In 2007, an art dealer/collector by the name of Ileana Sonnabend passed away. Within her rather large and valuable art collection – her net worth was estimated at $1 billion – was a piece titled, Canyon. The artist, Robert Rauschenberg, used a combination of paint, sculpture and a stuffed juvenile bald eagle in constructing the piece. When I say a stuffed bald eagle I’m not talking a stuffed animal you’d buy your kid to snuggle with. This was an actual taxidermied eagle.
In the audit of Sonnabend’s estate tax return the IRS noticed this prized piece of art had been valued at $0.00. While that may seem strange it was with good reason. In 1940 congress passed the Bald and Golden Eagle Protection Act making it illegal to possess, sell, purchase, transport, import or export a bald or golden eagle in any condition…dead or alive. Ms. Sonnabend had been granted permission to retain her ownership of the piece as long as it was on display at a public museum but it was illegal for her estate to sell it.
What’s the worth of something you can’t sell? The valuators of the estate argued it was $0.00. The IRS on the other hand came to a valuation of $65,000,000, which came with a $40,000,000 tax and penalties bill (see here for NY Times article).
Two different groups looked at the same set of facts, the same circumstances and came up with valuations that were $65,000,000 apart. How can that happen? Each side had reasons for their figures but let’s not get lost in details. From a big picture standpoint it happened because valuations are subjective. They require assumptions. They require individual opinions.
Take a dental practice valuation for example. There are a number of subjective elements to a dental practice valuation. If the valuator utilizes a cash flow method they have to make decisions on what to include as add-backs to net cash flow. There’s no standard to that (at least not one I can agree with) and what and how much of what gets added back in is up to debate. And that’s only the beginning. How do you figure replacement value? What about the capitalization rate, which is partly a product of intangibles like location.
You may or may not be familiar enough with valuation lingo to know exactly what I’m talking about but I’m sure you see my point…when you look at a practice valuation you see an opinion derived through a lot subjective decision making. Give two different valuators the same info and you are likely to get two different answers. Add a third and I’m sure we could all guess the result…a different number.
That’s not to say valuations are meaningless. They do have value. But the figures shown should not be viewed as sacrosanct and in a merger or acquisition the value figure should not be solely relied on to drive price. What does matter? The answer is dependent on whether you are the seller or the buyer. Let’s start with the seller.
Have you ever watched the Antique Roadshow or at least seen a clip of the show? Ever noticed what the experts say when they are giving a dollar figure to the person who brought in the 18th century Chinese rhinoceros horn cups (really). In this specific instance they state auction value. At other times they state retail value or insurance value. There’s differences in those definitions but all of them revolve around the same concept – how much money someone will pay the owner to part with the item. For the seller of a dental practice, that’s what matters. How much you can get for the practice.
What a buyer should be looking for is the return on investment. The value of dental practices is almost entirely made up in their cash flows. The assets of the business have little value (secondary market equipment value is much much much much much lower than new purchase cost). The “asset” with the greatest value is goodwill but the value of goodwill is usually derived from the cash flow of the business which brings it back around to cash flow being the predominant driver of value. What a buyer needs to be concerned about is what kind of cash flow they will receive from the practice and what risks exist to the sustainability of that cash flow.
Do not get too attached to valuations. If you are selling a practice, use it to assist you in establishing an asking price. If you are a buyer, use it as a starting point to determine what return on your investment you could expect to receive.