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Optometric Practice Appraisals

Michael Bacigalupi, O.D., Assistant Professor

Michael Bacigalupi, O.D., Assistant ProfessorWhether you have been in practice for 20 years or you have just graduated from Optometry school, you may have to read and understand an optometric practice appraisal.  This can be a daunting task.  Practice appraisals do not follow a single format.  They vary according to the appraiser.  But, by understanding the methodology of the major appraisal techniques, you will be able to understand these critical reports.  After all, whether you are buying or selling, the appraisal can impact your pocketbook!

There are a growing number of experts in the marketplace that are happy to assist you with creating a practice appraisal.  These experts range from practice brokers to lawyers to retired optometrists.  They all lay claim to the field of optometric practice appraisals.  But, no matter who does the work, they will all produce a report that defines the tangible and intangible assets of a practice. 

Tangible assets are hard assets such as optometric equipment, furnishings, computers, and supplies.  These are the things that a bank could sell if you happen to default on a loan.  The intangible assets are the soft assets such as the practice reputation, community standing, and goodwill.  These are the things that a bank would not be able to sell if you default on a loan.  Therefore, banks will not loan money to purchase these assets but that is enough about practice financing.  That might be the topic for another article. 

Tangible assets are the easiest to appraise.  The appraiser’s goal is to determine a current “fair market value” for each item within the sale of the practice.  For example, how much is a Topcon SL-7E slit lamp worth in today’s market?  Or, how much is a 2000 model Dell computer with a 17-inch monitor worth in today’s market? (Not much.)  Ophthalmic equipment dealers will provide lists of values for each of your items.  But keep in mind, the value that they place upon the item will likely be what they are willing to pay for that item.  Essentially, this is a wholesale value.  An alternative to this wholesale pricing is to look on-line at what used ophthalmic dealers are offering.  On their websites and even on Ebay, you will begin to see retail prices for used equipment.  Look at the way that the appraiser obtained the “fair market value” for the equipment.  Are these values retail values or wholesale values?

Intangible assets are more difficult to appraise.  There are a myriad of formulas and philosophies that permeate the industry.  In this area, the experience and trustworthiness of the appraiser becomes very important.  Goodwill, practice reputation, and covenant not to compete are all part of the intangible assets. 

There are multiple methods for practice appraisal including; comparable sales method, multiple earnings method and the asset method.  Because the asset method is the most commonly used appraisal form this will be the one addressed here. 

The asset method takes into account the items typically seen on a balance sheet: assets and liabilities.  In addition, the asset method assigns values to goodwill, records, and covenant not to compete. 
The assets of the practice will include the ophthalmic equipment, the furniture and leasehold improvements, the inventory, the records, and the accounts receivable.  As mentioned earlier, it is a fairly easy process to determine the market value for the equipment and furniture.  But, inventory value is not quite as easy. 

Fair market value for inventory is determined by subtracting an aging factor from the initial cost of the inventory.  The aging factor is typically 10 % unless the frames are old.  A good rule of thumb is to use a 10% aging factor if all of the frames are current and an additional 10% reduction for every 6 months of age that a frame has been displayed.  So, a frame the is current and less than 6 months old will be ‘aged’ 10% while a frame that has sat for 18 month will be ‘aged’ 30%. 

The values of each patient record or file will vary from $3.00 to $5.00 per chart.  The variability in value is determined by the practice’s average gross sales per patient.  The appraiser will look at the gross sales per patient for the practice and compare this to the national average.  Currently, the national average is $225 to $250 per patient.  So, if the practice being appraised has a sales average of $275 per patient, then their records would be valued up near $5.00 per record.  Once this value is assigned, the appraiser will simple take the number of comprehensive exams for the past three years and multiply that number by $5.00 to determine the total value of the records.  There is rarely a need to go through each file individually. 

Accounts receivable (AR) is a tricky subject.  If the seller of the practice wishes to sell the accounts receivable, then the value of this asset is based upon the collection rate.  This value is typically 60-75% of the account balance depending upon the age of the accounts.  It is recommended that AR not be purchased.   The selling OD should make every effort to collect on any debts they are owed and let the purchasing OD start with a ‘clean slate.’  Aggressive attempts to collect back debts by the selling OD could potentially damage the reputation of the practice for the purchasing OD.  Therefore, an agreement must be made before any collections are attempted.  If AR debts are not collected within 180 days from the date of a practice sale, it is unlikely that they will ever be collected.  So, the selling OD will often be willing to let the purchasing OD keep any of these debts once this time period expires. 

When the assets have all had values assigned to them, the appraisal will look something like this.

Assets:  
Ophthalmic Equip $76,040.00
Furniture & Leasehold Improve $16,140.00
Inventory $37,240.00
Records $19,750.00
Accounts Receivable $0
Total Tangible Assets $148,170.00

Liabilities for an optometric practice can include; office taxes, accounts payable, and other outstanding liabilities.  These are easy to determine by evaluating the financial statement of the practice.  Most established practices will have little or no liabilities with the exception of new equipment purchases.  When the liabilities have been uncovered, the appraiser will list them and subtract them from the assets.

Liabilities:  
Office Tax Liabilities $0
Accounts Payable $0
Other Liabilities (OCT instrument) $5,000
Total Liabilities $5,000
   
Total Assets – Total Liabilities $143,170.00

The intangible assets are difficult to value.  Goodwill is “the expectations of future profits under the ownership of someone other than the present owner.”   According to the Internal Revenue Service, “Goodwill is based upon earning capacity and its value, therefore it rests upon the excess of net earning over and above a fair return on net tangible assets…such factors as prestige and renown of successful operation over a prolonged period in a locality may be included in tangible value.”  The American Medical Association simply defines goodwill as, “the opportunity to take over the health care of a seller’s patient base.” 

There are 3 recognized formulas for determining the value of goodwill in an optometric practice.  The first is simply calculating 25% of the last year’s gross sales.  The second method is calculating 25% of the average of the last 3 year’s gross sales.   The third method is a qualitative analysis.  This is a series of value comparisons for the practice being appraised as it relates to the current market.  The appraiser will assign a value of +2, +1, or 0 to each of these evaluations and then sum these values.  The total of these values represents the percentage that will be multiplied by last year’s gross sales.

QUALITATIVE ANAYLSIS OF GOODWILL:
Gross trend +2
Net/Gross Ratio +2
Location +2
Competition +1
Recall effect +2
Fee structure +2
Staff efficiency 0
Lease terms +2
Work/life ratio +1
Turn Key +2
Community +2
New Patient Ratio +2
Office System +2
Similarity of buyer/seller +2
Seller’s reputation +2
Quality of records +2
Primary care/specialty +2
Growth potential +1
Employee retention +2
PR program 0
Affect of Managed Care +1
   
TOTAL: +33

AVG. GROSS X 33%=QUALITATIVE GOODWILL VALUE

The Covenant not to Compete agreement must specify time and distance.  Only a reasonable amount of time and distance will be enforceable in court.  For example, to say that the selling OD can not practice within the State of Florida for the next 20 years would be unreasonable in both distance and time.  But, if the Covenant specified that the selling OD could not practice within a 5 mile radius of the practice for the next 3 years, this is much more reasonable and likely enforceable.  Covenants are typically calculated as 10% of the last year’s gross production of a practice. 

The asset method report that will be generated by the practice appraiser will look like this.  Now you know what each of these items represents and how these values were calculated.

Assets:

  
Ophthalmic Equip $76,040.00
Furniture & Leasehold Improve $15,140.00
Inventory $37,240.00
Records $19,750.00
Accounts Receivable $0
Total Tangible Assets $148,170.00
   

Liabilities:

  
Office Tax Liabilities $0
Accounts Payable $0
Other Liabilities $5,000
Total Liabilities  
   
Total Assets – Total Liabilities $143,170.00
   
Intangible Assets:  
Goodwill $106,777.00
Covenant not to Compete $45,795.00
   
ASSET METHOD FAIR  
MARKET VALUE: $295,742.00

When looking at any practice or appraisals, look for trends.  Is the gross income going up each year?  Has it reached a plateau?  Have the operating expenses increased proportionate to the increased gross sales?  Are the expenses in line with the national averages?  Has the net income continued to grow at a reasonable rate?  Is the net acceptable for your cost of living?

Consider that a change in ownership will cause a change in the business.  National averages suggest that a new owner will result in a 10% to 30% reduction in the gross in the first year, so consider this when looking at how much debt service you will be taking on.  Remember that these numbers are just an average.  Some practices experience no loss of income.  Look into the transferability of insurance plans or the process of being credentialed.  Remember that a plan will not pay you until you are credentialed.  So, if it takes 3 months to “get on a plan,” think about the lost income that this represents.  Look at the community and the ophthalmic market.  Is the area growing?  Is their new competition coming to the market? 

Hopefully you will be able to utilize this information to help make sense out of the next practice appraisal that you read.  Remember, appraisals are not an exact science so do not hesitate to ask for clarification or justification for any findings.

Michael Bacigalupi, O.D. is an Assistant Professor at NSU College of Optometry in Fort Lauderdale, Florida. He can be contacted by email at bacigalu@nsu.nova.edu.

 

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