I have had a number of questions regarding the value of practices recently from both potential buyers and sellers. Some of them have referenced articles that have been published in the trades. Two particular articles have been problematic: an article in the American Optometric Association published in January 2015 and an article published in the Review of Optometric Business.
Both articles make the lamentable statement that practices are worth 55% to 65% of their annual averaged total sales volume. This is 20th century thinking, not 21st century reality. The author of the article in the Review of Optometric Business even doubles down by recommending against an appraisal, since “appraisals can be expensive”. If you start by using a formula that is outdated, and then proceed with a business decision without an appraisal, then you are going to be flying blind and probably will not have a good “landing”.
Thirty years ago, the marketplace was about 10% Managed Vision Care (MVC) or less. Most practices had about the same level of profitability if they were about the same size. So thirty years ago, most practices sold for 100% of their total sales. Twenty years ago, it was more like 75%.
Today you would be crazy to use any sort of multiplier on total sales. Profitability varies greatly from practice to practice, with MVC lowering fees paid to practices and increasing costs to file and collect fees. Practices that have done a great job in adapting to the “new normal” in MVC are still very profitable, while those that practice in the same fashion as they did in the last century are not very profitable at all.
The key number for value in an optometric practice, and really any business, is cash flow. The private equity firms that are now buying eye care practices, and have much more experience in buying and operating just about any business, use a multiplier of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). This is essentially the cash flow that they would have after purchasing the business based on the Profit and Loss statements of the previous three years. Yes, they do want to know what the total sales for the practice has been, but the value of the practice is determined by the cash flow.
A practice with $800,000 in total sales and $100,000 in cash flow would be worth less than a practice with $500,000 in total sales and $200,000 in cash flow according to this formula. The reason is obvious. The smaller practice generates twice as much cash to pay the mortgage, and pay the new owner, as the larger one. The articles listed at the top of this page would have it the other way around.