ADA -Las Vegas Nov 8,2008 1 Presented By JAMES M. RAMSEY BUYING AND SELLING AN AUDIOLOGY PRACTICE 1 ADA Convention ~ November 8, 2008

ADA -Las Vegas Nov 8,20081

Presented By

JAMES M. RAMSEY

BUYING AND SELLING AN BUYING AND SELLING AN AUDIOLOGY PRACTICEAUDIOLOGY PRACTICE

1

ADA Convention ~ November 8, 2008


Introduction

Objectives

To provide the framework for valuing and purchasing/selling an Audiology practice

To incorporate Effective Negotiating Skills in an effort to achieve an optimal outcome

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Introduction

Outline of Program Review Basic Accounting Concepts Valuation of an Audiology Practice Effective Negotiating to Optimize the

Outcome

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Accounting 101

Basic Accounting Equation (Balance Sheet)

Assets = Liabilities + Equity

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Sources of Funding

Debt (liability)

Equity Capital (Yours – Others) Retained Earnings - Profits

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Financial Statements

Balance Sheet (Single Date Valuation)

Assets = Liability(Debt) + Equity

Profit and Loss Statement (Income Statement) Stated Period of Time Profits or <Losses> = Revenue - Expenses

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Accounting Terms/Concepts

Accrual vs. Cash Basis of Accounting

“Matching Principle” Double Entry Bookkeeping System

Personal Checkbook Vs Using QuickBooks

Fiscal Year vs. Calendar Year Reporting

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Accounting Terms/Concepts

Current Assets – Working Capital Current vs. Long Term Debt Expense vs. Depreciable or Non-Depreciable

Assets Section 179 Depreciation

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Forms of Doing Business

Distinction Focuses on Tax Consequences Liability Protection Flexibility

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Forms of Doing Business

Most Frequent Legal / Tax Structure Sole Proprietorship (1040 Schedule C) General Partnership (1065 – Schedule K-1) C-Corporation (Form 1120, W-2 Income) S-Corporation (11205 – Taxed Like Partnership) LLC/P – Limited Liability Corporation-Partnership (1065) LP-Limited Partnership Entities to Reduce Payroll Taxes

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BUSINESS VALUATIONBUSINESS VALUATION

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Business Valuation

Define – Based on Reason for Valuation Liquidation – Focus on Value of Assets and Debt Not

Profits Company Operating at a Loss Divorce – “Equitable Distribution” Intrinsic Value – Not Necessarily Reflected on

Financial Statement Fair Market Value – Rev. Ruling 59-60

The Price a Willing Buyer Would Pay or Accept Neither Being Under the Obligation to Buy or Sell

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Basic Valuation Models

Adjusted Net Asset Method Income / Cash Flow Methodology

Capitalization of Earnings Rule of Thumb Methods(Multiple of EBIDTA) Discounted Cash Flow

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Adjusted Net Asset Method

Usually the Lowest Value The Whole Equals the Sum of the Parts Limited Applicability

Not Suitable for a “Going Concern” Liquidation

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Income/Cash Approach

An Audiology practice is worth the amount you would pay today to receive a stream of earnings (Cash Flow) in the future

Looks at Two Components (Time – Risk) Timing – Money you Receive in 5 Years is Worth less

than Cash in Hand The Amount Received & Likelihood of Receiving–

The Riskier the Future Cash Flow – Lower Value

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CAPITALIZATION OF EARNINGSCAPITALIZATION OF EARNINGS

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Capitalization of Earnings

EarningsHow much money you will receive on your investments (E = Annual Profits for One Year)

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Capitalization Rate (R) The rate of return you want to receive based

on your assessment of risk The safer the investment (i.e. likelihood that

you will realize the projected earnings) the lower the rate of return you will need to justify the amount you will invest

The Valuation FormulaValue = Earnings / Capitalization Rate

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Capitalization Rate (R) Example of two businesses earn $100,000

per year – Firm A is high risk where investor wants 25% return and the second is low risk and the investor wants 10% return Low Risk – $100,000/10% = $1,000,000 High Risk – $100,000/25% = $400,000

A Reasonable Approach where Earnings are Stable

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DISCOUNTED CASH FLOW (DCF)DISCOUNTED CASH FLOW (DCF)

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Discounted Cash Flow

Based on the value of a stream of future cash flow taking into account both the timing of the receipts and the cost of capital. The value of a business is the amount you would pay today for a future stream of cash.

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The Cost of Capital (Financing) Percentage Financed by Debt x Cost of Debt Percentage Financed by Equity x Cost of

Equity WACC – The Weighted Average

Cost of Capital Using Debt and/or Capital

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Computing Cost of Debt

Cost to borrow from a lender to the Firm based on lender’s assessment of the Company’s creditworthiness

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Key Terms

WACC – Weighted Average Cost of Capital The cost of financing using

debt and or capital

CAPM – Capital Asset Pricing Mode A mathematical calculation

to compute the Cost of Equity

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EBIDTA – Earnings Before Interest, Depreciation Taxes and

Amortization

A financial term used in business to reflect the cash flow of a business

The “Starting Point” in computing

“Free Cash Flow” to the Firm (FCF)

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Key Terms


Key Terms

FREE CASH FLOW (FCF)

The amount of cash generated each year that is available to either the creditors or owners

Equals

EBIDTA – Income Taxes – Changes in Working Capital – Capital Expenditures

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Key Terms

DISCOUNT RATE WACC The rate of return you require based on

actual financing using both debt and capital

Methodology• Comparable• WACC / CAPM• Schilt or Ibottson Table

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Methodology

Start with current P&L Normalize P&L (remove/adjust personal,

discretionary/non-business related items) Expenses of owner charged to

business Compensation above “norm” Charitable expense

Project 5 – 7 Years FCF

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Methodology

Compute the Present Value (PV) Years 1 – 5 Terminal Value

• Compute Terminal Value• Convert to Present Value

Result in the Total Value of the Company (Enterprise Value) Deduct Debt Balance of Equity Holder (Value)

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Present Value Years 1-5

Year Present Value Cash Flow Discount Factor

1 90,845 105,000 (1+.1558)

2 79,534 106,250 (1+.1558)2

3 72,253 111,563 (1+.1558)3

4 65,638 117,411 (1+.1558)4

5 59,629 122,998 (1+.1558)5

Total 367,899 563,222 - 30


Computing the Present Value of the Terminal Value

Terminal Value(TV) 5th years earnings Divided By DF-Gwth Rate

905,642 122,998 =15.58% -2%=13.58%

Present Value of TV Terminal Value Discount Factor

379,867 905,642

(1+.1558)6

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Present Value of cash Flows & The Terminal Value

Period of Time Present Value

Years 1-5 367,900

Terminal Value After 5 Years 379,867

Total-Enterprise Value(Value to be Allocated between Debt Holders & Equity Holders)

747,767

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Computing Enterprise ValueStart Year 1 Year 2 Year 3 Year 4 Year 5

Terminal Value Total

EBITDA160,00

0168,00

0 176,400185,22

0194,48

1884,10

1

Taxes on Earnings

-45,000 -47,250 -49,613 -52,093 -54,698

-248,65

4

Chg in WC 0 -4,000 -4,200 -4,410 -4,631 -17,241

Capex-

10,000 -10,500 -11,025 -11,576 -12,155 -55,256

CF105,00

0106,25

0 111,563117,14

1122,99

8 905,6421,468,593

Disc. Factor 115.58% 133.59% 154.41% 178.46% 206.27% 238.41%

Discounted CF 90,845 79,534 72,253 65,638 59,629 379,867747,76

7

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Simplified Method For Computing Discount Rate (Cap Rate)

James H. Schilt updated and published his theories in the June 1991 edition of the American Society of Appraisers publication, Business Valuation Review, in an article entitled “Selection of Capitalization Rates – Revisited”. He categorizes companies into one of the following five categories and assigns a risk premium accordingly.


Simplified Method for Computing Discount Rate-Cap Rate

Established businesses with a strong trade position that are well financed, have depth and management, whose past earnings have been stable, and whose future is highly predictable (6-10%)

Established businesses in a more competitive industry that are well financed, have depth and management, have stable past earnings, and whose future is fairly predictable (11-15%)



Businesses in a highly competitive industry that require little capital to enter, no management depth, and have a high element of risk, although the past record may be good. (16-20%)

Small businesses that depend upon the special skills of one or two people, or larger established businesses that are highly cyclical in nature. In both cases, future earnings may be expected to deviate widely from projections (21-25%)



Small “one-man” businesses of a personal service nature, where transferability of the income stream is in question. (26-30)



You add the risk premium, calculated above to the risk-free rate, just as with the Ibbotson Method. The calculation of the discount rate for a privately held company in the 35% tax bracket using the Schilt’s Build-Up Method is as follows:



Risk-free long-term government bond rate 6.7%

Risk premium for category 4 company 25%

Pretax discount rate 31.7%

Convert pretax rate to after-tax rate

(31.7% x (1-35%)) 20.61%

(31.7% x (1 – 35%))


RULES OF THUMBRULES OF THUMB

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Multiple of EBIDTA

3-6 Times EBIDTA (Earnings Before Interest, Depreciation, Taxes and Amortization

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Summary

Net Asset Method-Not Valid Capitalization-Simple & valid for Stable

Earnings DCF-Best for Valuing a steam of Cash Flow Multiple Of EBIDTA- Over simplified but

viewed with credibility

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NEGOTIATIONNEGOTIATION

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Objective

To enhance your ability to achieve an optimal outcome that is devised with a sense of fairness with a sensitivity for maintaining and/or enhancing the long term relationship.


Overview

How People Typically Negotiate – Descriptive

How People Should Negotiate – Prescriptive


DescriptiveDescriptive

How People Negotiate

Descriptive Negotiating Focusing on Positions Trade off between substantive outcome and

importance of relationship Possible Scenarios:

Soft-Soft Soft-Hard Hard-Hard

…ultimate challenge: to effectively negotiate with a sociopath!


Research Finding on Distributive Bargaining

The final price is usually close to halfway between the two opening offers.

People who have high targets usually do better.

Many cultures accepted exaggerated opening offers.

There’s a “deadline effect”: most deals will close during the last minutes or hours if you impose a deadline – e.g. labor negotiations and class negotiating exercises.

Lying can be a Problem


Prescriptive(“Getting To Yes” Roger Fisher)

Shift from zero sum to integrative(e.g Follet Sisters split Orange)

The Harvard model of principled negotiating

Separate people from problem. Focus on interests, not positions.

“If you would persuade, appeal to interests not reason.” –Ben Franklin

Look for options for mutual gain. Insist on using objective criteria, fair standards and fair

procedures.

“Never yield to pressure, only to principle.”


What is Theory Structured Negotiating?

A system of negotiating whereby we base our assessment, recommendations, and strategic planning on definitive theories, principles and guidelines. Obviously, the quality of these “principles” will dictate the outcome. If you use “The Prince”, by Machiavelli, you will get a different outcome than if you used The Book of Proverbs.


Theory Structured Negotiating“Blueprinting The Negotiation”

The Components Each Side’s “Consequences of No

Agreement” (CNA) or “Best Alternative To A Negotiated Agreement (BATNA).

Each side’s desired outcome based on the issues and priorities. (Each sides wish list)


The Process (Blueprint)

Estimating/Predicting/Identifying each side’s CNA/BATNA Wish List

Validating the accuracy of each side’s CNA and wish list

Creating value (Lax and Sebenius) Claiming value (Lax and Sebenius)


The Blueprint of the Negotiating The Blueprint of the Negotiating ProcessProcess


Cap Gains Rate 15% Interest Rate 8%

Tax Rate-Ord Inc 40% Stock( Assets) 650,000

Def Comp 0

BATNAYear 1 2 Total

Stock

Cash At closing 650,000 650,000

Financing 0

Capital Assets 1 2 Total

Cash at Closing 650,000 0 650,000

Annual payment 0 0 0

Total 650,000 0 650,000

Less Taxes (97,500) 0 (97,500)

After Tax 552,500 0 552,500

PV Factor 1.00 1.08

Present Value 552,500 0 552,500 After Tax PV Total Cash

Stock 552,500 650,000 53


MEO # 1 $800,000 with 50% at closing & 25% per year in 2nd & 3rd year

Year 1 2 3 Total

Cash at Closing 400,000 400,000

Annual payment 0 200,000 200,000 400,000

Capital Gains 400,000 200,000 200,000 800,000

Interest Income 32,000 16,000 0 48,000

Less Taxes (72,800) (36,400) (30,000) (139,200)

After Tax 359,200 179,600 170,000 708,800

PV Factor 1.00 1.08 1.17

Present Value 359,200 166,296 145,748 671,244 After Tax PV Total Cash

Stock 800,000

Interest 48,000

Def Comp 0 0

Total 671,244 848,000 54


MEO # 2 $400,000 cash +10% of grossYear 1 2 3 4 5 Total

Cash At closing 200,000 100,000 100,000 400,000 Interest 16,000 8,000 0 0 24,000

Prin 200,000 100,000 100,000 400,000 Total 216,000 108,000 100,000 0 0 424,000

Less Taxes Cap Gains (30,000) (15,000) (15,000) (60,000)Net After

Taxes 170,000 85,000 85,000 340,000 Ordinary Inc

Interest Income 16,000 8,000 0 0 0 24,000

Def Comp 80,000 84,000 88,200 92,610 97,241 442,051 Total 96,000 92,000 88,200 92,610 97,241 466,051

Less Taxes (38,400) (36,800) (35,280) (37,044) (38,896) (186,420)Net After Tax 57,600 55,200 52,920 55,566 58,344 279,630

Total After Tax 227,600 140,200 137,920 55,566 58,344 619,630

PV Factor 1.00 1.08 1.17 1.26 1.36

Present Value 227,600 129,815 118,244 44,110 42,885 562,654 PV Total Cash

Stock 400,000 Interest 24,000

Def Comp 442,051

Total 562,654 866,051 55


Cap Gains Rate 15% MEO # 3 $600,000 cash +2.3% of grossStock( Assets) 600,000 Est Revenue 800,000

Def Comp 18,644 Percent of Gross 2.3%

Year 1 2 3 4 5 Total

Cash 300,000 150,000 150,000 600,000

Interest 24,000 12,000 36,000

Total 324,000 162,000 150,000 0 0 636,000

Less Taxes

Cap Gains (45,000) (22,500) (22,500) (90,000)

Net After Taxes 255,000 127,500 127,500 0 0 510,000

Ordinary Inc

Interest Income 24,000 12,000 0 0 0 36,000

Def Comp 18,644 19,576 20,555 21,583 22,662 103,019

Total 42,644 31,576 20,555 21,583 22,662 139,019

Less Taxes (17,058) (12,630) (8,222) (8,633) (9,065) (55,608)

After Tax 25,586 18,946 12,333 12,950 13,597 83,411

Total After Taxes 280,586 146,446 139,833 12,950 13,597

PV Factor 1.00 1.08 1.17 1.26 1.36

Present Value 280,586 135,598 119,884 10,280 9,994 556,342 PV Total Cash

Stock 600,000

Interest 36,000

Def Comp 103,019

Total 556,342 739,019 56


BATNA MEO # 1 MEO # 2 MEO # 3

Stock 650,000 800,000 400,000 600,000

At Closing 650,000 400,000 200,000 300,000

Balance 0 2 years 200,000 300,000

DC 0 0 442,051 103,019

DC -Years 5 5

After Tax PV 552,500 671,244 562,654 556,342

Total Cash 650,000 848,000 739,019 739,019

EBIDTA 160,000 160,000 160,000 160,000

multiple 4.06 5.30 4.62 4.62 57


Tips – Techniques – ConventionsJudgmental Errors in Negotiating

Define: “The errors in our thinking or cognitive

processes that result in our not negotiating rationally or not doing what’s in our own best interest.”

Consequences:We don’t see flaws or adequately

evaluate alternatives.


Judgmental Errors in NegotiatingTips-Techniques-Conventions

(Assess from both Descriptive and Prescriptive perspectives)

Non-Rational escalation-(Endowment Factor)

Mythical Fixed Pie Anchoring and Adjustment Framing the negotiation – e.g. how

people view gains/losses


Tips – Techniques - Conventions

Give your logic before conclusions Importance of understanding the concept of

organizational negotiating Negotiating one item at a time vs. multiple items Keys to Success:

Accurate emotional and intellectual empathy You’re not ready to negotiate until you can present

the other side’s point of view more articulately and persuasively than they can and then give an “appropriate” response”



The 3rd Movement (Wharton) Opening Offer/Position Response Rebuttal

Never concede, only trade Value creating vs. value claiming – Pareto

curve/Efficient frontier Role Playing(Preparation Most Important factor in

your success) Not Optional Behavioral rehearsal Discovering “integrative” solutions Accurate empathy You’ll only appear to be extemporaneous



The Negotiating Team Spokesperson Back up Observer

The People Factor The “Dale Carnegie” component Cognitive dissonance – hard on the problem – soft

on the people Principle of the “State of Disequilibrium”



Anger/handling criticism Anger is one letter away from danger The most difficult emotion to control Disarming the critic



Munger: “The standard antidote to one’s overactive hostility is to train oneself to defer reaction. As my smart friend Tom Murphy so frequently says, ‘you can always tell someone off tomorrow, if it is such a good idea.’”



Communication Skills Listen more – Talk Less (20/80 Rule) – “Even a fool

is thought wise if he keeps silent and discerning if he holds his tongue” –Proverbs 17:28

Using “I” messages vs. “You” messages Feeling Behavior Consequences

The first sign you are communicating more effectively is when you do not follow your instincts.

Documents

ADA -Las Vegas Nov 8,2008 1 Presented By JAMES M. RAMSEY BUYING AND SELLING AN AUDIOLOGY PRACTICE 1 ADA Convention ~ November 8, 2008