Why Should I Spend The Money To Get A Professional Appraisal?

Dear Jerry,

I am one of those many junior associates out here in the real world who is negotiating to buy a practice from an established OD.  We are on friendly terms, but it is not easy coming up with a value both sides agree to.

I just read the comments by Dr. Brian Kane on your blog site stating that, “After purchasing three practices in the past 10 years and using many different methods to determine practice value, we found the repeating value in each case was 67% of collected gross +/- 4%.”

Do you still agree with that?

If so, why should I, or any buyer for that matter, borrow money to pay for a professional appraisal?  Why not just multiply the gross revenues by 67% and use that number? 

Dr. Beyer in Birmingham

Dear Dr. Beyer,

Fair question!

Interestingly, the exact same question was posed in the January 2009 issue of DENTAL ECONOMICS. I liked the answer given by Dental Consultant, Gary Schaub.

He said, “The answer lies in the details.”  You simply don’t get the full picture when you rely on a rule of thumb percentage of gross revenues to determine practice value.

Disclaimer

Let me preface my answer with the disclaimer that although I have extensive experience in this area, I have been out of the practice appraisal business for over five years.

I have definite thoughts on why you should get a professional appraisal, but I don’t ‘have a dog in the hunt’ if you decide not to.

Ratio Of Appraised Value To Practice Gross

I did my own non-scientific study several years ago when Marilee Blackwell, MBA and I were doing a lot of practice appraisals for ODs.

I took our 20 most recent appraisals at that time and ranked them based on the ratio of the appraised value versus the gross revenues for the latest fiscal year of the practice.

For example, if a practice grossed $600,000 and appraised for $400,000, the ratio was 66% ($400,000 /$600,000).

The average ratio of appraised value to practice gross came out to right at 70%. Based on that number, I agree with Dr. Kane’s value of 67% + or – 4%.

Now, here is why I would NEVER advise a buyer to rely on that rule of thumb to determine a purchase price.

While the average ratio of appraised value to gross revenue was 70%, the range of the ratios was from 90% to 40%!

There are just too many variables that come into play for me to be comfortable recommending that you rely on a simple rule of thumb.

The Main Variable Is Net Income

A $600,000 gross practice netting 40% ($240,000) would be worth a lot more to me than a $600,000 practice netting 20% ($120,000). Yet, a rule of thumb based on gross revenues would make no distinction in their value.

That’s the main reason I think a good appraisal is worth every dime you spend on it. 

You should also know that I would NEVER rely on the seller’s Profit and Loss statement to accurately reflect what I call the ‘true net’. 

You need a good accountant, or an experienced appraiser, to analyze the seller’s financials and come up with the true profit picture. Once you know the real profit number, it’s much easier to determine what you can afford to pay for a practice.

Look Before You Leap

Before you jump into a big purchase, think about what you are doing.

You are signing a legally binding contract that commits you to pay hundreds of thousands of dollars for a small business. And you are depending solely on the future cash flow of that business to pay for the purchase.

Underpay and you can laugh all the way to the bank. But, overpay and you might struggle financially for years. I’ve seen it happen and it’s a terrible situation for a young OD to be in.

That's why I think the modest expense of a professional appraisal is money well spent, especially for first time buyers.

(Aside to my readers, the name Dr. Beyer is, of course, a pseudonym.) 

Regards,
Jerry Hayes, OD

Disclaimer: The information and opinions contained on this site are for discussion purposes only and are NOT intended to serve as legal, accounting or investment advice. ©2009 Jerry Hayes, OD. Not to be reproduced without written permission of the author.