When planning an engagement to value a professional practice, the Certified Valuation Analyst (CVA) is going to consider three possible theories. These are (1) the income approach, (2) market data approach, and (3) asset based approach.
The Income Approach commonly includes capitalization or discount of an identified measure of earnings, gross revenue multiplier and "Rules of Thumb." The income method may incorporate aspects of asset valuation and market valuation methods. Using capitalization methods requires a projection of income. The multiple(s) of revenues or selling price to earnings represent conversion of historic sales data to multiples of renews. This is a rather simplistic method but since it is relatively quick to apply, it can be very useful as a first run. This method is frequently used to open negotiations.
The Market Approach focuses on the external phenomenon in the economy and industry rather than internal company dynamics. Value estimates reference arm's length transactional prices paid for equity/ownership interests in competing practices. Fortunately, today databases of potential comps are now available via subscription. Our experience shows accounting firms who are serious about their valuation practices subscribe to at least the top two and many are subscribing to the top four.
The Asset Approach is most frequently used in assessing liquidation value. Both tangible and intangible assets are identified. The valuation of client/patient relationships is a common component of intangible value. A strong point of the asset-based approach is its familiar report presentation. The conclusion is presented in a typical balance sheet format.
Revenue Ruling 59-60 states "A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgement and reasonableness must enter in the process of weighing those facts and determining their aggregate significance." Our Valuation Group will be happy to discuss the most relevant method of valuing the professional practice at issue.