By Mike Hutchinson, Lead Coach: Financial Performance & Reporting
I’ve been valuing businesses for a large part of my professional career and during that time I feel that I have developed a method that pretty much encompasses all the elements that ultimately have an impact on value. So, for example, here are just a few:
Profitability – (more recently refined to be EBITDA (an anachronism for Earnings Before Interest, Tax, Depreciation and Amortisation)). I know I have banged on about the relevance of profit to any valuation, and my view has not changed. It’s pretty simple to me, the more profit you make the more something is worth. But let’s leave that for another time.
Potential – the way I see it I would rather pay a little more for a practice with three empty surgeries than I would for one that was full to the rafters (assuming they both make the same profit). “Potential” represents the opportunity to ‘sweat the asset’, or make more from the same.
Location – well we don’t need Kirsty or Phil to remind us of the relevance of location. But its relevance is obvious. Yes I do know practices that have made a fortune on the 6th floor of a shopping precinct in Glasgow, but they are the exception rather than the rule. And yes, parking makes a difference!
Marketing – marketing!? What is he on about? Well let me tell you something, in the 200 hundred years I have been an accountant (I know, I find that hard to believe too, but you’ve seen the photos) there is one common theme that makes all businesses successful (where we measure success in terms of robust solid trading with a reasonable profit at the end of it all) and that is each of them have a systemised, well structured, very focused 24/7 – 365 marketing activity. And if you have got one in place, I’d pay a little extra.
Interior layout – once again this seems obvious to me. No matter what form of tenancy you are buying (lease or freehold) surely you would pay a little extra to have the correct layout (or less for the wrong one)? I mean if the receptionist had to sit on a few books balanced on the autoclave, or the decontamination room was behind a curtain in reception then you would think twice about how much the cost of rectification would be and that needs to be reflected in the price? Well, you would if you were buying a house.
Tenancy – when buying a practice it is absolutely vital you purchase a tenancy of reasonable length. If you buy the freehold it’s not a problem, but would you really want a lease that only had 2 years to run? I’ve just been involved in a sale where the buyer walked away because he could not get a 25 year lease (because, unbelievably, the landlord wanted a premium!). His rationale was that he needed 10 years to repay his borrowings and grow the practice, leaving him with 15 years to sell. He had a point.
Now, having done all that, looked at comparable sales, considered each element of the value, licked my finger and stuck it out the window, I always state the caveat “subject to a willing buyer and willing seller”. Well, in my experience that has all changed.
I’m still saying that both the buyer and seller have to agree, it’s just that there is another more significant player in the equation. Yes you’ve guessed it; it’s that big bad banker.
Those of you that can remember those halcyon days from 1999 to September 2008 can recall that raising finance was ‘a walk in the park’. Banks loved dentists, dentists loved banks. You needed money, they supplied it. It was like having your own cash dispenser. You went to the machine in the wall, entered the value of the goodwill, and the money came pouring out – as easy as taking candy from a baby.
But in September 2008 Armageddon occurred. Well, it appeared to for bankers at least. And everything from that day appears to have changed. Most bankers are still very good at saying ‘yes, very much open for business’ and ‘just had the best year ever’, but I am still struggling to gather any evidence that supports it. The only thing I have found is that I no longer blame ‘the suits’. There is a bigger badder baddy that goes by the name of Credit Control. So just getting the banker to say yes, counts for nothing until Credit Control have had their 5 pennyworth. They are the dementors of the banking world, sucking the energy and life out of every deal.
So what is it that the banks want to see?
1 – repayability. You have to demonstrate that the business can make the repayments on the debt, but not only at today’s rates but stress tested for an additional 5% over current levels (what does that tell you??)
2 – experience. No longer are funds available to people who have never done this type of thing before;
3 – deposit. How about a minimum of 30% (that has not come from borrowings elsewhere)?
4 – security. So, given that you have demonstrated comfortable repayability, you have a surfeit of experience and can make a substantial cash deposit, lets talk about security. In simple terms it needs to cover at least 100% of the funds borrowed. That feels a little harsh in the light of the above, so lets look at how they work that out:
Well, firstly, all freehold is valued circa 60-65% of market value. So if your property is debt free, the math is easy. Say its £500k, the security value would be £300k ish.
But what if you had a £200k mortgage? Is it 500-200=£300k @ 60% i.e. £180k? Sadly no – it’s £500k @ 60% (300k), less mortgage £200k = £100k. Ouch!
Here’s some math – if you have debt to value ratio of 40% (like the example above) and security is valued at 60% of market value you need gross asset values of five times the amount borrowed. That means if you want to borrow £500k you would be looking for gross freehold values of £2.5m (if debt was 40%). Oh dear, that looks a little harsh.
And sadly for us all that means is the caveat has changed, it has become “willing buyer, willing banker!”.
And the question is ‘who holds the strings when it comes to valuing practices?’ I hope for all our sakes it’s not the banks….
For more information, please contact the Breathe team to arrange a phone appointment:
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