Valuation Method

By Jon Dittrich, MBA, Profit Profile

One of the urban myths in veterinary medicine is the way a practice is valued. There is a notion that it is fair to calculate value based on the percentage of sales.

This method was widely used in the industry prior to 1990. Back then, most buy outs were handled by veterinarians and their attorneys – neither of whom were trained in modern valuation techniques. The advantage of the old method was that unskilled valuators quickly came up with a price. They simply took the previous year’s sales and multiplied this by a certain percentage. That was it. Quick and easy and in most cases WRONG!

Fortunately, valuation techniques have changed a lot in the last 20 years. Valuators specializing in veterinary practices have emerged. Let’s examine the more modern and accurate approach a bit further.

Assets – When you buy a practice you are really buying two items – assets and excess earnings. Assets used to conduct business represent the first component modern valuation techniques. In a veterinary hospital, these assets would include the building as well as medical and office equipment. These items have value. So estimating what they are worth will assign a brand new 6,000-square- foot building more value than a 20-year old, 2,000-square-foot building. Taking assets into account in valuation also would assign a new digital x-ray machine more worth than new analog x-ray machine.

I think that makes sense to most people. The old percentage of sales method ignores these differences.

Excess earningsThe second component to modern valuation, considers the ability of a practice to generate cash flow above and beyond normal expenses. You could call also call excess earnings simply business profits.

If the practice generates profits after paying all the bills, there is a premium put on this value and that is called goodwill. These profits are then capitalized (assigned a value). The higher the profit, the higher the goodwill. However, if there is no profit, then there is no goodwill –regardless of the revenue! In the old percentage of sales valuation, it ignores the profit component of a practice.

The combination of asset value and goodwill determine the price of a veterinary practice. The leading group in the veterinary industry developing and refining veterinary practice valuations is  Most leading veterinary practice valuators belong to this organization. (I am a Charter Member.) After recognizing the inaccuracies under the old percentage of sales method, the association devised this new approach – one I use in my own practice, Profit Profile Corporation.

Now let’s see the differences between excess earnings the percentage of sales method.