The mystery of Goodwill valuations – what is EBITDA?

The mystery of Goodwill valuations – what is EBITDA?

There are two main factors which influence dental practice goodwill values – the amount of gross fee income, and practice profitability.

The NASDAL quarterly goodwill survey reports on the average of goodwill values as a percentage of gross fee income.  This is a very simple measure of practice values – in some situations perhaps over simple.  However, it generally is the best measure of value for practices with fee income of around £500k or less.

Valuing goodwill using a multiple of profits is generally the best method for larger practices, and this is where “EBITDA” comes in.  EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortisation (Amortisation being a type of depreciation).  The multiple to be used is another matter for debate, but the dental corporates often use a multiple of 5 times EBITDA.  On the face of it, it should be relatively easy to calculate EBITDA – but there’s one very important adjustment which is often overlooked, demonstrated by the following example.

Consider a sole practitioner practice with associates, which has a pre tax net profit of £150,000.  The principal carries out £200,000 of gross fees personally.

After adjusting for interest and depreciation of, say, £20,000, the person valuing the practice (please note, I choose my words very carefully!) calculates an EBITDA of £170,000, and a consequent value of 5 times this, £850,000.

The principal then decides to take life much easier, and cuts his workload down to £100,000 gross fees per year, the practice pays an associate £45,000 to carry out the £100,000 of gross fees transferred by the principal.  Practice pre tax net profit drops to £105,000, and the person carrying out the valuation comes back and prepares a new valuation at 5 times EBITDA of £125,000, this time reduced to £625,000.

So, the practice value drops by £225,000 just because the principal decides to transfer some work to an associate – or does it?

In order to have a level playing field for practice valuations, the whole associate equivalent cost of the work carried out by the principal should be deducted from the profit – as if a large corporate were running the practice, where all dentists are associates.  Using this basis the practice pre tax net profit would be reduced to £60,000, EBITDA of £80,000, and goodwill value of £400,000.

The purpose of the above example is to highlight the impact on practice values when adjustments aren’t made in the calculation of EBITDA in relation to the value of work performed by practice principals.  In the example above the practice “value” has apparently more than halved as the principal changes his workload!

If you’ve been relying on selling your practice for 5 times the net profit shown on the bottom line of your P&L you might be disappointed!

PS To my good friends who are professional valuers – you’ll understand why I chose my words carefully!

 

Alan Suggett

Alan is a Chartered Accountant and partner in UNW LLP chartered accountants.

He is a member of the National Association of Specialist Dental Accountants & Lawyers (NASDAL) and a member of the technical committee, and chair of the NHS Superannuation committee.  He is also a member of the Association of Specialist Providers to Dentistry (ASPD).

Alan is the editor of the quarterly NASDAL goodwill survey which analyses all member client practice sales, purchases, and valuations.

If you have any questions, Alan can be contacted at UNW on

 

T:   07860 246 718    E:   alansuggett@unw.co.uk

 

UNW LLP, Citygate, St James’ Boulevard,

Newcastle upon Tyne NE1 4JE

 

 


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