Are Practice Sale Prices at a Premium or is Practice Equity Available at a Discount?
As part of our annual presentation series on buying or selling a professional practice, I make the statement that ‘the price a practice can or will sell for as a whole of business sale in the open market differs to the value that someone should pay for a percentage of equity within a continuing firm’. You may be thinking right now, how or why is this so? As you can imagine, it’s a great discussion starter.
So, what is the difference between the two?
Firstly, the proposition. The first proposal is to buy 100% of a practice in which you, as purchaser, will be able to make all the decisions, implement all the changes and essentially be able to run the acquisition the way you want, albeit with some guidance from the vendor (hopefully to ensure the successful transition of the client relationships and the like). Under this scenario, 8 out of 10 purchasers will also want to relocate the acquisition into their premises, resulting in the majority of the fees transferring straight to the bottom line of the purchaser as profit. Furthermore, we currently know that, in part due to the limited number of practices for sale in the open marketplace, acquisition prices remain strong. We tend to use the word ‘price’ under these circumstances.
The second scenario or proposition results in a practitioner buying equity within a continuing practice, perhaps for the first time, which will typically reflect a minority interest. Under these circumstances, this person joins others in the decision making processes about the firm. They are one voice amongst others. Therefore, the equity entrant will hopefully have a stronger focus on the benefit that they will receive from the acquisition following an allowance for a reasonable market salary. Obviously current market information is key to ensuring this assessment is as accurate as possible. Under such circumstances, we tend to use the word ‘value’.
It is rather frustrating and disappointing when I hear from younger practitioners who are being offered equity within a practice and that the person selling is suggesting that ‘because Tom up the road sold their whole practice for dollar in the dollar, that’s what you should pay me for a percentage of equity within this firm’. Nooooooooo, these two scenarios are not the same and hopefully the difference is evident.
As one attendee of our presentation series asked, ‘What’s the difference between the two scenarios in terms of price or value’? Excellent question.
So, if we take the approach that open market sales are tending to achieve good prices, perhaps even great prices, (from our experience, goodwill values will generally be more conservative than the sums achieved in the open marketplace) it is possible to suggest that the difference between an open marketplace sale price and an internal goodwill value could be as great as 25% – 50%. Does that mean that a full practice sale will net a 25% price premium or are internal equity transactions valued at a 20% discount? Perhaps the answer is in the eye of the beholder.
Nevertheless, what we do know at present is that selling the entire practice in the open market place is currently likely to achieve a better cash outcome than selling equity therein for many firms with below, say $2 Mill in annual revenue.