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Issue #18 - 4.24.07
Establishing a Baseline Practice Value for your Associate
Many of you are thinking about recruiting an associate and eventually offering them an opportunity to become your partner. When is the appropriate time to determine the value of your practice? If you plan to offer a partnership within the next few years, we recommend that you prepare a practice valuation within the first year of employment. We’ve often heard complaints from associates who have worked for several years and now being offered a partnership opportunity at an inflated price, since the practice valuation was prepared at the time of the partnership offer. In this scenario, does the associate want his/her contribution to the growth of the practice added to the value? The answer is a resounding NO! In these cases, we have seen many qualified associate candidates declining their partnership offer when the entry price appeared to be too high. If you are in your late 50’s or early 60’s, this scenario could have a major setback on your practice transition plans. Therefore, to avoid this potential disaster, we recommend establishing a baseline within the first year of employment.
Since there is a great deal of time and effort spent by the host doctor in the first year of employment to mentor the associate and in many instances providing them with a guaranteed salary in the early months of affiliation, it is fair to value the practice at the completion of the first year of employment. If, on the other hand, the partnership will commence in the first year, then establishing the baseline value prior to the associate’s employment is appropriate. If you do the math, most valuations include a calculation based upon three to four years of historical revenue data, so from the associate’s perspective, the inclusion of the their first year’s contribution in the baseline valuation should not skew the numbers too much. When using an approach, at the time for the partnership begins, you’ll update the valuation to reflect current economic conditions. In our opinion, this method minimizes any disincentive for the associate to work hard and help your practice grow without being penalized for his/her efforts. If you have done your financial homework, associate profit margins after the first year of employment should be 30 to 35%. If not, there is something wrong with your economic equation.
Updating the Baseline Value
All practice valuation consists of two classes of assets – Intangible Assets and Tangible Assets. Intangible Assets include goodwill, restrictive covenant, telephone number, location, namely all things you cannot see, feel or touch. Tangible Assets include dental and office equipment, technology, supplies, instruments, and sometimes-leasehold improvements. Once your baseline valuation is completed, you can easily segregate the practice’s value into these asset categories. First, add up all of your Tangible Assets from your practice valuation. This will give you the value of your Tangible Assets. Next subtract that total from your practice value and you’ll arrive at the value of your Intangible Assets.
Doing the Math
When it’s time to update your valuation, you’ll adjust the Intangible Assets by the Consumer Price Index (CPI) to factor in the effect of inflation on the value from baseline valuation to the update period. This does not result in a real increase in value, rather an acknowledgement that we have inflation in our economy. For example, $ 1.00 today does not purchase as much a $1.00 did one year ago. Not to consider this fact results in the host dentist discounting the practice’s value from a time value of money perspective. This can be significant if the time frame from baseline value to update value is several years! For example, if the update was prepared in 2006, and the baseline valuation occurred in 2004 you would calculate the effect of inflation over that 2-year period. To calculate this number we refer to the Bureau of Labor Statistics “Inflation Calculator” to update the Intangible Asset value. Tangible Assets are updated differently simply by re- appraising their value which is attributed to additional “wear and tear” over that period. If additional equipment or technology has been purchased since the baseline, you’ll add these assets to the Tangible Assets. We’ve listed an example below to illustrate our point.
| Updating Your Valuation | |
|---|---|
| Practice Value 2004 | $490,000 |
| Intangible Assets | $420,000 |
| Tangible Assets | $70,000 |
| Re-Value in 2006 | |
| Intangible Asset Value (3.3% CPI per year) | $448,237 |
| Reappraise Tangible Assets | $62,300 |
| Updated Value | $510,537 |
Summary
By setting a baseline value, you’ll show your potential partner that you are trying to establish an environment where fairness will be the operative word in your relationship. Throughout my years of consulting, the root cause of most partnership failures has been disagreements over money. So, begin your partnership the right way by placing your economic cards on the table to create a win-win relationship.
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