How Much is Your Practice Worth? CVMA Practice Value Estimate

New for 2007, practice owners who respond to the CVMA Practice Owners’ Economic Survey in their province will receive a Practice Value Estimate with their personal Practice Diagnostic Report. The Practice Value Estimate will be based on information from the practice financial statement and Practice Owners Economic Survey to give an estimate of the veterinary practice’s worth based on cash flow.

Whether the veterinary practice is for sale or not, an estimate of value is important for retirement planning, future partner buy-in, and as an ongoing measure of the overall practice success. If the practice is succeeding financially, the Practice Value Estimate will increase each year.

Approaches to valuation

Practices may be valued using 1, or a combination of 3 valuation approaches:

• Market Approach

• Asset Approach

• Income Approach

The Market Approach is the method used to value many houses. To arrive at the value, one looks to similar houses (or veterinary practices) in the area and sets a value based on “what the other guy got.”

The Asset Approach estimates a value of a veterinary practice based on the value of all the assets, including goodwill.

The Income Approach is based on the cash flow of the practice. Under the Income Approach, the value of a practice will depend on how profitable the practice is. The buyer pays himself/herself a fair market wage and whatever is left over determines the value of the practice. Assume a practice owner wants to sell his/her practice. The practice has a gross revenue of $500 000 and the owner earns $170 000 net income per year. If the owner is prepared to earn $70 000 as a replacement wage (the wage that an experienced associate or locum would earn), the practice has $100 000 profit or cash flow at the end of each year. If a potential buyer expects to pay off a loan to buy the practice in 4 years (under the assumption of average risk), the value of the practice using the Income Approach is 4 times the profit each year — $400 000.

Mr. Paul Ray (left) from Schering-Plough and CVMA past-president, Dr. Paul Boutet. Schering-Plough is a sponsor of the CVMA Business Management Program.

This method is based on the assumption that, like any other investment, the price a purchaser is willing to pay for a veterinary practice is determined by the size of the anticipated financial return. The magnitude of the return, the potential for growth, and the risk of return all drive the value of a veterinary practice.

The Practice Value Estimate provides an estimate based on an Income Approach only. The term “estimate” is used because the Practice Value Estimate will focus only on the magnitude of return — the value of the future income available to the practice owner. The Practice Value Estimate includes equipment, but does not include real estate or inventory.

The Practice Value Estimate is calculated (and limited) by the financial statement and information provided to make necessary adjustments to the financial statement. Adjustments are made to financial statements to account for income splitting, personal use of auto, ownership of building and property, and other personal deductions from the practice that would cloud the financial results. The interpretation of the adjustments to the financial statement may result in an estimate of value that could differ from one prepared through a more thorough process by a qualified veterinary practice appraiser.

The Practice Value Estimate assumes an average level of risk. Several practice characteristics like location, client demographics, facility, and equipment quality could influence the risk associated with a practice purchase and, in turn, influence the value. These and other factors that affect the risk of the investment are not explored.

The Practice Value Estimate is designed to give an estimate. A more accurate practice value can only be determined by a qualified practice appraiser. For purposes of 3rd party financing, a valuation report completed by a qualified appraiser is required.

To help put the Practice Value Estimate into perspective, it is presented as a percentage of gross revenue. Anecdotally, practice value has been expected to be between 2/3rd’s of gross revenue and 100% of 1 year’s gross revenue. Often, practice owners will blindly offer that their practice is worth anywhere between 2/3rd’s and 1 year’s gross revenue. Many practice owners will be disappointed when they receive their Practice Value Estimate.

Figure 1 shows the average 2006 Practice Value Estimates for companion and mixed animal practices across Canada. The Practice Value Estimate was calculated based on average gross revenue, expenses, and replacement wages, based on the 85th percentile for associate wages in each province. The level of risk was assumed to be average, and in each circumstance, it was assumed that the practice purchase price would be paid off in 4 years.

Figure 1.

Increasing the value of your practice.

In every province, the average practice value estimate is nowhere near the expected figure of 100% of gross revenue. The average for companion animal practices ranged from a low of 35% in British Columbia to a high of 53% in Ontario. The average Practice Value Estimate for mixed and large animal hospitals ranged from a low of 34% in Nova Scotia to a high of 69% in Prince Edward Island. In fact, only mixed and large animal practices in Prince Edward Island have a practice value estimate higher than the sought after 60%. Why is the difference between actual and expected Practice Value Estimate so great? Because the Practice Value Estimate is based on profit, it is affected by low revenues, high expenses, and unproductive hours.

When a homeowner wants to sell his/her house, he/she will usually paint it, fix up a couple of things that needed to be done during the last 5 years, and spit and polish the taps. Similarly, practice owners can increase the value of their practice by making a few changes.

Increasing revenues can directly affect profit and, therefore, affect the Practice Value Estimate. By using the example mentioned previously, if the average veterinary practice earning $500 000 gross revenue kept expenses constant and increased fees by 10%, revenue and profit would increase by $50 000. Because the Practice Value Estimate is profit multiplied by 4, the value could increase by $200 000 in 1 year. Any increase in profit adds 4 times the value of this increase to the estimated value of the practice.

Another way to directly affect the Practice Value Estimate is to reduce expenses. Every dollar of reduced expenses is $1.00 of increased profit. With the 4 times multiplier, a reduction in expenses of $1.00 increases the value of the practice by $4.00.

A 3rd way of increasing the Practice Value Estimate is by boosting productivity. If a practice owner could reduce his/her hours worked and not affect revenue or profitability, the value of the practice could go up. Suppose a veterinary practice owner was able to generate the same revenue with a reduced schedule, for example, by reducing his or her hours by 5 hours/week, he or she would save 250 hours/year. If the owner’s fair wage was estimated at $40/h, the practice would be saving $10 000, increasing the Practice Value Estimate by $40 000.

Like the homeowner, spit and polish and a fresh coat of paint will help with the curb appeal, but the bank will want to see that the potential buyer can pay back the loan. Ultimately, it all comes down to profit.