Q: What is a formula to purchase a practice

A:


I always recommend people purchase Dr. Fernandez's book Buying 
and Selling a 

Practice. He can be reached at: 1-800-882-4476. Below are two 
articles I have on my webpage from others that 

have asked a similar question. One from Dr. Whitney the other my 
answer with 

a response by Dr. Fernandez. I hope this helps







 



Good Buy ? ........or goodbye !  found on webpage: 
http://www.chiro.org/newDCs



By John Whitney, DC



 

In the past I have spoken often on the wisdom of acquiring a 
practice 

through purchase rather than going through the, "associate", route; 
or 

worse, starting from scratch. If you do a pro forma comparison you 
will 

quickly realize that purchasing rather than starting from scratch 
is a, 

very financially sound, way to acquire a practice.



Inherent within the most opportune offerings-for-sale, are certain 

characteristics.



  1. Usually a retiring doctor selling a practice is more desirable 
than 

a "young lion" who is simply re-locating. 2. Seller financing is 

available. 3. Seller financing at 10% interest or less. 4. Low down 

payment (10%) or no down payment. 5. Clearly supportable 
performance 

numbers (historicals). 6. Use of a broker. 7. Buyer/Seller 
compatibility

 8. Professionaly trained staff who know the practice



 



Setting the value of a practice can be very tricky. Generally, the 
value 

of a business is viewed from opposite perspectives by buyer and 
seller. 

The seller wants a current market price for his fixtures, 
equipment, and 

leasehold/real estate. The seller also want compensation for his 

inventory, the name he has established, and all the time, sweat and 

tears that went into making his practice what it is today. And from 
his 

point of view, making a little profit along the way couldn't hurt 

either.



In terms of the buyer, she is looking for an investment that will 
prove 

profitable to her. Usually, she wants a practice that will provide 
her 

with a fair salary plus 20 to 30 percent return on her investment. 
For 

example, if a buyer invests $150,000, and takes a $30,000 salary 
to run 

the practice, that practice should be able to provide another 
$30,000 to 

$45,000 in annual earning power before taxes. Otherwise, why take 
the 

risk in the first place? To figure out the return on 
investment,(ROI) 

take the gross, minus all expenses, and divide by the down 
payment.



 



FINANCIAL STATEMENTS



Before you can place a cash value on a practice, you'll need to ook 
at a 

number of the seller's financial documents. The Profit & Loss 

Statement,(aka Income Statement) is the initial document you will 
want 

to analyze. It has little value except as an indicator. Why? If done 

professionally, the P&Ls should be a work of art, that for tax 
reasons 

show the business in the worst possible light. But you need not be 

concerned about whether the present owner is managing to charge 
personal 

telephone bills, car payments, and insurance against the business. 
Your 

interests are deeper than that. You are keenly interested in a few 

provable facts and some hard fixed costs.



 



1. Monthly gross- try to obtain a minimum of three years data with 
as 

much detail as possible. This information is invaluable for future 

projections. In addition to checking data in the P&L, you may want 
to 

check tax reports and IRS/Revenue Canada statements. Be sure to 
cross 

check any single source against a second source to verify the 
validity 

of these numbers. As you are dealing with a service business in 
which no 

sales tax is collected, only the federal income tax statement will 

provide sufficient information.



2. Overhead -generally regarded as fixed and variable expenses plus 

doctors salary. This can be based on comparison with national 

(ICA/ACA/CCA) averages or from the Hsaio Report: DC salary=50%, 
employee 

wages=16%, rent=11%, equipment and supplies=12%, malpractice 
cost=4%. 

This information will help determine an accurate profit margin for 
the 

practice in question. Sometimes owners will inflate the cost of 
overhead 

expenses by including a lot of personal expenses and services, to 
create 

a lower profit margin for tax purposes. Your first task is to, 

"normalize", the expense statement; i.e. remove all the sellers 
personal 

expenses from practice expenses. For this you will need his 
cooperation 

and candor.



3. Rent- specifically, terms and conditions of the lease. You can 
also 

find this data in the lease agreement. Cross-check the lessee's 
numbers 

and agreements with those of the lessor.



4. Salaries/Commissions- other than the owner's. Also check with 
the 

IRS/Revenue Canada. Every employer has to file tax information on 
all 

employees, whether permanent, part-time, or sub-contractors.



5. Utilities/Insurance/Miscellaneous expenses- To verify, look 
through 

the company cheques/checks and year-end tax statements.



6. Profitability- can be determined by subtracting the cost of 
goods 

from monthly gross services to arrive at a gross profit. Next, add 

together all the operating expenses (overhead), and then subtract 
those 

from the gross profit, and your result will be the net profitability 
of 

the practice. Be careful, however, we are dealing with sole 

proprietorships and partnerships. They do not actually produce a 

definable net profit. They produce an income for the owner. This 
may not 

be listed in the P&L. In order to determine profitability in these 

instances, you need to check the owner's total income from the 
practice. 

If the owner is serious about selling the practice, there should be 
no 

problem in the disclosure of this information.



For example, let's look at a practice whose estimated annual 

grossbusiness is $200,000.



Gross Annual Services

 $200,000

Cost of Goods     1,000Gross Profit

   199,000

Rent.

 14,400

 Salaries

 65,000

Utilities, Insurance, Overhead

 10,000

Owner Salary

 40,000

Operating Costs 129,400Less Debt (10% note a month. 3 yr.)

 11,600

Total

------------------------------------------------------------
------------

 $141,000Net Profit $ 58,000



 



 



Another financial document you will need to review is the 
Capitalization 

Schedule which provides an accurate accounting of all fixtures, 

equipment, real estate (if any) or leasehold improvements, and all 
other 

assets owned by the business. Because practice owners gear these 

documents for their own tax purposes, they may not provide a 
completely 

accurate picture of what the equipment is worth. You'll have to 
look 

beyond these documents to the real situation at hand.



 



TO VERIFY INCOME



 



Take one month at random from the appointment book and follow 
through 

with each entry. Did the patient arrive, what service was rendered, 
was 

it accounted for, what was paid (cash-cheque-credit card), what 
was 

outstanding, does the deposit slip(s) for the week match 
appointment 

book income? Many offices do not report all income, but "skim" the 

cashpayments. This, of course, is income tax evasion; but so 
common, the 

doctor may talk to you openly about it. If this is the case it is very 

difficult to evaluate the practice. The accounting will show one 
thing 

and the doctor's testimony indicates something different.



 



PROPERTY AND IMPROVEMENTS



Assessing the value of a business is usually accomplished 
byplacing a 

value on any property and equipment, then adding a cash value to 
that. 

If any property is involved, this price can be determined by adding 
the 

land value to the value of improvements made thereon. Land value 
is 

determined by a review of the tax-assessed value compared to 
what 

like-sized parcels in similar locations have sold for in the current 

market. All real estate mustbe evaluated separately from the 
practice.



Evaluating improvements is another matter entirely. One way to 

takecurrent build-out costs for the type of building, (typically 
$35- 

$50 per square foot) and multiply that price per square feet times 
the 

number of square feet. The more realistic approach, which would 
appeal 

to a banker, is to calculate everything as a function of cash flow. 
To 

illustrate: the amount of rent a seller could get by leasing this 
space 

out, minus expenses (taxes, insurance, repairs.)



Once the value of the land improvements has been determined, a 
broker 

must estimate the value of any leasehold improvements, fixtures, 
and 

equipment. Leasehold improvements refers to those things 
attached to the 

building that are not easily removed, such as partitions, toilet 

facilities, special electrical wiring, and he like. Fixtures are 

carpeting, shelving, special lighting, counters, and so on. 
Equipment 

refers to any freestanding objects necessary to conduct your 
practice. 

Normally, a broker will give them a value that is below their 

replacement value but above their resale value.



Normally, a seller will want to add to that figure the broker's fee 
and 

a few thousand dollars more for negotiating room. This then will 
be the 

asking price.



 



RETURN ON INVESTMENT



The most common means of judging any practice is by its return on 

investment. Return on investment is not necessarily the same as 
profit 

where buying a practice is concerned. The first factor in 
determining 

ROI has to do with the money the buyer puts into the enterprise, 
and the 

second has to do with the performance of the existing practice.



For example let's say a practice is valued at $100,000 and requires 
a 

$40,000 down payment. If that practice makes $20,000 a year, 
(over and 

above the doctors, reasonable, salary) the return of investment is 
50 

percent.



Typically, a practice should return anywhere from 30 to 50 percent 
on 

investment. This is the average net in after-tax dollars. 
Depreciation, 

(Capital Cost Allowance), which is a device of tax planning and 
cash 

flow, should not be counted in the net because it should be set 
aside to 

replace equipment.



 



CAPITALIZED EARNINGS



Valuing a practice based on capitalized earnings is the reverse of 
the 

return-on-investment method of assessment. Certain practices 
won't show 

any value at all even though they are showing a profit; or they have 

very little value relative to the profit they make. In this regard, if 

you use this method of valuing a practice you should have some 
idea of 

capitalization rates, or you may be in trouble.



 



PROJECTED EARNINGS



Another frequently practiced way to valuate a business, 
particularly 

large-size practices, involves pricing the practice based on what 
it 

will make in the future. Generally, this method is used for 
practices 

that are growing. For this method, the ultimate price is contingent 
on 

its reaching that profit level. Most brokers do not base a practice 

price solely on its projected earnings.



 



INTANGIBLE VALUE



Looking at the value of intangibles is essential when valuating a 

practice. Some intangibles will be seen as assets while others will 
be 

negative factors affecting the price of the business. Factors such 
as 

willingness to train, ease of operation, excellent location, 
consistent 

profits, time length in business, terms of loan, owner financing, 

reputation of doctor, number of times practice sold, quality of 
staff, 

business practices (cash), transition time allowed (minimum of 
two 

months), transition protocol, and willingness to introduce to all 
valued 

contacts.



 



GOODWILL



Essentially goodwill is the difference between the asking price and 
the 

sum of all tangible and intangibles being purchased. Occasionally I 
hear 

people say that the idea of goodwill is nonsense. And that all one is 

purchasing is "a bunch of files"; further, one cannot sell/buy 
patients, 

blah, blah, blah. If you are using an advisor who holds such an 
opinion, 

you've chosen unwisely (just another example of well-meaning 
people who 

don't know what they are talking about)



Goodwill is usually the largest component of the price of a 
practice; it 

has to do with the practices reputation (and numbers). Goodwill is 

indeed worth something and it should be considered an asset. here 
is a 

potential problem about listing it as an asset, however. It has to do 

with taxes (like everything else in your life). The tax man may 
treat 

"goodwill" differently for a buyer as opposed to a seller (not in the 
US 

however) when it comes to taxes, - herein lies a possible problem.



In an effort to deal with this problem you may notice some brokers 
do 

not even list goodwill amongst the practice assets. Instead they 
put a 

very heavy price on the "covenant not to compete' clause instead,- 
and 

don't even deal with goodwill. The selling price does not change but 
the 

allocations of value do (and so may the tax implications).



How does one evaluate goodwill? Here are three highly 
controversial ways 

of making good-will evaluations:



 



1. Total office visits (last 12 months) X $3.00 e.g. 30 X 17 days/Mo. 
X 

12 X 3 = $15,300



 



2. Last year's net income divided by 4 + 50% e.g. 42,000 / 4 
=$10,500 + 

5,250 = 15,750



 



3. Last year's gross income divided by 4 + 1 0% e.g. 42,000 / 4 = 

$10,500 + 1 0% = 14,700



 



Please do not believe for a minute that this is gospel. These are 
simply 

arbitrary ways of trying to come to a fair price. Many accountants 
will 

laugh at these simple formulae, but they are a rough ballpark 
figures, 

and will likely be very close to what an accountants convoluted 
figures 

produce. Existentially, a practice will sell for exactly whatever a 

seller is willing to pay. That is only fair, and is the basis of our 

entire economy.



There are several subtle factors that must come to bear on "good 
will". 

For instance how good is it? Consider the length of time in 
practice, 

how many times has the practice been sold in the last 5- 6 years, 
is the 

lease a good one, location the best, doctor's reputation in the 

community, is the site aesthetically pleasing, socioeconomic level 
of 

practice and its geography, is this deal between people of the same 

general nature, gender, personality. These questions and more have 

bearing on good-will.



 



BROKERS



Brokers are matchmakers, they provide the expertise to make a 
deal work, 

make suggestions, dig out the complete truth, make suggestions 
for 

creative financing and act as a buffer to buyer and seller. The fact 
is 

that if the deal is being brokered it has an excellent chance of 
being 

consummated and buyer and seller walking away happy. However in 
the 

deals where buyer and seller try to do it themselves, 70% fail to 

consummate. That should tell you something. It's like trying to sell 

your own house. It is possible but.........perilous.



The cost of the broker is, most often, born in the form of a 10% 

commission, by the seller. More and more deals however are being 

brokered that contain the provision of "equal representation". Equal 

representation means the buyer and the seller both pay part of the 

broker's fee. That is not unfair. Both parties are benefiting from 
the 

broker's service; it is not unfair for both to pay for the service (it 

is a little unusual, however, that's changing.)



The bottom line? Get a good broker/consultant and work closely 
with 

them. Pay them their fee, and realize the time and aggravation 
saved - 

possibly the whole deal - is well worth the cost.



 



COMPATIBILITY



It should go without saying , but requires reinforcement, 
compatibility 

of techniques, philosophy, gender, sexual orientation, and 
personality 

are vital to make a deal work. For instance it is almost impossible 
for 

a male to buy and successfully take over a female D.C.'s practice. In 

addition, a suitable "transition protocol" should be engineered to 

correctly introduce a buyer to the sellers practice and patients. 
This 

is a retention strategy. If properly designed and executed, a 
retention 

strategy will ensure a high retention rate of those patients that 
are 

purchased as a part of the "goodwill".



In any case, the buyer should be prepared to emulate the seller in 
every 

conceivable way; at least for the first several months. The whole 
idea 

is not to traumatize the practice by anything new or different. The 

transition will be optimum if it is seamless, and shows no signs of 

anything different than what the patients have come to know and 
expect. 

This is the tough part for the buyer. Unfortunately it is common for 
the 

buyer to be convinced that what they think, act and do is a direct 

message from Universal Intelligence. They can hardly contain 
themselves 

from thrusting their wonderfulness onto this practice and the 

unsuspecting patients. It is common for the incoming doctor to 
want to 

change everything from the technique to the decor as fast as the 
seller 

can get out of the door. This is a shining example of a new 
graduates 

hubris; in reality this misguided force is nothing more than a 
hungry 

ego seeking expression. Friends, this behavior ain't rational . Stifle 

it. (Check the next section,"Transitional Protocol", to help you 
avoid 

this, all-too-human, pitfall.



Q:



    I am looking at the possible purchase of an existing practice and 
need to 

know a "formula" for evaluating worth.  Some incidentals about the 
office in 

question:  This practice did pre-pay a percentage of patients, what 
do I need 

to know about that as far as my reimbursement or using that to 
leverage a 

lower price?  Thanks!  



A:



Thanks for the e-mail. First .. there are many questions you need to 
have 

answered prior to purchasing an established practice. First and 
foremost .. 

what are you buying? Is it the patient base .. old files .. paid for 

equipment .. lease agreements .. etc. Is the doctor leaving for a 
specific 

reason .. is it a distress sale as they are being sued .. physical 
health 

reasons .. going bankrupt .. a changing insurance acceptance climate 
.. 

office area is changing demographically .. etc. Has the staff been 
there for 

sometime .. will they stay or do they need to go. 



As important .. how have they acquired their patient base in the 
past and 

presently? Is it via HMO contracts and can you be assured in 
writing from the 

HMO that you can take over .. is it from advertising dollars that 
once you 

stop the practice drops dramatically .. is it from a specific 
industry or 

corporation that may be heading out of town and you are unaware 
of it. Also 

.. what percentage referred .. did they come from a form of regular 
internal 

and external marketing .. what and when .. gather the alliances and 
reference 

names and numbers and be sure they help during any transition so 
these places 

continue to refer.



Also .. what are you buying .. how old is the equipment and how 
much is owed 

on the lease and can you re-negotiate any contract more favorable 
to you. As 

far as old patient files .. these are notoriously hard to reactivate 
and are 

usually worthless (although can be useful with creative 
marketing). Are you 

purchasing old accounts that is owed to the office .. if it concerns 
a 

patient directly .. theyžll be hard to get paid on. If it is an 
insurance 

company it may be easier but you need to be careful and concerned 
about how 

much % you take on without some safeguards. 



By all means hire an attorney or accountant if the purchase price is 

substantial for you. Purchasing a practice..  even if financed to 
some degree 

by the seller .. takes more than a handshake and the money spent on 

professional advice will be well spent for sure.



As far as "pre-pay" patients. There are a number of cash plans out 
there from 

UCAFF (unlimited care for a fixed fee) to reduced fees if paid in 
increments 

over the period of care. If you agree on the purchase price and care 
is still 

being rendered to these pre paid folks .. you must have some 
payment for 

services that are yet to be provided and already paid for. Calculate 
how much 

each visit would be dependent on what was paid and the potential 
and real 

number of visits. Usually at a rate of 5-6 visits a month (probably 
more in 

the beginning) and determine if money is still owed. In reality you 
are provi

ding care for free unless you can agree on a price .. either a 
reduction on 

the purchase price or up front money that was already paid to the 
clinic for 

service yet to be provided should be considered.



As far as a formula towards purchase .. it all depends. I am sending 
you via 

the next e-mail a formula that was provided to me by Dr. Pete 
Fernandez .. an 

established seminar provider and consultant. When someone e-
mailed me asking 

for a formula I asked Dr. Petežs advice as he has a service that will 
do all 

the work for you and usually can purchase it cheaper than you can 
as they 

know the negotiating angles. Although the e-mail was sent in 
response to a 

specific question and office figures posed to me .. you can still 
gather the 

general idea. You can reach Dr. Fernandez if you want to learn of his 

services via e-mail at: depete@drfernandez.com



Here is Dr. Petežs advice:



Below is an e-mail answer to a question sent to me about 
purchasing an 

existing practice. The DC wishing my opinion sent me the figures 
recorded 

below. I asked Dr. Peter Fernandez, who has been a chiropractic 
consultant 

for many years and has a service assisting in the purchasing of 
practices to 

review the figures and offer us his opinion. Below is his answer .. 
if you 

are thinking of purchasing a practice review thgis carefully .. plug 
your own 

figures into this and make use of all or some of the information. If 
you 

desire professional assistance .. and if you feel it is necessary .. 
contact 

Dr. Fernandez at:

susie@drfernandez.com





A doctor should not consider buying any practice until he gets all 
the 

necessary firm, verifiable figures regarding the practice.  I get 
nervous 

when a possible purchasing doctor guesses at the office overhead 
(I'll bet it 

is more than the estimated $6000 a month).  And, he doesn't trust 
the selling 

doctor's collection figures of $196,480.  He should be able to check 
the 

deposit slips, bank statements and tax forms to make sure of what 
he is 

buying.

 

I am very leary of the Broker's Valuation of the practice.  Any DC 
purchasing 

a practice should hire a Buyer's Representative (like myself, or 
someone 

else), a person who represents him/her in this type transaction.

 

The Selling Broker's Valuation is:

 

    Yearly Income            $196,480 X .63              =    $123,782

    Equipment Value                                              =        

19,552

    Accounts Receivable   $ 79,784 X .65              =        51,859

                                                     TOTAL             =    

$195,193

 

 

My valuation from the figures supplied by the doctor:

 

Goodwill:

This practice supposedly has a net profit of over 50% (the doctor 
better 

double check these figures).  Therefore, the goodwill of the 
practice needs 

to be determined by a net profit formula.  The net profit formula 
from my 

book, "How To Buy and Sell a Practice," (modified in 1999) is three 
months 

net income X three.

 

                        $10,000 a month X 3    =    $30,000 X  3    =         

       $90,000.00

                 

Equipment:

The value of the equipment and furnishings is probably around 
$15,000 if the 

equipment was purchased new 5 years ago, if older, reduce the 
price 

drastically.

 

Accounts Receivable:

This varies widely ... If this is a cash practice, the average account 
over 

90 days old has a "$0" value, current AR's have a 50% value.

 

If this practice is an insurance practice (let's assume that it is), 
the AR's 

should be broken down into categories that are collectible with an 
aging 

analysis to determine the value.  But in this case, I'll value it at 
45% of 

the accounts receivables.  Thus: $79,784   X   .45  =  $  35,902

 

        The value of this practice is:                       =    $ 90,000

        Goodwill:                                                     =    $ 

15,000 

        Accounts Receivable:                                 =    $ 35,902

        Miscellaneous Supplies:                             =    $   2,000

        High Value to the Practice:                         =    $146,902

 

I'd offer $120,000 and let the buyer negotiate upward.  

 

There are problems with the take-over of the practice.  

 

1.   There will be a new CA (patients are loyal to the old DC and 
CA.)  If an 

established CA stays with the practice and boosts the new doctor, 
a 

successful transition may take place.  However, in this case, the 
new CA 

doesn't have patient loyalty.  And, the patients won't have any 
loyalty to 

the practice.  Thus, the transaction will suffer.

 

2.  While it's true that if you buy accounts receivables and can't 
collect 

them, you can write off the non-collectible accounts.  It's not as 
easy as 

the broker states.  The buyer first has to reasonably value each 
account 

(what the doctor thinks is reasonable and the IRS will probably 
think 

differently).  When the doctor can't collect the accounts, the doctor 
can 

write them off.  However, if he collects more than his valuation, he 
has to 

claim it as additional income.  My advice...be careful!

 

When someone wants to buy a practice, he should make it very easy 
for the 

seller to sell.  Asking the seller to sell his practice, then 
separately sell 

his equipment, and then collect his own AR, will usually kill the 
sale.



Buy the equipment and collect the AR yourself.  Make it easy for 
the old 

doctor to sell.

 

Don't collect the old doctor's AR for him for less than 40% to you.  
It's a 

real pain to collect someone elses money.  No one will feel that 
they owe the 

new doctor anything.

 

Now comes the question, should this doctor buy the practice?  
Assuming a 

$147,000 sale price, he'll have to come up with at least $20,000 
down, then 

finance $127,000 over 15 years at 10% (or more).  The monthly 
payment would 

be $1365.

 

Therefore the overhead of this practice would grow to $7365 a 
month.

 

My recommendations, if all the supplied figures are accurate and if 
the 

doctor feels he can effectively take care of the number of his 
patients, and 

the number of the departing doctor's patients without losing any (a 
big if), 

BUY THE PRACTICE.  He'll end up with:

 

        His monthly income:                                        $  5,000

        The departing doctor's monthly income:         $ 16,000

                            Sub-total:                                     $ 

21,000

        With an Overhead of:                                       $  7,365

                            Net Profit:                                    $ 

13,635

 

Not bad, a high net profit practice and he doesn't have to move.

 

Hope this helps.

 

Dr. Pete Fernandez

 

P.S.    Remember, this doc is earning $5000 a month.  If he opens 
his own 

practice, his overhead will be at least $6000 a month, a loss of 
$1000 a 

month.