Six Reasons Professional Practice Valuations Differ From Other Business Valuations
The term professional practice includes a variety of entities including accounting firms, architecture and engineering firms, law firms, dental practices, physician practices, veterinarian practices, and professional consulting firms. Although there are technical distinctions between these practices, they pale in comparison to other small businesses. Valuing professional practices requires understanding of these differences by the valuation expert to derive the appropriate value of the practice.
Below are some of the major differences between professional practice valuations and other business valuations:
1- Type of Assets
Professional practices have a higher proportion of intangible assets than other businesses. For this reason, when using the asset approach to valuation, the valuation analyst must be well versed in the valuation of intangible assets. They derive their values primarily from their contribution to the economic income of the practice.
2- Dependence on the Professional
There is a greater dependence on one or a few individuals in professional practices than in other businesses. For the valuation analyst this means that:
a- The contributions of the professionals in the practice have to be evaluated carefully for proper allocation to each practitioner in the firm.
b- In some cases, the distinctions between the elements of intangible value associated with institutional practice versus the individual practitioners have to be determined as clearly as possible.
3- Professional Licenses
Holding a practice license confers intangible economic value to the practice. The reason is that an independent third party endorsement provides credibility to the level of competence of the practice and the professionals. Professional license also limits the entrance in the profession. In marital dissolution litigations, some states (i.e. New York) recognize licenses as a valuable marital asset. In practices with many practitioners, the addition of all the licenses from all the professionals confers intangible value called Goodwill to the institution itself.
4- Cash Basis Accounting
Most practices use cash basis accounting that may require adjusting financial statements to accrual basis accounting for valuation purposes. However, there may be some comparative data from similar practices that are presented on a cash basis. In these cases, it is advisable to use cash basis data for comparative purposes and use accrual basis accounting for the rest of the valuation process.
5- Limited Life of the Practice
Most small professional practices do not have a perpetual life as big ones. This is because once the practitioner retires, or departs from the firm for any reason, the practice ceases to exist, unless a proper transfer occurred to keep the practice going. The income approach is the prevailing valuation approach for these small practices; therefore, their limited life should be reflected in the projections underlying the income approach analyses.
6- Value Drivers for Professional Practice
Professional practices distinguish themselves from their competitors through a few key factors called value drivers. Some of these value drivers include: location of the practice and its demographics, client acquisition and retention, reputation, employees, practitioner’s work habits, contractual relations, to name a few. These factors are reflected in the valuation of the practice in various ways such as discount rate, capitalization rate, discount for lack of marketability, and pricing multiples.
Achille Ekeu, MBA, CVA
President & CEO
The Washington Valuation Group
Achille is a Certified Valuation Analyst (CVA) and Member of the National Association of Certified Valuators and Analysts (NACVA) in the DC-MD Chapter. He provides valuation services for Estate and Gift Tax, Buy Sale, Debt Financing, Buy-Sell Agreements and Litigation Support in Divorce cases. He can be contacted by phone at 240-274-9570 or by email at firstname.lastname@example.org.