What Kind of Practice Appraisal Do You Need?

Jim Stephenson, DVM ~ Simmons Northeast

This discussion is a focus on business (practice) appraisals but many of the premises can be applied to real estate appraisals as well.

Optional formats exist for practice (business) appraisals, depending on your need, (purpose of the appraisal), your budget, and your time frame. Variation also exists in the “standard of value”, required in a particular appraisal situation and premises of value applied. So, depending on your need and the situation there are several kinds of appraisals. All appraisals should aspire to follow specific standards for minimum acceptable format as dictated by the established business appraisal organizations, the most common such standard being the USPAP (Uniform Standard of Professional Appraisal Practice.

– Appraisal formats generally are in one of four formats:

1. Preliminary (Advisory)
2. Oral
3. Letter Form Written Appraisal (short form “informal”)
4. Formal Written

– The purpose of the appraisal and structure of ownership may require different kinds of appraisals since the standards of value will vary:

1. Fair Market Value
2. Investment Value
3. Fair Value
4. Intrinsic Value

– Even further variations in the type of appraisal you might need are based on premises of value. The premises of value typically used are:

1. Liquidation Value
2. Going Concern
3. Assemblage of Assets

So how does this apply to you? First, what is the purpose of the appraisal? Most often it will be to buy, or sell a practice.

Other reasons for wanting an appraisal commonly seen are:

1. Potential litigation issues involving a split of a partnership or shareholder dissolution
2. Impending Divorce
3. Estate settlement
4. Buy-Sell agreements among shareholders/partners
5. Mergers and Acquisition

For this discussion we will focus on the purpose of most of the appraisals requested – for the purchase or sale of a practice.

Practices that are either being bought or sold on a 100% ownership basis will almost always be based on the standard of value referred to as the Fair Market Value. This standard is well defined by the IRS as, “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

The usual exceptions to this are those practices purchased by an entity that may have a perceived value of the investment (practice) based on his or her own investment requirements, perceived synergy or other strategic advantage, or unique aversion to risk. This is called Investment Value. A good example of this kind of buyer is the consolidator, (such as VCA) who in buying a strategically located practice or having multiple practices could achieve some market dominance and/or economy of scale that provides greater return than could the average investor.

In the event the practice has become vacant, but all the functions and features of the practice are in place and ready to go there is a value on the fixed assets of the practice referred to as Assemblage of Assets. Although this is rare, it may happen in the event of a death or disability of the owner/veterinarian. Another variation the appraiser faces is whether to value the assets, or the equity (stock) of the practice.

How do you know what kind of appraisal to get? Generally speaking, you probably won’t know until you have discussed the purpose and the practice at hand in some length with the appraiser. Although sometimes outside parties, such as judges, may mandate the type of appraisal required, the selection of which standard and premise of value is what the appraiser is trained to do. It is helpful to realize that variations may apply to different situations and there is not necessarily a “one size fits all” appraisal.

What is more applicable to those seeking an appraisal is the format of the appraisal. Depending on your needs, you may not need a full, formal written appraisal. In some instances a comprehensive appraisal with a verbal report is sufficient. Or in some instances even a limited or preliminary appraisal presented either orally or written on an advisory basis will suffice. The following scenarios may help you understand what format of appraisal will be sufficient.

Case # 1: Buyer looking at a practice to buy. The seller had appraisal performed by his/her appraiser a couple of months prior.

Does the buyer need a full, separate appraisal?? Not necessarily. A Preliminary (advisory) appraisal will suffice in this case. Most appraisers can provide a review of the existing appraisal if the seller’s appraiser has (or will) release the appraisal for outside review. From this, rather than working to come to an exact number from which much debate is sure to arise, a conclusion as to the reasonableness of the seller’s appraisal can be determined. Examination of the required debt scenarios can be undertaken in this exercise to validate the results in regard to feasibility. Thus a justification of the selling price can be determined within the format of this type of appraisal. If the buyer’s appraiser looks it over and says it stinks, (but you still want to pursue the purchase) be prepared for your appraiser to do a more complete appraisal and to debate the value on your behalf.

Case # 2: The seller thinking about selling, but does not have a specific buyer nor is the practice on the market.

A preliminary appraisal may be all that is needed in this case. A preliminary appraisal will give a range of values and provide reasonable expectations of market reaction to those values. Such an exercise requires the same basic analysis but not the refinement necessary to reach an absolute single value. This type of appraisal is good to temper expectations and helps plan or position the seller for an up and coming or future sale. There is also much to gain in regards to benchmarking your expenses and may help the seller improve management in certain areas to enhance the profitability or growth of the practice.

Case # 3: Seller looking to sell a partial interest in the practice to an existing associate.

Typically the seller in this scenario will seek a full written formal appraisal that is well articulated and can be followed by the buyer and reviewed by the buyer’s consultant. In some instances the appraisal is jointly secured by the buyer and the seller. In this case the appraiser represents the appraisal and not either party. If the buyer and seller each seek their own appraisal through a negotiation representative (appraiser/broker) the representatives can usually negotiate the price based on their expertise and findings without a formal full written appraisal. However, substantiation of any values brought to the table must be available and thus at least the equivalent of a limited appraisal will typically be performed by both negotiating representatives.

Case # 4: What if it’s a graduated buy in/sell out?

At each level of the buy in/out at least a limited, written appraisal following the basic standards and premises of the original appraisal should be undertaken. If agreed to by the parties this can be done by a single appraiser, ideally the same one that provided the original one. Many buy/sell clauses in shareholder agreements provide for a simple buy/sell agreement as a percentage of revenues. There may be significant pitfalls in such an approach since rarely does a practice value change consistently with the gross revenues.

Case # 5: The practice has lost most of the clients based on illness or lack of attention by the owner/veterinarian. Owner/veterinarian wants to sell.

The best bet here would initially be a preliminary appraisal presented orally. From here a determination can be made as to the best premise of value to use, and either a limited or full formal written appraisal can then be provided to assist the owner in liquidation of the assets.

Many other scenarios exist. Mergers and acquisitions may require the appraisal based on investment value of several practices as a combined entity. Death of the primary owner/veterinarian may dictate a Fair Market Value appraisal of a practice with only an estate as the owner, either for sale, or in some instances, for estate settlement and probate courts. Etc., etc.

The key point is that different kinds of appraisals are appropriate for different situations. The costs of the various approaches vary tremendously. Although pricing the different kinds of appraisals and representations are not the purpose of this presentation, hopefully you can proceed in a dialogue with your prospective appraiser/representative knowing there are options, some are more appropriate than others, and the cost and billing structure may vary tremendously.

For a printable PDF click ~ What kind of practice appraisal do you need?

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