We ask two experts the same question to give you two different answers on a complex issue
Peter J. Ackerman, CPA
"I just hired an associate who graduated in June. My plan is to have her become my partner in about two years. When is the appropriate time to value my practice for this event?"
The chance that your transition plan will materialize is slim to none without a practice valuation in place prior to the associate entering the practice.
If you ignore the valuation, you can be assured the associate will take the position at the time of the buy-in that "the practice was a fraction of the size it is now, therefore the buy-in value should be a fraction of the current fair market value." The argument will continue with "I'm not going to pay for my own goodwill."
The practice owner typically takes the position "my practice grew not because of the goodwill of the particular associate, but because the associate produced dentistry on my patient base. Any growth was due to my efforts, the reputation of the practice and advertising dollars invested by me."
Who's right? Both parties have legitimate and rational arguments because the value was never agreed upon. It is the exception rather than the norm that two dentists in this position would be able to bridge the gap in valuation.
Setting all parties' expectations and documenting them from day one can easily avoid this problem. The first step is to value the practice. It is the starting point for all transition strategies. Each party must understand and agree upon the baseline value. Next determine the value or formula for value at the buy-in date. Will it be today's value, the then fair market value, or somewhere in between? How will equipment purchases be accounted for, advertising dollars, etc.? What are the penalties if either party fails to transition as agreed to?
"Join my practice and we will see how it goes" is the most common transition model and is the reason why most associate to ownership opportunities fail.
Peter J. Ackerman, CPA, is a principal of ADS Midwest, a firm that provides practice brokerage, appraisal, and consulting services to dentists and related specialists throughout the Midwest, and past president of ADS. He can be reached at email@example.com or call (855) 463-0101.
Tom Snyder, DMD, MBA
We recommend that your practice's value be determined no later than through the end of 2014. The practice value will become her partnership interest buy-in value.
If the practice is "saturated," meaning there are sufficient patients to be transferred to the associate, you should experience a strong growth in revenue over the next few years. The lost "future practice value" revenue that an owner may feel is being lost by valuing the practice now will be offset by an increase in net profit the owner will receive from the associate's efforts during the employment phase.
However, your practice value still needs to be updated prior to beginning your partnership. It is important to understand the components of a practice valuation in order to update your current practice valuation. All practice values consist of two classes of assets - intangible assets and tangible assets. Intangible assets include goodwill, restrictive covenant, telephone number, and location, and usually comprise the majority of a practice's value. Tangible assets include dental and office equipment, technology, supplies, instruments, and sometimes leasehold improvements if you are a tenant.
Doing the Math
When it's time to update your valuation, you'll adjust the intangible assets by calculating the Consumer Price Index (CPI) to factor in the impact of inflation on the intangible asset value from the time of the baseline valuation. This calculation adjusts the intangible asset value for the impact of inflation since the original value was calculated. Not to consider the impact of inflation effectively results in the owner discounting the practice's intangible value from a time value of money perspective. Revaluing the tangible assets at the commencement of your partnership will include adding new purchases of equipment or technology. Also, the value of the existing equipment should be adjusted to reflect additional "wear and tear" since the baseline value.
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.
Tom Snyder, DMD, MBA, is the director of transition services for Henry Schein Professional Practice Transitions. He can be reached at (800) 988-5674 or Tom.Snyder@henryschein.com.