The Value of Valuations

Our first article in this series discussed various types of business reorganization and expansion models, including mergers, acquisitions, horizontal and vertical integration, and takeovers. The discussion provided a global view of opportunities for the audiology practice owner. As proprietors are well aware, global perspectives are interesting for general discussion but provide little guidance regarding details of the many factors comprising a transition.

This article addresses valuations. At first, valuation appears to be easily quantified but in the end, it is a source of endless discussion and compromise. Valuation, as the term implies, is the value placed on your practice using method(s) acceptable to the negotiating parties.

It is common for individuals to anticipate the value of a product or service using educated guesses, ''gut'' instinct, or emotive responses. For example, the color or style is pleasing to an individual and therefore, the product has more intrinsic value to that person. As a group, these non-scientific estimations are determined by some heuristic assessment (Heuristics can be defined as a shortcut to reasoning often used by people in decision-making). The process often leads to systematically erroneous judgments or biases.

There are a number of methods for determining the value of your audiology practice.

The most basic method is to use heuristics as your guide. For example, ''I've worked hard for many years to build this impressive and important practice, my business has a value of X dollars''. Although this reasoning may provide a valid price by either serendipity or following the good fortune of locating a prospective buyer using a parallel set of heuristic determinants, the probability of either occurrence is extremely low, rendering this method unreliable.

Another method is to ask your accountant or financial adviser to perform an assessment of value. Their professional expertise provides some credibility to the valuation. However, any sophisticated buyer would likely question a bias toward the assessor's client [you], the exact method(s) used for determination and the overall reliability of the assessment regarding a probable/possible bias.

A more formal process to determine the value of your practice enlists a professional valuation analyst. There are a number of valuation credentialing organizations including the Institute of Business Appraisers, the American Society of Appraisers, the American Institute of Certified Public Accountants, and the National Association of Certified Valuation Analysts. Each of these organizations offers credentialing for valuation professionals.

There is a distinct advantage to using a certified valuation analyst. Specifically, the result will be a relatively unbiased and independent appraisal of your practices' value using methodology standard to and recognized by the industry and the IRS. The disadvantage to using a certified valuation analyst is cost. Fees ranging from $5,000 to $10,000 are not considered extraordinary.

Valuation analysts typically use multiple valuation methodologies. The goal of each is a determination of fair market value or FMV. Three common ''tests'' are:

1- Market comparable approach (MCA). MCA is similar to the comparisons used for home appraisals with one important difference. ''Comps'' for home appraisals take actual selling prices of similar homes in the area, then adjusts the values [up or down] based on the unique features of the appraised home. MCA for businesses uses comparable sales in the area modified by the unique characteristics of the audiology practice being appraised. Additionally, considerable weight may be given to one unique characteristic referred to as ''goodwill''. Goodwill relates to reputation and standing within the community. Goodwill may be defined as the amount paid for an ongoing concern, in excess of the value of its' net assets. Goodwill includes items recognized by customers such as; excellence, convenience, price, personality, comfort or any attribute that adds value to your practice when compared to a similar practice in a similar area. The qualitative nature of goodwill can cause a serious area of contention between seller and buyer. The seller heuristically claims tremendous intangible value to his or her audiology practice while the buyer fails to recognize these unique attributes. In the event the buyer accepts the assessment for goodwill, the question of impact to goodwill once the practice is sold will certainly be raised. This is an especially important negotiating point in cases where goodwill comprises a sizable portion of the purchase price.

2- The Composite approach (CA) this approach compares your audiology practice to the ''ideal practice''. Obviously, this requires considerable subjectivity using a series of financial elements and multipliers. The most important components of this method are the practice's gross fees and pretax income. These attributes are adjusted using established multipliers and compared to a standard ''rating sheet''. The result is added to the value of the practice's tangible assets and a fair market value is determined. The CA provides a quantitative assessment of a qualitative element and is another key negotiating point.

3- Discounted cash flow approach (DCFA). DCFA makes certain assumptions that your audiology practice will generate a certain amount of cash during some future period (for example, the next 5 to 10 years). This cash flow is assumed to be available to the new owner as profit. A formula using net present value is applied. The net present value calculation applies a discount rate to each period's cash flow to estimate today's value of a future value. More simply stated, ''A dollar today certainly is not worth what it used to be''. You may have also heard the discount rate described as cost of capital.

Summary:

This article has addressed alternative methods for placing a value on your audiology practice. The least expensive, quickest and least reliable method uses heuristics or ''gut feeling''. The most expensive, most cumbersome, and more reliable method employs a certified practice valuation analyst. All techniques have a common subjective element referred to as Goodwill. This part of the valuation invariably compels serious discussion and negotiation between seller and buyer.

A practice valuation is a vital component to any decision regarding the sale or other transition of an audiology practice. However, other important components also require focused vigilance. The next article in this series will discuss methods for an audiology practice owner to enhance the value of his or her business.

For more information on this and related topics, please contact Tom Northey MSM or Mike Fisher MBA at Audiology Economics. The phone number is 303-761-7600 extension 14.