Calculating a fair "buy in"

[eyemd1234]

I was just looking for some input on the "Buy-In" for a practice. Can anyone offer some insight on what's considered a fair buy in for a practice? How is it calculated? Does 250k - 350k sound too high (without the cost of the equipment buy in included)? Thanks.

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[KHE]

I was just looking for some input on the "Buy-In" for a practice. Can anyone offer some insight on what's considered a fair buy in for a practice? How is it calculated? Does 250k - 350k sound too high (without the cost of the equipment buy in included)? Thanks.

I am an optometrist and have negotiated at least 10 practice purchases, (some of them unsuccessfully) and have also helped an ophthalmologist set up their own practice after they had a few failed partnership negotiations on their own, so take my opinion with a grain of salt.

What it really comes down to however 95% of the time in any business is: How much is the practice going to net you after you purchase it and pay your note? The actual dollar amount is somewhat irrelevant if it's in line with projected income.

For example, a practice that grosses a million dollars a year and nets the owner doctor $400000 is almost certainly more valuable than the practice that grosses a million dollars a year and nets the owner doctor $200000.

In rare cases, you may find it acceptable after analyzing a situation where you might pay a premium for a practice that seems to be struggling but is a real diamond in the rough and you are confident that as the new owner you can correct the deficiencies. You may also find yourselves trying to negotiate down the price of a practice that may be producing decent revenue for the doctor but has been declining in recent years, or is clearly in need of upgraded equipment or decor.

Good luck

 

[orbitsurgMD]

I am an optometrist and have negotiated at least 10 practice purchases, (some of them unsuccessfully) and have also helped an ophthalmologist set up their own practice after they had a few failed partnership negotiations on their own, so take my opinion with a grain of salt.

What it really comes down to however 95% of the time in any business is: How much is the practice going to net you after you purchase it and pay your note? The actual dollar amount is somewhat irrelevant if it's in line with projected income.

For example, a practice that grosses a million dollars a year and nets the owner doctor $400000 is almost certainly more valuable than the practice that grosses a million dollars a year and nets the owner doctor $200000.

In rare cases, you may find it acceptable after analyzing a situation where you might pay a premium for a practice that seems to be struggling but is a real diamond in the rough and you are confident that as the new owner you can correct the deficiencies. You may also find yourselves trying to negotiate down the price of a practice that may be producing decent revenue for the doctor but has been declining in recent years, or is clearly in need of upgraded equipment or decor.

Good luck

Just remember, diamonds in the rough are still in the rough. If you are the one who buys it and has to do the cutting and polishing, that is your sweat equity, not the seller's. Bid accordingly.

I agree about the net driving the price, which is why understanding where the net comes from makes all the difference. Delayed capital equipment replacement? That is a strike. Expiring sub-market lease? A strike. Excessive dependence on procedures with highly volatile demand? A strike. Offsetting staffing costs with family members (wife is manager, wife's salary is not commensurate with the market for similarly-experienced personnel, shifting costs to the profit side of the report.) Strike. Flat or falling recent revenue trend, strike. Poor payer mix with little chance to make it richer, strike.

Sellers like to price through the retrospectoscope: "who wouldn't want this practice, look what it did for me, paid for my house(s), funded my kids' college educations, earned me a great retirement fund . . . ." You need to look at the practice through the crystal ball.

 

[KHE]

Just remember, diamonds in the rough are still in the rough. If you are the one who buys it and has to do the cutting and polishing, that is your sweat equity, not the seller's. Bid accordingly.

I agree about the net driving the price, which is why understanding where the net comes from makes all the difference. Delayed capital equipment replacement? That is a strike. Expiring sub-market lease? A strike. Excessive dependence on procedures with highly volatile demand? A strike. Offsetting staffing costs with family members (wife is manager, wife's salary is not commensurate with the market for similarly-experienced personnel, shifting costs to the profit side of the report.) Strike. Flat or falling recent revenue trend, strike. Poor payer mix with little chance to make it richer, strike.

Sellers like to price through the retrospectoscope: "who wouldn't want this practice, look what it did for me, paid for my house(s), funded my kids' college educations, earned me a great retirement fund . . . . You need to look at the practice through the crystal ball.

There is a lot of truth in everything you have posted here but people who are venturing into a buy in or a start up of any type should realize that there never is going to be a perfect situation. There is always going to be some "strikes" here and there. Each strike has to be analyzed in the context of the entire purchase and the long term goals of the practice.

An example:

When I bought my practice, the seller wanted to charge me full price for a new computer system that had just been installed a year ago. Well, everyone knows that year old computers aren't worth even half of what the original purchase price was. However, the seller was incredibly stubborn about that issue so in the end I relented and paid the asking price even though I certainly technically overpaid for the practice. However, I wasn't going to let a more than half million dollar deal fall through the cracks on account of $15000 worth of computer equipment, and over the course of a 30 year career...the $15000 is a mere drop in the bucket. That's the kind of thing I'm referring to. Nothing's perfect....always compromises.

 

[Eyesore]

What do you guys/gals think about the mysterious "goodwill component"?

 

[KHE]

What do you guys/gals think about the mysterious "goodwill component"?

This is a link to the defintion of "good will."

http://www.businessdictionary.com/definition/goodwill.html

Obviously, it's a very difficult think to quantify. In this day and age of heavy managed care penetration, my opinion is that good will is valued significantly less than in the past.

However, it makes little sense to get too worked up over the value of this thing or that thing. It makes no difference if you overpay for goodwill, but underpay for something else. At the end of the day, the question you have to ask yourself is really this:

1) Does the price I'm paying for this practice allow me to generate enough of a salary to pay the note and still live?

2) Is there reasonable potential for growth in this situation?

Paying for good will is also something that is generally sorted out by accountants because I believe (don't quote me on this) that good will can be depreciated in different ways by the seller and the buyer so there may be tax strategies implemented to benefit a party to the transaction.

 

[orbitsurgMD]

What do you guys/gals think about the mysterious "goodwill component"?

Always an interesting topic for discussion, goodwill is. Just defining it is difficult.

In a sense, it means everything in the asset value of the practice not valued as a hard asset, that is not plant and equipment and not deposits or accounts receivable.

How to value it? Good question. Everyone tries but nobody really knows for sure. What is the value of buying a particular practice over and above its hard asset value? How much more will I earn by virtue of buying this practice now, going forward, compared to starting out cold in the community? Does the particular location favor your practice stability and growth (this office in this building in this part of town with this staff and maybe this selling doctor sticking around to promote me?) What would it cost me in time, forgone income, advertising and other referral-generating activity to get to the same place? Is the goodwill of the seller truly alienable as the seller would have it, or is there something uniquely about him that he really can't sell and I really can't buy that would affect my practice once I took over (does he belong to a particular church in the community that brings a lot of business to him that might not come to me for the same reasons?) If my practice is more successful if it is a successor to that of a well-regarded doctor, then for a time after purchase, the volume of business might be better because of his goodwill. Some of the success has to be your own sweat equity and your own earned goodwill, and eventually all of it will be yours--so separating out your contributions from his is where the value comes into the picture. Getting you onto valuable insurance panels faster is part of that goodwill, getting you good introductions to referring doctors in the community is another. So a big part of the goodwill valuation depends on how well the seller does to introduce you to patients, the medical community and necessary third-party payers. How well he does, not how well you do. Too often, sellers think goodwill is something about which they can afford to be passive, that it is something they can merely mention as to raise the price, and then they are disappointed when buyers don't see things the same way.

I will say that once an ophthalmologist stops doing surgery, the value of "goodwill" starts to decline rapidly--in fact more than six months without taking referrals to the OR is pretty much a practice in need of resuscitation and/or salvage--and goodwill is zero or negative.

 

[orbitsurgMD]

This is a link to the defintion of "good will."

http://www.businessdictionary.com/definition/goodwill.html

Obviously, it's a very difficult think to quantify. In this day and age of heavy managed care penetration, my opinion is that good will is valued significantly less than in the past.

However, it makes little sense to get too worked up over the value of this thing or that thing. It makes no difference if you overpay for goodwill, but underpay for something else.

Can't say I agree. It makes no sense to even speak of goodwill unless you intend to value it accurately to be sure you aren't overpaying. Sure, you don't let an otherwise good deal tank for the sake of a negligible difference in value--leave the other guy thinking he got a fair deal in negotiations--but you do need to know what you are paying for, and your lenders will certainly expect you to know what you are paying for.

At the end of the day, the question you have to ask yourself is really this:

1) Does the price I'm paying for this practice allow me to generate enough of a salary to pay the note and still live?

I should hope that goes without saying. In fact I would run, not walk from any deal that left me with any question of this in my mind.

Maybe a better way to look at things is to say you should never pay more for a practice than you would pay to get the same business by any other means.
If a practice can't support you well and allow you to pay for it at the same time, then it is overpriced. You have to anticipate the future trend of income here.

2) Is there reasonable potential for growth in this situation?

If there isn't, the practice needs to be valued at hard asset value alone and goodwill claims need to be carefully examined. Suppose you were valuing a practice somewhere there was a net population loss, such that you would have to take someone else's patients to keep up your volume, perhaps buying other practices or reducing staffing. Goodwill won't be worth as much unless there is something truly exceptional about the practice to make you believe the seller's practice will maintain or grow while all others will do the opposite.

Paying for good will is also something that is generally sorted out by accountants because I believe (don't quote me on this) that good will can be depreciated in different ways by the seller and the buyer so there may be tax strategies implemented to benefit a party to the transaction.

Tax treatment is besides the point; overpaying on a 5 or 25-year schedule is still overpaying.

 

[KHE]

Can't say I agree. It makes no sense to even speak of goodwill unless you intend to value it accurately to be sure you aren't overpaying. Sure, you don't let an otherwise good deal tank for the sake of a negligible difference in value--leave the other guy thinking he got a fair deal in negotiations--but you do need to know what you are paying for, and your lenders will certainly expect you to know what you are paying for.


Tax treatment is besides the point; overpaying on a 5 or 25-year schedule is still overpaying.

Well then by this definition, goodwill becomes any dollar you pay for the practice above and beyond the hard asset value.

So then how do you value it? I don't think you can because its value is directly related to the price that a buyer is willing to pay.

A practice that has a hard asset value of $200000 and sells for $500000 essentially has a good will value of $300000. But if someone else comes along and is willing to pay $600000 for the same practice, then the good will is now valued at $400000.

This is why the way I always value these situations is:

How much money do I reasonably need to live? Will this practice generate enough of an income for me quickly enough to allow me to pay the note and still reasonably live?

 

[orbitsurgMD]

Well then by this definition, goodwill becomes any dollar you pay for the practice above and beyond the hard asset value.

So then how do you value it? I don't think you can because its value is directly related to the price that a buyer is willing to pay.

A practice that has a hard asset value of $200000 and sells for $500000 essentially has a good will value of $300000. But if someone else comes along and is willing to pay $600000 for the same practice, then the good will is now valued at $400000.

This is why the way I always value these situations is:

How much money do I reasonably need to live? Will this practice generate enough of an income for me quickly enough to allow me to pay the note and still reasonably live?

Well, . . . you're right. Valuing goodwill is imprecise and therefore difficult. And naturally sellers sometimes want more for goodwill than many buyers think is fair. And it is the difference between the net hard asset value and the selling price, unless of course it isn't. Making sure it is valued fairly and getting the seller to see that is the job of the dutiful buyer, no?

What does one buy when buying a going practice? One thing is the benefit of walking into the new practice and being busy straight away. In essence, that is the goodwill. It is the difference in value between starting out not busy and starting out busy (meaning getting paying work, of course.) The busier you are with well-paid work, the more valuable the goodwill, and conversely, the less busy, the less valuable the goodwill. In a highly competitive area, starting out busy is worth more, because it is presumably harder to do, while in an underserved area, getting busy without help might be easier, and so "goodwill" is comparatively less valuable.

If, for example, starting out "cold" gives you $300,000 less first year gross income and $150,000 less second year income than otherwise, then "buying" goodwill is related to that lost income--related, not equal to that income difference--you wouldn't pay $450,000 just to earn $450,000. Remember, the income is for your work that you do. So the value of the goodwill might be seen as the value of whatever promotional activity you might have to pay for to generate the same amount of business volume in your practice at the outset of your practice. As time goes by, your practice enjoys your own earned-in goodwill which eventually "replaces" the goodwill you started out with that came from your seller, or at least that is what you hope for.

So how to put a dollar figure on that? Some writers have suggested an indeterminate value based on the performance of the practice after it changes hands. That goes to the issue of alienability of the seller's goodwill, the business that will remain with the new owner after the old owner leaves.
Unless there is no other practice for patients to go for care, there is usually some attrition. Also, some business may come or go not due to the reputation of the practice but due to insurance contracts changes among the patients in a community. A practice that does not broadly accept plans might find itself on the outside with patients transferring if a major local employer changes health plans. I can't tell you how many colleagues have related the story of running into a patient in public who says " Oh we loved coming to your office, but our insurance changed so we can't . . ." when the difference in costs to them on a biannual exam might have been all of $20. What is the "value" of goodwill there? Obviously not $20.

 

[KHE]

What does one buy when buying a going practice? One thing is the benefit of walking into the new practice and being busy straight away. In essence, that is the goodwill. It is the difference in value between starting out not busy and starting out busy (meaning getting paying work, of course.) The busier you are with well-paid work, the more valuable the goodwill, and conversely, the less busy, the less valuable the goodwill. In a highly competitive area, starting out busy is worth more, because it is presumably harder to do, while in an underserved area, getting busy without help might be easier, and so "goodwill" is comparatively less valuable.

When you purchase any business, you are essentially purchasing an income stream, and the amount you pay is based on the probability that you (the purchaser) will be able to generate the same income.

If, for example, starting out "cold" gives you $300,000 less first year gross income and $150,000 less second year income than otherwise, then "buying" goodwill is related to that lost income--related, not equal to that income difference--you wouldn't pay $450,000 just to earn $450,000. Remember, the income is for your work that you do. So the value of the goodwill might be seen as the value of whatever promotional activity you might have to pay for to generate the same amount of business volume in your practice at the outset of your practice. As time goes by, your practice enjoys your own earned-in goodwill which eventually "replaces" the goodwill you started out with that came from your seller, or at least that is what you hope for.

So how to put a dollar figure on that? Some writers have suggested an indeterminate value based on the performance of the practice after it changes hands.

I can't speak for anyone else, but to me that seems unwise to base the purchase price on future performance. What if the person buying it is an idiot, and the business suffers? Should the seller be penalized because the buyer was an idiot?

That goes to the issue of alienability of the seller's goodwill, the business that will remain with the new owner after the old owner leaves.
Unless there is no other practice for patients to go for care, there is usually some attrition.

My experience in both ophthalmology and optometry is that this is relatively rare. There is always some attrition but I have found it almost always limited to two types of patients, with a few others scattered around.

1) Patients who have moved but continued to travel a great distance to see the former doctor. Now that there is a new provider, there is little incentive to continue to travel the same distance.

2) Patients who have this bizarre notion that they are somehow "punishing" the old doctor by switching practices. "What?? He retired? How dare he? I'm going somewhere else." To me, that always makes so little sense. At least give the new person a shot. Your record is there...it's the same facility, likely the same staff, and more often than not, the buyer is someone who has the seller's same philosophy on patient care. But, it is what it is...human nature.

Also, some business may come or go not due to the reputation of the practice but due to insurance contracts changes among the patients in a community. A practice that does not broadly accept plans might find itself on the outside with patients transferring if a major local employer changes health plans. I can't tell you how many colleagues have related the story of running into a patient in public who says " Oh we loved coming to your office, but our insurance changed so we can't . . ." when the difference in costs to them on a biannual exam might have been all of $20. What is the "value" of goodwill there? Obviously not $20.

There is nothing you can do about this in all but the rarest of practices. We have all had that experience of losing patients over insurance issues. It only makes sense, though. Health insurance is very expensive. I only see providers on my insurance panel, and I'm sure you all do too. Why would you pay hundreds, sometimes thousands of dollars a month for insurance and then NOT see someone on your plan? Because the doc is a "good guy?" That's not going to happen too much.

However, the upside of the issue is that managed care plans will bring patients into your office with little or no advertising. We've also all had the experience of asking patients "how did you find our office?" only to have the response be "you're on my plan." So if there's any silver lining in it, it does make it easier to get people in the door.

Good discussion.....