DRAFT

PRESENTATION TO

THE FAMILY LAW SECTION

OF THE

CONNECTICUT BAR ASSOCIATION

THE VALUATION OF PROFESSIONAL PRACTICES

FOR DIVORCE PURPOSES

March 9, 1999

J.L. Pierson & Co. LLC

BUSINESS VALUATION

P.O. Box 2392

Darien, CT 06820-0392

203-325-2703

http://www.jlpierson.com

jlp@jlpierson.com

INTRODUCTION

Black's Law Dictionary defines profession as "a vocation or occupation requiring special advanced education, knowledge and skills." As applications of science and learning have extend to other fields, such vocations have received the same designation.

The valuation of practices has now evolved into a profession.

Reasons to value professional practices: either transactional [buy-ins or sell-offs, could be estate tax related though rare] or controversial. Only the latter will be covered here, and more specifically controversy connected with marital dissolution.

ONE . CHARACTERISTICS OF PROFESSIONAL PRACTICES

• Service business with fewer tangible assets,
• Relationship of trust between client and professional,
• Practice or professional(s) rely on referrals,
• Specific college or graduate degree often required,
• License required by governmental or regulatory agency, or certification by recognized professional organization(s.)

Does that mean that price is generally not a factor? How does the practitioner get business? Basic economics of education vs. Pay-back.

TWO . PROFESSIONAL PRACTICES VS. SMALL BUSINESS

• Larger reliance on intangible assets; thus valuation methods generally used are based on earnings capability as opposed to assets.
• Dependance on the professional: somewhat akin to key man issue. What's the difference between professional and practice goodwill?
• Limitations on license transfer, effect on the market.
• Supply and demand of specialty.
• Cash basis accounting.
• Value drivers. See Chart A.

CHART A

Checklist of factorsaffecting

the values of professional practices

Factor	More Desirable	Less Desirable
Location + demographics	Urban High growth Affluent Stable population	Rural Mature or declining market Poor Transient population
Client persistence	Very stable	High turnover
Dependence on referrals vs. direct client contact	Large direct client base	One or few referral sources
Contractual relationships	Strong relationships	Relationships threatened by termination
Supply/Demand [for acquisition]	High demand, low supply	High supply, low demand
Reputation	Stellar, far and wide	Non-existent or tarnished
Facilities + technology	State of the art	Antiquated
Employees	Adequate and dedicated	Inadequate or departing
Practitioner's work habits	Light work load	Workaholic
% of "managed care" patients [medical only]	Few or none	High percentage from HMO
Potential synergies	high propensity to be revenue source for potential acquirer.	No such potential

Source: Shannon P. Pratt, Robert F. Reilly, Robert P. Schweihs Valuing Small Businesses & Professional Practices, New York: McGraw-Hill, 3^rd Edition, 1998 p.566.

THREE . ADJUSTING THE BALANCE SHEET OF A PROFESSIONAL PRACTICE

• Cash
• Accounts Receivables: collectible or not.
• Work-In-Process Inventory: adjust for % unbilled, % uncollected.
• Supplies
• Prepaid Expenses
• Equipment
• Leasehold improvements
• Intangible assets -see Chart B

CHART B

Intangible Assets Commonly Found in

Various Professional Practices

Computer software	Licenses
Computerized databases	Literary works
Cooperative agreements	Litigation awards & damages
Copyrights	Management contracts
Customer contacts	Marketing/Promotional materials
Customer lists	Noncompete covenants
Customer relationships	Patents + Patent applications
Designs and drawings	Patient charts and records
Employment contracts	Permits
Favorable leases	Procedural manuals
Franchise agreements	Royalty agreements
Going-concern value	Schematics + diagrams
Goodwill	Know-how
Government contracts	Laboratory notebooks
Historical documents	Subscription lists
HMO enrollment lists	Supplier contracts
Insurance expirations	Technical + Specialty library/documentation
Joint ventures	Trade secrets
Library	Trained + Assembled workforce

Source: Shannon P. Pratt, Robert F. Reilly, Robert P. Schweihs Valuing Small Businesses & Professional Practices, New York: McGraw-Hill, 3^rd Edition, 1998 p.576.

FOUR . ELEMENTS CREATING PROFESSIONAL AND

PRACTICE GOODWILL IN THE LAW

• Practice vs. Professional's Goodwill: New York cases O'Brien vs. O'Brien (1985) and McSparron vs. McSparron (1995.)



• Elements of Goodwill for buy/sell transactions:



• Expected Earning levels.
• Competition levels.
• Referral base.
• Type of clients/patients.
• Work habits of the practitioner
• Fees earned compared to peers.
• Location of the practice.
• Employees of the practice.
• General marketability of the practice.

FIVE . METHODS COMMONLY USED FOR PRACTICES

• Discounting of economic income.



• Capitalization of economic income.



• Multiples of revenues see Chart C.



• Comparative transactions/buy-ins.



• Punitive and retirement formulas.



• Capitalized excess earnings.



• Asset accumulation or adjusted book value method.



• Depreciating goodwill.