FOURTH QUARTER: Volume 5, Number 4
November - January 2011
VALUATION AND APPRAISAL OF THE SMALL BUSINESS
(Methodologies for the Physician Entrepreneur and Healthcare Administrator)
By: Lester Barenbaum; PhD
By: Michael Saponara; JD CPA
The market value of a publicly traded company’s [like a hospital-corporation] equity can be calculated at a point in time by multiplying its share price by the number of shares of common stock outstanding. The share price is determined in the public marketplace by buyers and sellers who trade the stock.
Introduction
Buyers of publicly traded company shares such as IBM expend money now (invest) for the right to receive uncertain future economic benefits. The price (value) an investor pays for a share is based upon his or her assessment of the size, timing and certainty of receiving future economic benefits. Likewise, a seller of IBM equity is willing to forego his or her expectation of future economic benefits if the investor believes that the benefits given up are worth less than the proceeds (value) from selling the ownership position.
Thus, the share price of IBM [publicly traded hospital corporation] at a given point in time represents the value of future economic benefits as perceived by buyers and sellers of IBM equity at a point in time. This value is observable through transactions in the marketplace.
In contrast, closely held businesses like a medical practice, Ambulatory Surgery Center or medical clinic also generate economic benefits for their doctor owners but the value of those companies cannot be directly observed by activity in traded markets.
The Ingredients of Value
Estimates of the market value of medically related non-traded entities are needed for various reasons [death, divorce, retirement, sale, business succession planning, organic growth medium, etc]. Naturally, when buying or selling a medical practice, or related business, each side of the transaction needs to form their own opinion of value. Of course, doctors or owners of closely held businesses and/or private medical and healthcare entities often gift shares of the business to their children.
The IRS may require that these gifts be valued. Financial litigation related to lawsuits, shareholder oppressive action and economic damages - to name a few - are situations that often require a determination of the market value of the business. And, doctors and business owners often find it useful to value their healthcare business on a periodic basis as way of assessing performance over time.
Valuation professions estimate value by applying valuation theory. The value of financial assets whether traded or not is generally based upon the following:
- The level of expected distributable future cash flows
- The timing of those expected distributable cash flows
- The uncertainty in receiving expected future cash flows
This special issue begins with a discussion of the underpinnings of these value drivers. How these value drivers are included in the various approaches to value is also discussed. Examples of valuation issues that can result in errors when moving from valuation theory to practice are explored.
The issue ends with a case study illustrating the business valuation process.
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