One of the great things about practice ownership is building equity. I’ve always figured as long as we need to work to make a living, why not build equity alongside earning our income and one day cash that equity out additional to the income? We’re working anyway, right, why not get the check at the end?!
Year after year, when we survey colleagues, practice transition, and specifically practice valuation, is at the top of the topics of interest list, and why wouldn’t it be? We always begin with the end in mind, right, and for many colleagues, nary a day goes by they’re not thinking about the value of the practice and how this impacts and even determines both the nature and the timing of the end-game.
By the way, Friends, for a full conversation about practice value and valuation, have a look back at BOWEN’S BLOG Post #35 – The State of Private Practice Value. In that post, we cover an array of considerations and methods for determining the value of an independent optometric practice, but of late, there’s been a good bit of HELP DESK inquiry specifically regarding calculating Goodwill of the practice, and with that, it seems a good time to share some fruits of those conversations with the class.
That said, a discussion about Goodwill begins with an understanding that Goodwill is actually an ASSET. A helpful definition of Goodwill is the reasonable expectation of continued earnings based on the business’s reputation, acquired customer (patient) base and continued operational practices, and Goodwill is typically transferred to the new owner in the sale of a practice as an asset. Like all practice assets, Goodwill is something actually owned by the practice and like other assets, may even be included on the practice’s Balance Sheet. Unlike Tangible Assets of the business, however, such as bank accounts, receivables, improvements, equipment, inventory, furniture, etc., Goodwill is considered and transferred to the buyer of a practice as an Intangible Asset. And of course with that, the value of Goodwill is at least partly in the eye of the beholder and thus at times a bone of contention between a seller a buyer.
So how do we calculate Goodwill? It’s a great question, and the answer might not be as technical as you thought.
For starters, the Goodwill of a business is not actually figured until a value of the business has been determined by some valuation consideration and the Target Purchase Price set. Once a value and Purchase Price is determined, you sort of “back into” a value for Goodwill from there. This process starts by figuring the practice’s Net (Tangible) Assets, which is its Total Assets minus its Total Liabilities. You then subtract this Net Assets figure from Target Purchase Price, and that difference is considered the Goodwill, which again, is an Intangible Asset. So the calculation reads like this:
Total Assets – Total Liabilities = Net Assets… then Target Purchase Price – Net Assets = Goodwill
To streamline the equation even further for our math whiz readers, if Purchase Price is P, Assets is A and Liabilities is L, the super streamlined formula reads like this:
Goodwill = P −( A − L )
So looking at this inversely, when we talk about an Assets and Goodwill Valuation, we’re simply adding Goodwill to the Net Assets Value to derive the Purchase Price.
This all established, here’s a bit of a twist on the Assets and Goodwill valuation consideration. Remembering our definition of Goodwill above, and realizing the value of Goodwill is at least somewhat in the eye of the beholder (think a seller and buyer might behold that differently??), you might see an Assets and Goodwill valuation subjected to a multiplier. So for example, let’s say a well-established practice is unusually profitable, has no debt and is growing rapidly, say $400,000 a year (we recently did a Fair Market Valuation on just such a practice). In a case like this, you might see the “normal” Assets and Goodwill value multiplied by a factor of say 1.2 or 1.3 to get to an Asking Price the seller would accept or NO DEAL! And of course, there is no practice sale unless the Seller says so!
In case you’re wondering, the opposite can be the case as well, and believe it or not, there’s actually something known Negative Goodwill, even sometimes referred to as Badwill. This, as you’ve guessed is taking the “normal” Assets and Goodwill value times a multiplier that’s less than 1, say .85. So in the case of Negative Goodwill, you could say the practice is being or was purchased at a bargain price.
Again, Goodwill is often shown on a business’s Balance Sheet, and it bears mention as we think about the accounting that as an Intangible Asset, Goodwill is not amortized or depreciated but is instead periodically tested for Goodwill Impairment. If the Goodwill is thought to be “impaired,” the value of Goodwill would be written off, reducing the practice’s earnings, and of course it thus makes sense to keep the practice’s Net Asset Value strong and its revenue growing.
Well, Partners, that’s the jest of it. My hope is we’ve taken some of the mystique out of the Goodwill consideration for you, and we’ve realized it’s actually a pretty simple concept. We have a Target or Asking Price, the Net Assets don’t add up to that, so we call the difference between the Net Assets and Asking Price the Goodwill. That’s about how it slices!
Like all THRIVE content, the purpose of BOWEN’S BLOG and SUMMIT TALK Podlecture conversations is to keep us driving together toward IMPACT. If something here has struck a chord, shoot us an email or give us a call and let’s talk it out! Email Tbowen@mythrivecoaches.com or call 402-794-4064.