OBSERVATIONS ‘05

Q&A OF BLUNDERS, CAUTIONS, AND STRATEGEMS IMPACTING THE PRACTICE SALE THROUGHOUT 2005 (part II)

By Sam Reader

Compliments of S.G.Reader & Associates, Inc

What is in an Evaluation?

A.It depends on where it is coming from and what side of the fence you are on.

Case in point: Dr. A is in the process of getting a divorce. He tells me that his wife hired her own CPA to evaluate the worth of the clinic. This clinic has been in existence for five years located in a remote and undesirable part of the country. His technique is eclectic, a hodgepodge of special, metaphysical and nutritional treatment programs. His collections – $265k annually. The evaluation came in at over $450k, not to include receivables or property. The $450k would include clinic files, equipment, furnishings and staff. Her cut would be one half of the estate.

In probing the qualifications of this CPA, I found this was his third evaluation in his 10 year career, never sold a business, much less a chiropractic office. This scenario is all too frequent and common. Is the clinic worth $450k?

Only to the doctor who buys it. Here were just a few of the clinic’s inherent problems:

Production numbers had dropped substantially over the last year due to doctor’s distraction of the divorce.
The doctor had just lost two major insurance panels representing 50% of his income.
Most distressing, his unique and specific treatment protocol.
The odds of finding his replacement located in such a remote and undesirable location were a long shot.

Bottom line: I felt the clinic was not worth more than $85k, and that was being generous. The three factors to be considered in the evaluation include:

12-month net cash flow plus tangible assets.
The collections-to-asking price ratio (comp of community).
Net income-to-debt service ratio (the new doctor’s take home pay after his payment to the bank).

For the most part, an evaluator’s maneuverability in placing value on a clinic is constrained by these three factors. Not much room for subjectivity. It has been my experience that although many chiropractic brokers and/or evaluators may use different methods to arrive at a value, the end result or difference is usually a plus or minus 5-10%. Very consistent in this industry. This should be fortunate for both parties; unfortunately, some judges do not seek out this consistency.

In this case, the judge appointed his own evaluator, someone who appraised small and different types of businesses, such as adult bookstores, laundromats, bars, tattoo parlors, and the like. This individual decided to evaluate somewhere in the middle – coming in at $262k. His justification? “It’s in the middle!”

There are times that I must pinch myself to make sure I’m not living out an episode of the Twilight Zone. In the end, I suggested the attorney and CPA representing the wife find a broker who could actually sell this clinic for $450k, allowing both parties to split the proceeds following the miraculous sale. You guessed it! The attorney was opposed to the idea (too practical). To this day and thousands of dollars later, both parties are still “duking” it out.

This clinic cannot meet rent, much less attract a buyer. All of this could have been avoided if both parties mutually agreed to one evaluator and/or several evaluators within the profession. Regardless of which side of the fence you are on, the reliability and validity from evaluators within the industry will be remarkably consistent. The judge is never opposed to any evaluator when both parties are in agreement.

In another situation, the doctor had become so distraught from this never ending and senseless process, he abandoned the clinic. The spouse, who felt the clinic was worth $1 million and spent about one-eighth of that in attorney fees to collect it, is now without. The doctor is running from the law, living incognito in some third-world country. This too could have been avoided if both parties had agreed to retain evaluators within the industry.

Is there any harm in hiring an evaluator who sells general businesses?

Again, be cautious. Find out how many clinics they have sold specific to the industry.

Case in point: Dr. K calls me with a dilemma. He had his practice evaluated by a general business brokerage firm from the northeast. He collected $150k per year. The evaluation came in at $520k. This would not include receivables or property. Furthermore, the evaluation cost over $9k. Is the clinic worth $520k? Only to the doctor who buys it! The doctor was not too surprised that a year had passed with no serious shoppers. His dilemma? The $9k-plus evaluation would be rebated upon close of sale. The hope of selling his clinic, much less getting his rebate, was fading. I asked him to put in a call to his broker asking if he could speak with the funder bank rolling this expensive project. Basic arithmetic proved there were not enough collections to cash flow the substantial debt service to funder, as well as provide adequate take home pay to the new doctor. You guessed it! The broker could not produce a name or number for any funder willing to back the evaluation, even though Dr. K was guaranteed the evaluation would be backed by the broker’s funder.

These calls have become all too frequent and common. Could the situation have been avoided? Absolutely. A simple phone call to the funder(s) prior to the guaranteed evaluation would have been in order. Doing a comp of the community would have also been wise. A comp is simple and quick.

For example: $150k (collections) ÷ $120k (asking price) = 1.25

This ratio of 1.25 is usual and customary for Dr. K’s community and region. The prices for most clinics within a region can be easily accessed on a website. It is not rocket science. Dr. K could have had the option of doing a charge back on his credit card for purchasing a bogus evaluation. Unfortunately, he paid by check. Again, I felt myself drifting back in the Twilight Zone.

Learn from the mistakes of others.

Be Wise. Move Forward. Enjoy!