(Re)setting Expectations on the Value of an Optometric Practice
May 20, 2022
It’s often the case that the value of an optometric practice is just not understood by the average OD — and neither are the methods for valuing a practice.
For ODs, buying or selling a practice can be one of the foundational experiences of their lives and is often the biggest purchase or sale they’ve ever made. Selling your practice begins with valuation, a method that may or may not be fair to the seller.
For young ODs who are looking to purchase a practice, there are many factors to consider, not the least of which is when and how to pay off debt. It’s often beneficial for younger ODs to keep cash on the balance sheet and keep those outstanding loans for a few reasons.
In this post, you’ll learn more about best practices for selling your practice or buying a new one.
How the Value of an Optometric Practice is Measured
The way practices are valued when it’s time to sell can often surprise ODs. Practices that have over a million dollars in yearly revenue might only be valued at $200k – $300k.
When sellers consider buying a business, they’re looking at a few factors, one of which is predicting future cash flow and another of which is the risk of buying the practice.
When you consider what an optometrist can make as a full-time associate at a private practice compared to the risks of owning a business, owning a $500k practice isn’t really that different in terms of income.
One rule for valuation is 60% of gross income. If you’re doing a fair market value appraisal for the IRS, there are three methodologies — here are some optometry practice valuation rules of thumb:
- Asset-based approach — OD practices that are valued this way are generally valued very low because there just aren’t a lot of high-value assets in an OD practice
- Market transaction methodology — much like buying a house, comparable sales are examined (often between 55% – 75% of revenues)
- Multiples of earnings — this is the best way. The multiplier is based on the demanded return of an investor based on risks perceived on the asset. This is why private equity pays so much: often between $800k to $1MM.
Subjectivity is baked into all of this, so there’s a lot of variation based on what people think something is worth.
The only number that matters is the number two parties agree on when it’s time to buy/sell, which is ultimately subjective. For example, you can say that the floor for you is based on your retirement profile — that’s subjective, but it’s not an invalid method of selling.
The same goes for buyers. If a buyer simply wants to pay a certain price, regardless of what the business has been “valued” at, and the seller agrees to it, that’s the value of the optometric practice.
Are These Valuation Practices Fair?
What’s difficult is that sellers often overestimate the value of an optometric practice. Fairness doesn’t necessarily factor into the equation. Realism is important, but so is what you want.
Trying to keep emotions out of the process is key. If you’re selling a business, you need to think about the buyers’ wants and needs (especially given that we are in a buyer’s market).
A profitable business isn’t the only factor to consider. For instance, future expected cash flows can be heavily impacted by the need for modern equipment or building improvements/updates.
If $150k is necessary for the buyer to update your business, this is going to depress the value.
It’s also important to keep in mind that this is an illiquid asset. It’s not easy to convert to cash. Simply finding a buyer can be difficult, which may mean the seller simply has no option but to take what’s offered if they want to sell, especially if they’re on some sort of timeline.
Another factor to consider is the reality of how well a buyer can replicate your production. If you’re an outlier producer, then your multiple may be valued as lower because the practice depends so much on what you’re personally doing.
That’s why bringing in an associate can be so valuable. It de-risks the practice. Buyers can see that you’re not the center of the business, that expected cash flow will not go down when you leave. The less the practice depends on you, the more it’s worth to a buyer because they can expect cash flow to remain the same.
What Affects the Value of an Optometric Practice When Buying?
One big thing to consider is that young buyers have a significant advantage when it comes to buying an optometric practice — their age. Young ODs can bring drive and motivation to a business that may have been missing for years, or even decades, as the owner of the business reached an equilibrium where they were satisfied with how the practice performed.
Buyers who bet on themselves are generally successful, especially young buyers.
But sometimes what matters is just what you want. Do you want this patient base? Do you want to live in this location? What are your plans for your life outside of work? Do you want to work all week and on the weekend and hustle, or do you want to work only a few days a week? Do you really want this? Is it right for you?
This, more than anything else, should guide buying decisions. Practices that are “overvalued” often end up being extremely profitable to buyers who have a clear idea of what they want to do with the business and implement that successfully. In other cases, practices that were “undervalued” have failed.
Keep in mind that “overpaying” isn’t necessarily a huge problem. Sometimes that “overpayment” might only be $20k or $30k. Even a $100k difference might not matter much if you’re able to implement systems and practices on day 1 that significantly raise revenue — say by 20% – 30%, which isn’t uncommon.
Ask yourself how the practice is going to perform when you take the reins. Ask yourself what your future expectations are. What is my expected income? What are my payments, and what is left over? Does it justify the headaches of owning a business?
Something else to keep in mind is that it’s often not a great idea to keep the seller around. Keeping them on retainer to ask questions is a better plan as sellers can often let their emotions take over when changes are made to the business.
This can lead to serious problems if the seller decides they’re not happy with the changes a young buyer has made, especially if they verbalize that dissatisfaction to the community and the patient base. That’s why you need to consider a variety of factors when trying to determine the value of an optometric practice — there are just so many variables to keep track of.
Why Large Amounts of Debt Aren’t Necessarily Bad for Young ODs
Young ODs may worry that it will be hard to get a loan for a business because of the debt they already carry, but that’s rarely the case.
Even with a personal mortgage and car payments on top of student loan payments, many banks are still willing to make loans if the practice is cash flow positive and the financials of the practice warrant it.
Income potential is high for ODs — $120k to $180k right out of school. If you own a practice, you’re essentially going to earn more money as an owner than an employee. The bank takes this into account because they know that you can pay off the debt with this kind of cash flow.
Banks also prefer to see that you have cash on hand than that you have paid off debt. Cash has much more utility, especially if you have an emergency of some sort — you’re still able to make your payments. Even with less debt, payments are still due whether you’re able to work or not. It’s better to have $50k on hand than to prepay your student loans by $50k.
Pitfalls to Avoid and Points to Remember When Considering the Value of an Optometric Practice
Doctors need to save as much as possible over the course of their careers to ensure that selling the practice isn’t going to be their only chance of retiring and that they get the value of their optometric practice that they expect. The best position is to be in a place where selling the practice is going to only earn you extra money that can enhance your retirement.
Sellers need to remember that it’s a buyer’s market. It’s simply the case that you often have to take what you’re offered. Buyers get to set the expectations. Stubbornness in sellers can keep a business from ever being sold.
Listen to the Whole Conversation
Adam Cmejila and Nathan Hayes discuss the value of an optometric practice, optometry practice valuation rules of thumb, and more on their podcast on this topic — listen to the full episode here.
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