Considerations in Practice Valuation

1
Considerations in Practice Valuation

• A Quick Dirty Method of Practice Value
  Estimation
• John G. McDaniel, OD, MLHR
• President
• Waugoo Consulting Group

2
Introduction

• About myself John McDaniel, OD, MLHR
• About Waugoo Consulting Group, LLC
• Contact information
• JMcDaniel_at_WaugooConsulting.com
• 614-352-4423

3
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

4
DIY Valuations?

• Can some of these be done yourself?
• In my experience, only one the quick and dirty
  (QD) 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
• QD estimation is a simplified version of the
  industry market multiplier method used in full
  blown appraisals

5
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 dont 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

6
QD Estimation

• 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?

7
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

8
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

9
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

10
Calculate Weighted Mean GR (?GRWT )
11
Calculate Weighted Mean GR (?GRWT )

• Enter the GR for each year

12
Calculate Weighted Mean GR (?GRWT )
13
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

14
Calculate Weighted Mean GR (?GRWT )
15
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

16
Calculate Weighted Mean GR (?GRWT )
17
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

18
Calculate Weighted Mean GR (?GRWT )
19
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)

20
Calculate Weighted Mean GR (?GRWT )
21
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

22
Calculate Weighted Mean Growth Rate
(?GrowthRateWT )
23
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?

24
Calculate Weighted Mean Growth Rate (?GRWT )
25
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

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Multiplier Selection Growth Rate
27
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

28
Calculate Weighted Mean Net Income as a of GR
(?NetIncGRWT )

• 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

29
Calculate Weighted Mean Net Income as a of GR
(?NetIncGRWT )
30
Calculate Weighted Mean Net Income as a of GR
(?NetIncGRWT )

• 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/GRNetIncGR
  )
• Create weights (WT) similar to before
• Multiply the WT x NetIncGR
• 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?

31
Calculate Weighted Mean Net Income as a of GR
(?NetIncGRWT )
32
Multiplier Selection Net Income
33
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!

34
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 doesnt take the real potential into
  consideration
• Yup, and that is how it should be price based on
  past performance
• Dont 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 doesnt take into account ______ (AR,
  AP, staff, location)
• Yup this is why this is an estimation still
  need real/full blown valuation/appraisal

35
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

36
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_at_WaugooConsulting.com
• Phone [phone]
• Thanks to all of you for taking the time to
  listen!
• Questions???