How To Value A Buy-In/Buy-Out
- Volume 18 - Issue 12 - December 2005
- 7172 reads
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Right now, many senior residents and fellows are facing the next step in their career, namely joining a practice. The idea of getting paid more than what they have received for the past few years along with working in a practice brings them a sense of excitement and foreboding.
After the interview process and mutual acceptance by each party, the discussion eventually turns to the topic of partnership. The owners only want to hire someone who will become an owner of the practice and will eventually buy them out. The owners explained in great detail the process of buying in for the new podiatrist and then explained buying out the owners. At the end of the evening, the new DPM has a headache and wonders if he or she went from the frying pan into the fire.
The owner of any business knows it takes time and energy to build up that business. These business owners create equity in their practice, similar in concept to what you get as you pay off the mortgage on your home. However, the value of the equity in a business is not easy to quantify. The value of a business to the owner is usually much greater than the value of the same business to a potential purchaser. The value of an ongoing business supplies the owner with an income for his or her family. One problem that may surface is that the owner feels emotionally attached to the business. To the owner, starting the practice, building it and seeing it flourish results in an emotional attachment. This may cloud what should be an analytical, non-emotional process.
What One Will Hear During The Initial Buy-In Discussion
If you ask three valuation experts to value a practice, do not be surprised if you get three different values. Do not look for what is fair. Fair is subjective and what is fair to the buyer may not be fair to the seller and vice versa. If the seller feels the price is too low for the practice and the buyer feels the price is too high, the valuation may be close to an acceptable number. If everyone agrees on a valuation process and the process ends up with a price that the buyer decides is too high and walks away, no one wins. Start the process with an objective, open mind and then work to find out what is acceptable to both parties.
The new DPM begins looking for a practice sometime in October of the year before he or she graduates. He or she finds a practice owned by a DPM, who explains that he or she would like the buyer to work for three years as an employee and then begin the buy-in process. During the three years as an employee, the new DPM will receive a base salary that increases each year along with a productivity bonus if he or she meets certain benchmarks.
The seller explains that at the end of the potential buyer’s third year (or earlier if he or she wants it), the practice’s accountant will discuss the buy-in process and provide a number based on the latest financial information. The formula for the valuation of the practice will be equal to the collections for the past 12 months.
For the sake of a discussion example, the selling DPM’s gross collections total $650,000 before he or she hires the new podiatrist. Now let us consider a few key discussion points.
Why The Incoming DPM’s Collections Should Not Affect The Valuation Of The Practice
The valuation of the practice should not increase due to the new DPM’s efforts. If the new DPM generates another $500,000 a year in collections in his or her third year, the new DPM should not buy into a practice now valued at $650,000 (owner) plus $500,000 (new employee), or a total of $1,150,000.