Implementing succession into your professional business can be an extremely daunting thing. For most, this can be a new experience. For others, this maybe a second attempt at a bad succession strategy.
Regardless of the reason, many questions are common in any succession. The most frequently asked questions I get are:
- I’m wanting to retire, but don’t know how
- What is my current practice worth?
- Who is going to buy it?
- How will I be paid?
- Over what period will my succession process last?
- What are the tax implications?
The two biggest questions that come from a selling practitioner once they decide they want to sell are:
- How do it do it?
- What’s the business worth?
The first thing I need to tell you is … the closer to exit date without any plan the lower the value.
1. What is my business’s value?
Let start with value because if there is no value then realistically you can just cease the practice whenever you want.
If your practice or your team’s income (if you’re part of a multi-partner business) generates over and above a commercial salary for a Principal practitioner, then your practice will have value. This value may be as low as just your working capital (WIP and Debtors) or could also include goodwill. For a lot of you, you will probably ask … how do I calculate goodwill? Below is a simple formula for calculating goodwill.
Goodwill = Business Value – Working Capital
The difficulty is in determining the business value. The most common valuation methods for professional businesses are:
| Valuation Method |
Predominantly used when |
| Discounted Cash Flow |
There is a continuation of a business as it factors in future cash flows and risk attached to those. |
| Future Maintainable Earnings |
For most professional purchase/sales as it is the easiest method to capitalise estimated future earnings for established businesses. |
| Net Realisable Value |
Used to separate business assets into components that are ready to be sold. |
| Special Value |
Used when a potential acquirer is willing to purchase above market value (strategic buy). |
As Future Maintainable Earnings is the most commonly used for the majority of 1-3 partner exists and restructures, I have provided an example valuation calculation as an appendix. In this example I used a 3x multiple. Note, a higher multiple will be applied when there is lower business risk for the purchaser and 3x is considered low to medium risk.
The next step after determining the business value is to calculate the working capital. For those who don’t know what working capital is, think of Lock-up. How much of the businesses cash is locked up at any given time? The better cash practices your firm has, the greater the adjusted goodwill value.
2. Who is going to buy?
The best scenario for succession is for someone within the firm to purchase, or part-purchase. Note, I cover how best initiate this in section 2.
Apart from succession within, there are multiple options available. You can sell to a willing third party in the form of sole practitioner or a multiple Principal firm. The more attractive you make your firm, the more people who are willing to consider a purchase. But be wary of additional considerations around who owns the premises and/or cost of breaking leases. As well as current employees post transaction for external sales.
Your best bet if you haven’t planned anything is to put your practice on the market through a brokerage firm. This can be a timely and costly exercise for those firms that aren’t quite up to scratch.
3. How will you get paid?
Regardless of how you sell your practice, there will be an element of cash (or cash equivalent) that gets paid. How much cash will depend on the structure of the transaction. For most 100% exiting practitioners this amount will be a combination of 60%-70% upfront, followed by one or two retentions over the course of six to eighteen months (commonly known as a financial handcuffs). If the exiting practitioner is part of a multi-principal practice, then the risk is relatively low and can be upward to 100%.
The amount of cash that gets withheld will relate to the risk of the transaction and timing of the exiting practitioner. If you manage to sell your practice for a higher price, then there will be greater risk for the purchaser and an increased chance of amount being held for a longer period of time. These time periods can be reduced if you give up additional rights i.e. right to practice for x amount of time.
Remember that you as the exiting partitioner can determine the length of your exit. Generally, the longer the length of your exit, the overall increase in consideration received, but this consideration will be spread over a wider period verse a chunk upfront.
Honestly speaking, the slice of how you will be paid will come down to the negotiation of the contracts.
4. What are the taxation consequences?
If there is a goodwill value attributed to the sale, then consideration needs to be given to taxation. There are capital gains taxation (CGT) provisions that allow the sale goodwill in practices to be free. For these concessions to apply, care is needed to ensure your transactions are structured correctly, as they do not apply to all circumstances. You need to consider the flow of proceeds, timing and elections to name a few.
You will also have to consider the indirect taxes like duties on any purchase or transfer. This may still be the case if you restructure the firm if the ultimate owners aren’t the same for all involved.
The above concepts are just the high-level considerations your professional business needs to consider when wanting to sell. If you would like to discuss further, contact me directly by email at jason@odysseyadvisors.com.au
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