A business valuation for all occasions

How much is your chiropractic practice worth? Everyone wonders and the question is hard to answer. The difficulty lies, in part, because the value of any practice or business often varies, depending upon who is asking the question and why the question is being asked.

A chiropractor attempting to sell his or her practice will, quite naturally, want to place the highest value possible on the practice, while any potential buyer will obviously seek to acquire the practice as inexpensively as possible. Those buyers will usually place a lower value on the operation. From these differing vantage points a market value sometimes results.

Fair market value is defined as the price the property will bring when offered for sale by a willing seller to a willing buyer, neither being obliged to buy or sell. While a variety of factors can and do affect the fair market value and the selling price of many chiropractic practices, the Intenal Revenue Service has its own views about the value of your business.

Why value a practice?
Some unfortunate occasions make it both necessary and painful to place a value on the chiropractic practice. Death is one of those. When death occurs, it is far better for the survivors or the estate to place a value on the chiropractic practice rather than have the IRS force a value on it.

Whenever the principal in a chiropractic practice dies without a buy/sell agreement in place, no key-person insurance in effect or without a valuation for the operation, the IRS may attempt to place its value on the estate.

Surprisingly, it is generally to the advantage of the surviving spouse to obtain a high estate valuation for any and all inherited assets since there is no federal estate tax when assets pass to the spouse. After all, the higher the valuation, the less the taxable gain if the practice is later sold.

For anyone other than the surviving spouse, the lowest possible valuation is usually in their best interests.

Since every asset in an estate is valued at market value at the date of death, proper valuation is vital regardless of who inherits the chiropractic practice.

How the IRS values your practice
The IRS takes into account a number of factors when it places a value on a practice or any other business. These factors include:

1. The nature and history of the business;

2. The economic outlook in general and the outlook for the healthcare industry in particular;

3. Book value (that is, the “net assets,” which are the total of all assets minus total liabilities) and financial condition.

4. Earning capacity.

5. Dividend-paying capacity.

6. Goodwill or other intangible value.

7. Prior sales of stock of the incorporated practice.

In fact, whenever a chiropractic practice is sold, the IRS demands an accounting that requires a breakdown of the assets of the operation. Generally, each asset of the practice is treated as being sold separately when it comes to determining the seller’s income, gain or loss and the buyer’s basis or book value of each of the assets acquired.

The purchase price of a practice must be allocated among the assets using a so-called “residual method” under which any amount that cannot be connected with an asset is labeled “goodwill”.

The buyer and the seller of a practice may agree in writing to allocate part or all of the consideration involved to the various components of the practice, such as furniture, the various pieces of equipment, signs, improvements to the building and patient lists. This allocation will usually be accepted by the IRS if both parties are bound by the agreement — unless the IRS determines that the allocation is inappropriate.

The purchaser and the seller must both file Form 8594 (Asset Acquisition Statement) upon transfer of the assets used in any trade or business to which goodwill or going concern value could attach.

In the ongoing battle to develop a value for the practice, a value which will benefit both the estate and the survivors, the taxpayer, the IRS or a buyer or seller, valuation can mean many different things. Into this fray gallop the “experts” with even more ideas about determining the value of your chiropractic practice.

Alternative valuation methods
The IRS method of valuation is not the only one available.

• Gross valuation method. For example, Glen Desmond and John Marcella in The Handbook of Small Business Valuation recommend using a simple formula to determine the value of a business:

Net assets + property + (1 to 2 times x salary and perks) = value

In other words, according to these authors, the value of any business or practice is inventory (if any) at cost plus the practice’s fixtures and equipment at their depreciated value. Factor in the real estate and non-depreciable property and the principal’s salary plus perks, along with any profits retained in the practice and the result is a realistic value of any chiropractic operation.

Although debt and accounts payable are subtracted from this value figure, the end result is usually a cut-and-dried amount that ignores many extremely important factors. It also ignores the Internal Revenue Service’s stated method for placing a value on your practice.

• ‘Five times’ method. One appraiser of businesses in general, not only chiropractic practices, relies on an alternate “bottom line” method of valuation. That method, quite simply, is five times the net profit of the practice — first adding back the principal’s salary and retirement-plan contributions and before income taxes.

This method could best be compared with “capitalizing” the earnings of the practice at 20 percent (five years) in order to determine the value of the operation’s goodwill. The “five times” figure is not a figure that is chiseled in stone; it could be four, six or three, but the concept remains the same.

Often this valuation method will produce a value quite similar to the gross income valuation method. Many chiropractors in the $500,000 income range, for example, produce about $100,000 “net” — which the principal takes as compensation and (usually) retirement plan contributions or other “perks.”

In a situation such as this, either valuation will produce a $500,000 goodwill valuation: One year’s gross income is $500,000; or, five times the net ($100,000 before the owner’s total compensation is $500,000.

Frequently, but not always, the two valuation methods will produce a very similar valuation figure for goodwill.

One definition of goodwill is the commercial advantage of any practice, due to its established popularity, reputation, patronage, advertising, location and similar attributes over and beyond its tangible assets.

In the sale of a practice, the amount over and beyond the value of the hard or tangible assets represents profit to the seller. The buyer accounts for that figure by labeling it as goodwill (and, in most cases, writing it off over a 15-year period).

Unfortunately, a going business does not enjoy a similar write-off for the goodwill the business has accumulated since its formation. Reflected in the operation’s books or not, that goodwill is there. The questions is: How much of a role will that goodwill and/or other “intangible assets” play in the valuation equation?

Obviously, every chiropractor must first decide why he or she wants to establish a value for their practice. With this question answered, you can decide whether a low or a high value is desired. A low value could merely be the book value taken directly from the operation’s financial statements or income tax returns. A high value can take into consideration all of the intangible assets such as goodwill that are not reflected on the chiropractic practice’s books.

Mark E. Battersby is a tax and financial advisor, freelance writer, lecturer and author with offices in suburban Philadelphia. He can be contacted at 610-789-2480.

Disclaimer: The author is not engaged in rendering tax, legal or accounting advice. Please consult you professional adviser for any issue related to your practice.