Purchase and Sale - Tenth Post

AF: Having dealt with the value of the practice, it is important to keep in mind that the purchase price will be based not only of the value of the practice but additional factors such as the timing of the practice in terms of whether the vendor requires an expeditious completion of the transaction; how the practice is to be financed; and what is included in the purchase price. As in the discussions which have taken place concerning associateships, many of the issues involved in a Sale/Purchase of a chiropractic practice are interwoven as part of a big picture. It would be foolhardy and quite impractical to deal with any particular issues such as billings or a purchase price without looking at other issues such as staff turnover, what assets are included or the patient base. As such, the topic of which have been dealt with previously may well be raised again in a different context or as indicated, in the "big picture."

What should be included in the transfer of a practice, and just as importantly what constraints do the parties have in dealing with assets of the practice?

It would appear to be trite to indicate that a vendor can only sell what a vendor owns. However that is not necessarily the rule that governs a commercial transaction. The better principle to work by is that a "vendor has the right to transfer any interest which he, she or it may have in an asset subject to any constraints which may be placed on that transfer." For example, with respect to a computer that a doctor may have purchased, he or she may sell the computer to a purchaser, if there is no lien placed upon the equipment; if the equipment is actually owned and not leased; and if the doctor is the owner as compared to a management company. In any event, even if the computer can be sold, it is surely also trite to indicate that the computer software cannot be sold B it can only be assigned pursuant to the software agreement which generally exists and governs the acquisition of the software by a person purchasing the software from a retail vendor.

If equipment is the subject matter of a lien by a lender such as a financial institution, it is imperative that the vendors ensure that the lien can be lifted prior to the completion of the transaction or by using the proceeds obtained at the closing of the transaction. Vendors obligate themselves to discharge such liens pursuant to the Agreement of Purchase and Sale. This principle likewise applies to equipment that is leased. If the purchaser is to assume the lease then the Vendor should ensure that the lease agreement can be transferred to the purchaser and at what cost prior to signing any sale agreement. The leasing company may require that the vendor purchase the equipment or "pay off" the lease prior to any transfer of the equipment.

If the equipment is owned by a management company then it is imperative that the Vendors ensure that the management company is a party to the sale agreement. A vendor would not want to be surprised, at closing, by a management company that he or she may not control which is unwilling to transfer the assets.

The Purchaser should review the practice location of the Vendor very carefully to ascertain what is to be included at the time of the closing of the transaction. The list of assets being transferred would include a comprehensive list of each assets and might include the following: receptionist desk, chair, reception shares, end table, pictures, filing cabinets, telephone system, radio, television, refrigerator, fax machine, photocopier, computer, assignment of computer software, exterior sign box and sign, treatment tables, view box, x-ray, developer, office desk, chairs, skeleton, fire extinguisher, smoke detector, plants. This list is by no means comprehensive. A purchaser would be well served by visiting the location at least twice to ensure that a comprehensive list of assets to be included in the purchase agreement was actually created.

With respect to assets such as an x-ray machine, photocopier, computer, etc., a purchaser should have a provision inserted in the Offer whereby the Vendor agrees that the assets will be in good working order on closing. While the assets should be in the same condition which existed at the time that the Offer was presented (with or without a clause requiring them to be in good working order) it is not uncommon for a purchaser to fail to examine and try all equipment prior to the Offer being signed. This is a clear example of when the principle "let the buyer beware" applies.

In addition to the assets previously mentioned, a purchaser should have specific regard to the following assets:

1. Patient Files: The files should be transferred to the purchaser in their entirety. This should include all old files (which may be used to reactivate a relationship between the doctor and a patient) in the possession of the vendor together with all x-rays relating to the files. The vendor should require that the purchaser maintain the records for at least 7 years after the completion of the transaction and in addition, the vendor should ensure that he or she has reasonable access to the files or a copy of them if required by law (this might include matters such as a malpractice claim; billing dispute; a licensing board issue; or an income tax audit).

2. Financial Records: In so far as the Purchaser might require financial records for the ongoing care of patients or the maintaining of the practice, the purchaser should obtain such financial records. Again, the vendor should ensure that he or she has access to the records as may be reasonably required and that such records are not destroyed except in accordance with the sale agreement.

3. Supplies: Any supplies which are customarily maintained at the practice should be included in the purchase price. The vendor should agree to maintain the level of supplies in its usual quantity.

4. Inventory: If the vendor maintains products such as orthotics, vitamins or back supports, the purchaser will want to ensure that they are being acquired at the cost that the vendor paid, and secondly, that the inventory is in merchantable condition, that is, that each of the products is saleable, ie. the packaging is in a proper condition and/or the product has not reached or is about to reach its expiry date. In addition, the purchaser will want to ensure that the level of the inventory of the vendor is maintained in its usual capacity.

5. The computer software will require, as indicated, an assignment of the software licence agreements. If such software is created by a particular software producer, the licence agreements should be reviewed carefully to determine whether there are any restrictions affecting the transfer of the software in addition to the cost associated with the transfer.

The Vendor should ensure that any assets which are to be transferred to the Purchaser are subject to a Bill of Sale being provided to the purchaser. If assets are leased then the terms and conditions of the leasing arrangements should be reviewed carefully and dealt with in accordance with the lease and the purchase agreements. It is most important that the Vendor review any appropriate documentation relating to the ownership and leasing of equipment prior to executing an agreement relating to the sale of a practice. Being surprised after signing an agreement can be an expensive enterprise.

From the position of the Purchaser the assets which are specified in the Agreement of Purchase and Sale must be in existence at the time of closing, in good working order and free and clear of all encumbrances. A Purchaser who has paid a significant amount of money for a practice will be loath to have to expend any further funds to equip the office, whether that involves the replacement or addition of assets. The fact that a Vendor has an extensive amount of assets is of little concern to a Purchaser who is generally concerned only with the amount of the purchase price and the ability to maintain the practice in its previous state after the completion of the transaction.

Purchase and Sale - Ninth Post

OTHER ISSUES

There are other approaches for the valuation of a practice, but they are generally used to confirm a value determined by another approach.

Other factors can enter into the valuation of a practice and make it more complicated. A major factor is the involvement of a corporation. With its inherent separation from the individual, income tax implications can enter into the calculation. Similarly, the allocation of the purchase price between tangible assets and goodwill can cause subtle or large changes in overall value.

Another factor is the effect of an associate or partnership arrangement. This may affect the ability to sell and, in the case of partnership, the income tax implications can affect the price.

The multi-disciplinary clinic brings its own issues. Will the potential purchaser be acquiring all aspects of the clinic? If so, there are different valuation issues for the other specialties.

Finally, consideration should be given to the potential for a "special purchaser" who perceives an even greater benefit and who may be willing to pay more than the average purchaser.

It should be evident to both potential purchasers and vendors that the value is a reflection of the practice as a whole. The illusion that a practice is worth a fixed percentage of historical revenue, regardless of the present circumstances, should give way to a clearer understanding of what factors really count in determining the value of a practice.


AMF:

The effort which is required to determine the value of a practice should take into consideration the fact that unlike real estate and commercial operations such as restaurants, and retail establishments the transfer of a professional practice involves to a very large extent the transfer of a practitioner's history as a doctor. The bottom line for any purchaser must be his or her ability to have earnings continue to be generated from the practice.

For a prospective vendor and/or purchaser the rumors, generalities, rules, policies, attitudes and guidelines involving the price to be paid for a practice abound in multitudes. "Everyone" has an opinion and "everyone" will provide guidance to a purchaser or vendor in terms of what he or she can expect to pay or receive from a sale of a practice. While it would be optimum to quote a textbook, study or economic principle that could be used as the guiding light for participants in a transfer of a professional practice relating solely to that of a chiropractor, alas, such does not exist to the knowledge of the writer.

If experience is any indicator of what transpires in the transfer of a chiropractic practice, (and having spent twenty-five years participating in the professional guidance of chiropractors) then generalities based upon experience may be the best indicator of what will result from the negotiations involving the establishment of the price relating to the transfer of a chiropractic practice. It is the experience of the writer that when all is said and done, and the experts have reviewed the practice to establish the sale price based upon billings, taking into account past revenues, receivables, equipment, leasehold improvements, etc., etc., etc., the parties ultimately will arrive at a value having regard to the billings. In the area of real estate acquisition it has been stated that the three most important factors in establishing the value of a property are location, location and location. In the area of practice valuations relating to chiropractic practices, the three most important factors are billings, billings and billings.

In addition, It is the experience of the writer that the parties must direct themselves to considering how revenue is generated from the practice. Obviously any general rule is subject to exception and should be adopted with careful consideration. No purchaser should be acquiring a practice for a "generally accepted" percentage of billings averaged over a number of years when the billings are decreasing.

However, just as important are the consideration which add to the discussion concerning the value of the practice in terms of the equipment, leasehold improvements and other assets. It is unlikely that a purchaser will be willing to acquire substantial equipment for a substantial price when such equipment does little to increase the billings of the practice. It is the position of the writer that historically, while a value is given to equipment and other assets, the value of the practice will be somewhere between 2/3 and 3/4 of a year's billings averaged over three years. From that starting point the value will go up or down depending on all of the factors which have been previously discussed including such matters as location, security of the lease, referral base, type of practice, turnover period, security of billings, name of practice, state of equipment, staff, financing by the vendor, etc.

For the purposes of establishing a value attributable to a chiropractic practice the golden rule can be enunciated in two words: "Status Quo" -- that being, "the more that can stay the same, the more the practice is worth!"

Purchase and Sale - Eight Post

EW: The conceptual framework for valuation of a practice has been examined in the previous article. We now look at practical approaches to determining value. They include: Net asset value, comparable market, and approaches based on earnings.

NET ASSET VALUE

This approach is used where the practice has wound down and there is no value beyond selling the equipment and other tangible assets. It is also used where the goodwill of the practice is of a personal nature, and therefore, not transferable or saleable. This personal goodwill represents the personal skills, techniques, experience and contacts of the individual chiropractor. Lastly, it is used in the valuation of a successful practice, going-concern, where the tangible assets are determined and valued separately from the goodwill.

Net asset value can be determined in a few ways. The simplistic approach would be to value the tangible assets (eg. Equipment, furniture, etc.) at their depreciated book value on the financial statements. This may be applicable where their value in use closely approximates book value. Often, adjustments have to be made to book value, either increasing or decreasing the value. An example of an adjustment would be for land and building, where they are included in the sale of the practice. They would have to be adjusted to reflect outside appraisal. Another type of adjustment may be to reflect costs of liquidation where a practice may be closing or be subject to a bankruptcy situation. In that situation, a purchaser could be acquiring someone=s used equipment at bargain prices.

COMPARABLE MARKET

This approach determines the value by comparing it to other practices that have been sold close to the date of valuation. Most of us are familiar with this approach, especially as it pertains to real estate. Unlike real estate, however, transactions involving chiropractors tend to be private and there are not many comparable practices for sale at any given time. Many times, practitioners will make reference to a practice which they have heard has been sold at a given price and suggest that they be entitled to at least the same since their practices are similar. Since there are a multitude of factors which affect the value (see previous articles), NO TWO PRACTICES ARE ALIKE!

Clearly, to be useful as the primary valuation approach, one needs a large sample of practices sold with all relevant factors addressed. Because of its inherent drawbacks, this approach is most often used as a reality check with which to assess a value using another method.

EARNINGS BASED APPROACHES

In all cases, earnings based approaches assume the continuation of the practice after its sale known as a going concern assumption. The purpose is to determine a price which will provide to the purchaser a return on their investment at a rate of return that is acceptable to them, given the risk inherent in the practice. To many this may appear odd, talking about a practice as if it were, say, an investment in stocks or mutual funds. However, one must use the same theoretical approach to purchasing this type of business or any other. That return on investment, as described in the previous article, is the expected cash flow that the practice is expected to produce in the future. Expected cash flow is most often represented by maintainable earnings. In other words, what level of revenue less expenses can be expected to occur in the future based on the existing practice.

Capitalization of Maintainable Earnings

In its most simplistic form, this method looks at historical profits over a period of years and adjusts those profits for unusual items. Those items could include removing salaries to family members, eliminating revenues from revenue sources which will not continue in the future and adjusting for conditions which will change with the sale of the practice. The profits would typically be averaged to come up with a figure for maintainable earnings. However, to use previous years profits, or use an average only apply if the historical profits are an indication of the future. A practice which is on the downswing or is suddenly incurring excessive expenses would not be assessed based on distant history. Similarly, a practice which is experiencing significant growth should not be penalized by sticking to outdated numbers. In those cases, the more recent profits are often an indication of maintainable earnings and would be used.

Once a maintainable earnings amount is established, it is then necessary to capitalize those earnings to determine a value. This process involves assessing the risk inherent with achieving the level of earnings and deriving a capitalization rate. In previous articles, we have listed many of the factors affecting risk. The capitalization rate is more often referred to as a multiple. Therefore, the lower the risk, the higher the multiple. Multiples can vary from 2 times to five times earnings depending on the risk and whether a salary for the practitioner has been assumed in the expenses. There are a number of variations of this method. Even so, it is still the most comprehensive approach because it encompasses the revenues and the expenses, as well as the assets.

Maintainable Fee Revenue

This popular method, in its most simplistic form, looks at historical revenues over a period of years and capitalizes an average at a rate which reflects risk in order to determine goodwill. Similar to the earnings method, revenue should be adjusted for non-recurring income and, often ignore historical revenue in favour of more recent relevant data, particularly where there have been recent changes in the practice. The capitalization rate which considers all the risk factors is calculated by percentage. The lower the risk, the higher the percentage. Utilizing this method, a value for a chiropractic practice could vary from 20% to 70% of annual maintainable revenue plus tangible asset value.

This method suggests that revenue is the key determinant of cash flow. It further assumes that there exists a constant relationship between revenue and that cash flow. Because of its simplicity, the maintainable revenue approach has become a "rule of thumb" for the valuation of many professional practices, including chiropractors. Its simplicity is also its weakness, because it ignores the fact that some practices may pay higher than average rent, or be more efficient with their overhead. Some may have associates to whom they pay a portion of the fees billed. Because of these deficiencies, this method should be used with caution and can be used as a reality check with a valuation based on earnings.

Purchase and Sale - Seventh Post

Goodwill

Thus far, we have been discussing a number of concepts and factors affecting the value of goodwill. In most cases, it comprises most of the eventual price so it is extremely important that both vendor and purchaser understand what type of goodwill has value. There are two types of goodwill: Commercial and personal. Because of the nature of professional practice, they often overlap and make valuation difficult.

Commercial goodwill is the goodwill which has value and can be sold or transferred to other parties. It represents the perceived benefit to prospective purchasers of getting into practice with an established office, existing patient base, staff and premises. It's value is in direct proportion to the ability to maintain the earning capacity of the practice.

Personal goodwill has little or no value and is not transferable or saleable. It represents the personal skills, techniques, experience and contacts of the individual chiropractor. The degree to which these factors cannot be emulated by a prospective purchaser will affect the ability to sell the practice. A typical example would be where a chiropractor practices a unique procedure that no one else does, including prospective purchasers. If this procedure is the only source of revenue, the practice will have no value for goodwill.

In looking at the conceptual framework for determining the value of a practice, a prospective vendor should be more aware of what factors determine that value and therefore implement changes to their practice to improve its ultimate liquidity and sale price. Prospective purchasers should have a better understanding of what elements to look for in a practice in order to find the right practice for the right price.


AMF: For both the Purchaser and the Vendor it is important to keep in mind the bottom line B how much is being paid and how much can be retained after the payment of debts, including taxes.

The Purchaser must remain concerned about the ability of the "asset" being able to generate the income which has been represented to have existed at closing by the Vendor. Was there "value" to the "asset". All things being equal, the Aasset@ should be able to provide income which has been anticipated by the Purchaser to be derived by the practice after closing.

Empirically and by anecdotal discussion with purchasers, there is no reason why the billings generate previously by a practice cannot be maintained by the purchaser with a "drop off" rate of no more than 15%. The drop in patient income after closing should be able to be maintained at an amount not less than 10%. In order to accomplish this fact, the Purchaser must be in a position to maintain the "goodwill" after closing as it had been maintained prior to the transfer of the practice. The status quo is the most vital part of a practice in that the less that is changed the better. There is a sense of security for a patient who attends an office and is able to be assured that things will remain the same in terms of staff, location, treatment technique, billings and other office protocols.

There is danger to making any immediate changes to the practice which will cause a patient to question whether the "office" has changed to an extent whereby the patient is content to seek care elsewhere. This includes the addition or replacement of equipment or furniture.

There will always be some "drop off" by patients who are members of the Vendor's immediate family or for some reason may have a relationship with the Vendor which will result in the patient remaining with the Vendor after closing notwithstanding the non-competition and non-solicitation provision. The Purchaser should recognize that these patients exist and should ascertain from the Vendor the extent of the list and how it will affect the future income of the practice.

A practitioner should keep in mind that as long as there is a purchaser willing to pay for that portion of a chiropractic practice which exceeds the actual value of furniture, equipment and leasehold improvements (whether that value is established by replacement cost, undepreciated value or actual cost) goodwill will continue to be an asset which can be created, maintained, bought and sold.

Purchase and Sale - Sixth Post

The next issue which will be considered by the parties is the type of practice being carried on by the Vendor. Does the Vendor carry on a particular type of practice which may limit his or her marketability? For example, if the chiropractor practices acupuncture or is a naturopath or has some particular expertise, ie. a sports fellowship or predominantly deals with paediatrics or geriatrics, the marketplace with respect to a potential Purchaser may shrink. The more specialized the practice the less potential Purchasers that may be available to acquire the practice. The greater the marketability of the practice the greater its value. Inevitably, the Vendor and Purchaser must be compatible in terms of their practices.

While it will be difficult if not impossible for a practitioner to change his or her practice technique in the time available for a transition of a practice, it may be beneficial for a Vendor to bring to a practice another practitioner who is in a position to assist the practice for the purposes of making it more saleable. Such would be the case in the event that the chiropractor is also a naturopath and is only able to sell the practice to a chiropractor who does not have dual licensure. The Vendor could enter into an associateship agreement with a naturopath to assist a Purchaser is acquiring the practice and maintaining the clinic's ability to provide care outside of the knowledge of the Purchaser.

For the purposes of establishing a value to the practice, it will be necessary to ascertain the basis from which patients are derived. Are the patients referred to the clinic from a source which may not exist after closing (ie. a relative of the Vendor)? Do the new patients come from an internal referral source (ie. existing patients)? If such is the case, the goodwill is of more value than a source of patients which will disappear after closing.

What are the billing practices of the Vendor? The Purchaser will be stepping into the shoes of the Vendor so he or she must be prepared to assume the same billing procedures of the Vendor. This applies to issues concerning what the Vendor bills in terms of quantum together with any policies that might exist in terms of discounts to students, children and seniors, and any credit policies which the Vendor may have.

Any Purchaser who alters the policies concerning billings to patients, or for that matter any office issues including office hours, methods of practice or even the office design does so at his or her peril. Again, any change in the status quo is an invitation to disaster.


EW: In the previous article, some of the factors in determining the price were addressed. Since value ultimately results in a number, taking those factors into consideration, how is value established?

First, it is imperative that both vendor and purchaser have an understanding of what value really means. After quickly suggesting that it means the worth of something, an examination of some valuation concepts will provide greater clarity to the determination of value.