Goodwill explained
By growing, investing in, and managing your practice, you’re inherently building goodwill, but what is goodwill and what else could you be doing to increase the value of your practice?
Learn MoreWhen you buy a practice, it’s not enough to just run your eye over the numbers—you have to unravel the mystery of goodwill too.
In assessing a fair value for a professional practice, one obvious factor is always front and centre—profitability. However, there are a range of other factors that a potential buyer of a medical, dental or veterinary practice should consider. They include patient numbers and local competition. Will the existing owner continue to work in the practice for a period of time? Is there is a restraint of trade to stop the outgoing owner from setting up around the corner?
Then there is the great unknown with any practice purchase—the value of goodwill.
Goodwill refers to intangible assets that can either limit or boost the future earnings of the practice. It includes the location, patient lists, staff strengths, non-compete covenants and the existing owner’s reputation with their patients and the broader community.
Typically, goodwill can account for 60 to 80 per cent of the practice’s total value, or even as high as 100 per cent depending on the sector.
Valuation benchmarks
When banks determine the value of a practice, BOQ Specialist finance consultant Cameron Chater says, they typically use a couple of methods. First, they apply a percentage of gross revenue, while also factoring in the value of any equipment at the clinic.
They then crosscheck that figure by calculating a multiple of the practice’s earnings before interest, taxes, depreciation and amortisation (EBITDA), while again calculating any equipment value. The banks then use those two figures to determine an approximate value of the practice.
“That’s not to say that this is exactly what the practice is worth. Goodwill is intangible and difficult to put a number on, at the end of the day the methods above give a good indication of a practice value based on performance,” Cameron says.
In determining how much to pay for a practice, potential buyers should seek answers to other questions such as:
- Are the current patient fees appropriate?
- Are staff levels and wages too high or too low?
- Is there potential for growth via increased services or opening hours?
- What is the state of equipment such as dental chairs and tools such as ultrasound machines, sterilisers and X-ray devices?
Furthermore, if the existing owner has let the practice decline, that should be factored into the price also.
Intangible assets
Cameron adds that one of the key elements in valuing goodwill is whether the existing owner will continue to have a role in the practice after a sale. “Most of the goodwill sits with the owner of that practice who is regularly seeing patients and who the patients have built trust with.”
However, the positive for buyers is that historically goodwill remains with the practice after the seller leaves, especially if the new owner is professional and friendly. Most patients and clients are willing to transfer their loyalty to the new buyer if the new entity receives endorsements from the seller.
Three choices
In most cases, buyers have three principal purchase options.
First, you can buy 100 per cent of the practice and have no ongoing input from the existing owner.
Second, you can buy the practice outright, but have the owner stay on for a period of time to assist with the smooth transition of the business. “This option encourages a supportive introduction and handover process with patients and staff,” Cameron says.
Third, you can buy a portion of the business with the possibility of purchasing the rest of the practice at a later time. Cameron says the third option comes with inherent trade-offs for a buyer. “If the existing owner is staying on and keeping, say, 50 per cent of the business, they’ll probably want to retain a lot of control. After all, they've put a lot of emotional and financial investment in over the years.”
Perfect planning
The other must-do for any practice buyer, according to Cameron, is to draft a comprehensive business plan. This will ensure that any possible purchase is right for you.
Such a plan should:
- articulate your goals for the practice;
- identify potential risks and how to mitigate them;
- assess the strengths and opportunities of the client base and competitors in the market;
- describe your current and planned financial positions; and
- forecast for initial and future expected cash flow needs based on growth plans and current profitability of the practice.
“When buying a practice, a business plan helps ensure that you’ve thought things through and considered all of the options,” Cameron says.
The existence of a sound business plan is also likely to engender more confidence from a financial institution if you need a loan.
Positive outlook
With COVID-19 having dampened the interest of prospective sellers and buyers, Cameron believes confidence is returning to the market.
“This is good news for buyers because people are more confident to proceed with the sale of a practice now.”
He adds that valuing a medical, dental or veterinary practice is not an exact science. Buyers, sellers and the banks will inevitably have a different opinion on the value of a practice. However, if you do your homework, the risk of a poor purchase will be greatly minimised.
Want to know more about finance options for practice ownership? Speak to one of our local finance specialist on 1300 160 160 or to learn more, take a look at our practice purchase loans to find out how we can tailor a finance solution for you.
