Practice Valuation

Larger practices with corporate finance departments may well have considerable experience with commercial sales and acquisitions, but even they, although helping clients to value their businesses, may well never have stopped to consider just what their own is worth. It is therefore hardly surprising that the same holds true for small firms. In fact, the vast majority of partners in independent firms have no idea of what their business is worth and will probably give little thought to the subject until the time comes when they want to retire and sell the practice or need to make a strategic merger in order to maintain or improve their position in an increasingly competitive marketplace.

In recent years we have seen a very active merger and acquisition market; partly because client demands for a wider range of skills and services mean that firms must buy in the expertise they need, but also because a merger is often the most effective means of solving the succession issues that have plagued the independent sector of the profession - and will continue to do so for a good many years to come. Historical factors as well as market forces and succession issues also drive of the M&A market. In the past there has been a natural cycle for small firms where partners set up, practice and retire over a 30 year period. However in the 1970s and 80s there was an explosion in ICAEW membership which, in turn, led to an increase in the number of new firms. Now there are too many firms for the marketplace, and the small general practitioners in particular are struggling.

Although a forthcoming sale or merger is one good reason for finding out what your business is worth, it is not the only one. It may well be a factor requiring consideration in paying out retiring partners or even in raising development capital from outside sources.

The valuation of the practice depends upon whether there is sufficient financial information available on which to make a precise judgement. The gross fee and net profit figures in themselves are unhelpful without knowledge of the staffing arrangements, type of clients serviced and the growth trend in recent years. In any assessment, and especially with a smaller practice, it is essential to note the charge rate structure, the recovery levels, quality control standards and what passes through the profit and loss account. The seller will need to adjust the declared results for any additional costs which he anticipates will arise.

Generally speaking, the higher the proportion of Type 1 lower end work in the firm, the higher the practice value. Most buyers are seeking a portfolio of general practice and compliance cases which can be turned round by their existing efficient staff and work methodologies. Profitability, in theory, comes from lowering the cost base of the job. By contrast, Type 2 benefit-driven services require the seller's staff to transfer unless the work is done by the seller, in which case the buyer must find a replacement with the same skills. Either way, the economics of scale are less good. However, if one of the prime reasons for the merger is the acquisition of a particular nice service or specialist department then this will have a commensurate effect on the value of the business.

Traditionally, there are two methods of putting a price on a practice; either a valuation based on a percentage GRF, or a multiple of superprofits available in the practice over and above the partners' salaries appropriate for the size and type of the firm. The market emphasis is on the GRF multiple basis, whereas the superprofits method is of particular value for a specialist practice or as a check on the GRF basis.

During the 1980s it was not uncommon for practices to be bought and sold at multiples of 1.5 to 2 times GRF. In the 1990s this fell to 0.7 to 1.2 times GRF and the average for smaller practices is now 0.8 to1 in most cases.

Valuation example

The vast majority of partners have invested a considerable amount of money - not to mention time and effort - into the development of their firms: surely they should know what that investment is worth.