Q&A with Larry McCormick, DVM MBA
Simmons Great Lakes
Q: Is a formal practice valuation important? I prefer to negotiate the lowest price I can from the seller without going to the expense of performing a practice valuation.
A: Short answer yes. You need to do your due diligence.
Various practice attributes, such as the clinic location, the affluence of clientele and quality of medicine practiced, may all be outstanding and provide support for your purchase considerations. However, such attributes do not provide insights on the profitability of the practice. Because there is a close relationship between practice worth and profitability, determining practice profitability is an important component of a practice valuation.
Profits are the financial return one receives from making an investment in business ownership. If the current practice operations do not generate the level of profit necessary to justify the seller’s asking price, then the buyer will be paying for practice potential. Buyers generally dislike paying for practice potential since in such situations, the seller is receiving credit, i.e., a portion of the sales price, for something that the buyer will make happen in the future instead of paying for what the current owner has already made happen.
In certain instances, you may want to consider having a Practice Purchase Feasibility Analysis (also called an Ability to Pay Analysis) performed instead of a practice valuation. In situations where the seller already has had a practice valuation performed, a second valuation performed by the buyer can become an issue of opinions –the seller’s opinion versus your veterinary practice valuator’s opinion). The feasibility analysis starts with the seller’s asking price and using actual practice financial data, attempts to determine whether sufficient cash flows exists to buy the practice and to maintain a reasonable quality of life after …
a) paying the normally expected operating expenses of the practice,
b) servicing all debt obligations incurred by purchasing the practice (& real estate if you are doing so),
c) accounting for an estimation of the buyer’s expected federal and state taxes, and
d) compensating you, the buyer, for your efforts as a practicing veterinarian and for your efforts in the management of the practice.
If the analysis is determined to be feasible, then the asking price is probably at fair market value. If the analysis is not feasible, then the analysis will help to prepare you to negotiate with the seller based on the facts and realities of what the seller has to sell. Going through the process is also a good education on how the practice is operated.
Valuation reports and feasibility analyses provide critical data needed to properly assess a potential practice purchase opportunity. Negotiating a price without making sure that it is grounded in the financial realities of the practice is risky and potentially very costly should the practice have less profitability than expected.