What is Goodwill?
This "intangible" figures heavily in a practice's worth.
BY BRAD RUDEN, M.B.A., Phoenix, Ariz.
Whether buying into a practice as a partner or purchasing a practice outright, the most difficult aspect of any practice's worth is its goodwill value. Part of the difficulty in assigning value to goodwill is the inherent intangibility of goodwill -- how does one assign value to something that can't be seen or touched? Many approaches and techniques are available for us to use to ascertain goodwill value and we'll explore them here.
Let's establish a definition
For most practices, goodwill is typically defined as:
- Established office procedures
- Practice reputation and name recognition
- Staff training and experience
- The likelihood of patient retention
- Office location
- Patient demographics
- Financial condition
- Departing doctor's non-compete clause
- Transition assistance for the new owner.
These elements are intangible because although they've contributed to the success and worth of a practice, their values are not recorded in the practice's financial statements. These elements have institutional value due to their ability to help transfer patient volume and revenue from one owner to the next.
Quantifying the intangible
In past years, when reimbursements were high, "rules of thumb" were commonly accepted as approximations of goodwill value. However, the continued encroachment of managed care and declining reimbursements demand that more scrutiny be paid to items such as goodwill. This brings us again to the issue of how to measure the worth of something that isn't recorded in financial statements.
Although the goodwill elements outlined above are not directly recorded in financial statements, one can argue that their impact on a practice is still reflected in the practice's profitability.
Just as a poor reputation, unattractive office location or questionable financial practices will negatively affect a practice's ability to generate revenue, a good reputation, prime office location or solid financial protocols will have a positive effect on a practice's revenue stream.
Optometry is a service industry and, as in any service industry, the value of a business lies in its ability to generate revenue from the services provided; the intangible value of an optometry practice is directly related to the amount of revenue generated from providing optometric services. In other words, goodwill becomes a salable asset when it's viewed as the expectation of future profits accruing to someone other than the present owner.
With this in mind, I propose that one approach is to view goodwill as a function of profitability above and beyond average income. My position is that if a practice can generate higher- than-average income for its doctors, then it's reasonable to assume that a fair amount of goodwill is present. Inversely, if a practice is generating lower-than-average income, then it makes it much more difficult to argue for goodwill.
This approach identifies goodwill as a function of cash flow and profitability. By doing this, we take the intangible aspect of goodwill and make it tangible. We have taken the components that help contribute to the success of the practice and tied them to the practice's revenues. In this way, practices that have profitably negotiated their way through the recent changes and fluctuation in the marketplace will have maintained, or possibly increased, their goodwill value, while those practices that are losing profitability are seeing their values decrease. Accepting this approach, you can take several steps to "prove" the goodwill value of your practice.
Learn to unwind
First, track all personal or discretionary expenses in the practice. These are items that don't contribute to ongoing operations but are expenses that benefit the owner(s) of the practice. The cost of these expenses are "un-wound" from the financials to identify the true operating overhead of the practice as well as to ascertain its true financial benefits to the owner(s).
Some discretionary expenses most easily targeted for review are travel, entertainment, all forms of insurance coverage (property, health, auto, professional liability, etc.), and any inflated family wages. If you own the practice and real estate through separate corporations, match the rental payments to the current market rates.
To accomplish this type of analysis, you should maintain complete, accurate financial statements as well as other supporting documents/appendices for review. These should provide an overview of the practice's monthly/annual operations and portray an accurate picture of its financial health.
Put it in context
Once you have identified the true overhead and financial gain of the practice, compare the resulting figure to state, regional and national averages for similar practices. If your practice is generating income and benefits equal to or greater than the national average, then you can make a sound argument that goodwill is a justifiable asset in the sale of your practice. A premium price is paid for premium performance.
What else counts?
As I stated earlier, there are many approaches and techniques used to ascertain goodwill value. Even if a practice isn't generating income in excess of an average income figure, there's often still a sound basis for some minimal goodwill. The argument for minimal goodwill in an underperforming practice can be bolstered by addressing other aspects such as number of medical charts, outline of established business procedures (which may reduce overhead or create a competitive advantage), a history of key staff members staying with the practice, an overview of transferable managed care contracts, etc. These are benefits which can accrue to a new owner and may not be reflected in a practice's financial records.
What goodwill really means
Profitable practices will always have some goodwill value and less successful practices will have a more difficult argument to make. For a practice to maintain or increase its intangible value to a potential partner or owner, it should do everything possible to maintain its profitability. After all, goodwill means nothing if it can't be translated into real income or benefits for the doctor/owner.
Mr. Ruden works for MedPro Consulting. You can contact him at (602) 274-1668 or at email@example.com.