetime member of VetPartners and a former co-chair of the VetPartners Valuation Council. She is also co-founder of Summit Veterinary Advisors, although she is now retired from the firm. Lorraine continues as an active member of the Valuation Council, assisting and spearheading new publications.
Lorraine List

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