Valuing a Professional Practice
The need to value a professional practice--whether a law firm, medical practice or other professional entity--may
arise due to any one of a number of events. Once a valuation need is
triggered, know what factors and methods are most important when
determining the worth of a business.
Common Events That May Lead to the Need for a Professional-Practice
Valuation
The need to value a professional practice may arise due to a wide range of
issues that may be business related or personal in nature. These valuation
triggers include:
- Negotiation of the sale or merger of the practice
- The purchase of another practice
- The addition of an equity member to the practice
- The entrance into or renewal of a buy-sell agreement with other practice members
- The retirement, death or disability of a member of the practice
- The dissolution of a partner’s marriage
Determining a Valuation Methodology
Several factors are typically considered in determining the valuation
methodology, as well as the resulting value, of a professional practice. The
method used generally depends upon the purpose for which the valuation is
being conducted. For instance, if a valuation is necessitated due to an
impending merger, there might be a synergistic value that would be higher
than the fair market value used for purposes of a divorce settlement.
Valuing a Practice’s Underlying Assets
Commonly, a fair market appraisal of the practice’s assets is the starting
point for valuing the overall practice. Assets fall into three broad
categories: financial, tangible and intangible. Financial assets include
not only cash but also work-in-process. Tangible assets include any real
estate owned by the practice, office equipment and the like. Intangible
assets include the practice’s client or patient base, its workforce and its
goodwill. All three categories must be valued fairly.
Measures should be taken to ensure that all of the practice’s tangible
assets are being accounted for at accurate values. The appraiser should look
not only at the practice’s balance sheet but also at other documents--receipts, depreciation schedules related to tax returns, etc.--to secure a
true picture of the assets’ worth. Note that balance sheet depreciation
schedules and purchase-related invoices reflect cost, not fair market value.
Intangibles, Including Goodwill
As might be expected, intangible assets are the most difficult to value.
Estimating the worth of a practice’s reputation, its position in the
marketplace, its location and its referral sources is a difficult task and
requires specialized expertise in the valuation of professional practices.
With established practices, goodwill commonly comprises a significant
portion of the overall value. (This is especially true in the valuation of a
medical practice.)
An appraiser needs to assess the practice’s unique characteristics to value
goodwill. These characteristics include the nature of the practice, its
location, the demographics, the practice’s fee structure, its staff, the
terms of its lease (if applicable), its malpractice exposure, etc. Once
these unique characteristics of the practice are weighed, the value of the
goodwill can be determined through the use of goodwill valuation formulas.
Dealing with Hidden Income
Depending on the particular practice, varying amounts of income may not be
fully reflected on financial statements or the practice’s tax forms.
Instead, substantial amounts of income may be disguised or hidden in the
form of fringe benefits or perquisites. Because the potential for hidden
assets is elevated in certain types of practices, it is important that the
appraiser identify and uncover any hidden income and/or assets in order to
discern the practice’s true value.
Conclusion
Due to the unique characteristics of a professional practice, an expert is
typically required in the valuation process. In the event you or your
clients require the valuation of an interest in a professional practice,
look to a qualified appraiser with broad experience in practice valuations.
This newsletter is provided by
Somerset for our clients and other interested persons upon request.
Since technical information is presented in generalized fashion, no
final conclusion on these topics should be made without further review.
For additional information on the issues discussed, please contact
Steve Riddle,
Tom
Thieme,
Rex Collins,
Ken
Stalcup or
Doug
Ayres
of our
Litigation, Valuation & Forensic Team.
This document is not intended or written to be used, and cannot be used,
for the purpose of avoiding tax penalties that may be imposed on the
taxpayer.
Somerset CPAs,
P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
www.somersetcpas.com
info@somersetcpas.com
