How is a practice value determined and is there more than one premise of value?
Earnings drive value. A hospital must be profitable to have value. Profits are the most important aspect of driving value. Income must exceed expenses. The acronym used to describe earnings that produce value is known as EBITDA or otherwise known as earnings before interest, taxes, depreciation and amortization. Everyone doing valuation work in the veterinary profession uses EBITDA as the basis of determining value. It’s all about earnings.
Actually, valuation consists of two parts, one is determining the EBITDA and the second is determining the risk of the investment. The lower the risk, the higher the value and the higher the risk, the lower the value. So it is risk and earnings that determine value. The premise of value can be different based upon who the user is. Corporations use their own criteria and private buyers are required to consider the criteria that banks use in the making of the practice purchase loan.
The two most common premises of value for veterinary practices are fair market value and investment value. Investment value in veterinary medicine is used by the corporate acquirer of practices. This method of valuation is predicated on what the investment is worth to them and considers financing to complete the transaction is not required. Corporate acquirers typically assume less risk and consequently pay higher values for practices. They assume less risk since they are acquiring one practice at a time as part of a roll up where the value of 100 practices which have been combined is worth much more together than each hospital individually. Corporate acquires of practices will typically sell their rollup of hospitals to another corporate acquirer of hospitals every 5 to 7 years.
The other premise of value is fair market value and is typically used by those creating valuations for practices traded in the private market place. It assumes that practices will trade with the requirement of bank financing and integrates bank financing and the banks criteria for lending to make a transaction occur. This typically carries greater risk and lower valuations than what corporations will pay. So when an individual veterinarian wishes to buy a practice, they may have some funds of their own to use to make a transaction occur but will also require the individual to apply for bank financing. The banks criteria for loan approval now becomes an influence to making a transaction occur.
This answers that burning question of why the corporate acquirers of practices are paying more than what private individuals can afford to pay in making a purchase of practice needing bank financing. This has become the nature of what most will consider when deciding to purchase a practice and understanding the marketplace.