Why Do I Need A Business Valuation

Published Mon, September 1 2008 4:31pm by

A Business valuation is the process applied by a qualified valuation expert to determine the fair market value of an owner's interest in a business. As a current or prospective pharmacy owner, a business valuation will provide you with an analysis of the pharmacy's value along with the strengths and weaknesses inherent in the business. The purpose of this article is to identify the concepts behind valuation in pharmacy as well as the reasons why a valuation would be conducted.

There are many reasons why you may need a valuation as a pharmacist. Some of the main reasons are to raise capital, protect your business, for estate planning purposes or buying and selling a pharmacy.

The operations of your pharmacy will be funded by a combination of debt and equity. In most cases, debt providers will require an independent valuation to ascertain a number of financial factors associated with the lending of money to your business. As part of this analysis, a lending party will seek that you achieve a specified LVR (Loan-to-Value-Ratio) as well as understand your business performance and its ability to service any debt levels.

Lending institutions are required to price risk and take this into consideration when providing rates for finance, (as per the Basel II Accord to which most lending institutions have signed). A valuation should provide risk measures to ensure that each lending opportunity is appropriately priced. If your business is running well, your risk should be low and hence you should be able to obtain finance at a competitive rate. As yet, we have not seen this occur and this is one of the primary reasons for the sub-prime issues in the US, (in association with the methods in which the funds were obtained).

A pharmacy valuation can also act to protect your business. In instances were partnerships or multiple owners are part of the ownership structure, a valuation is critical in determining items such as buy-out clauses, buy-out funding and business value clauses of the ownership agreement. The valuation will also provide some clarification of the worth of each owner's portion.

Even in the instance where you are the sole owner, clarifying the value of the pharmacy can be crucial for issues of Estate Planning. Your business is one of your personal assets and included in your estate. If you don't have a reliable valuation for your pharmacy, on the dissolution of your estate, the value of your pharmacy may not truly reflect its worth - hence the outcomes may differ from expectations.

When buying or selling a pharmacy, there is no question that you will require a valuation. As a buyer, you will seek to verify that the market price is reasonable given the performance of the business. Furthermore, you may also require the valuation to obtain finance for the purchase and determine how much you can afford to pay for the business. A valuation may also provide key information as to the risks, strengths and weaknesses of the business which will provide valuable information when considering the purchase. As a seller, you should seek an independent valuation to verify your broker's assessment of sale price and gain a second opinion as to the value of your business. More often than not, business brokers are not qualified to provide business valuations, and their PI (Personal Indemnity) Insurance often states that they cannot provide qualified valuations or even use the word "valuation" in any opinion of market worth. So make sure you seek qualified advice.

When conducting a pharmacy valuation, there are a number of issues you should consider. What is a valuation providing? What needs to be considered? Where do I source my information and what does this all mean?

From the outset, I must point out that a valuation is not a determination of market price. In cases where the market is informed, all parties are fully informed and the buyer and sellers act free from emotion; the value of the business will equal the market value/sale price of the business. However, it is rarely the case that both the buyer and seller are fully informed and that neither party is acting on the basis of emotions. Ultimately, the market value of any business is result of negotiation between the buyer and the seller. As such, it is important to realise that a valuation is not necessarily an appraisal of market worth.

While valuation is not an exact science, arriving at a single figure requires the analysis of complex market dynamics and a sound understanding of both the quantitative and qualitative aspects of the business. As part of this analysis, one should consider the financials as a record of how the business is performing. In addition, factors such as the location, size, hours of operation of the business should be considered; along with personal issues such as the experience of the owner, the friendliness of the staff and reputation of the pharmacy. In addition, one must consider the regulatory environment along with the strength of competition, complimentary services and level of goodwill linked to the current owner.

As part of the valuation process, seek to identify benchmarks comparable to your own pharmacy. These figures can often put the value of your business into perspective and identify possible areas of over or underspending in the business. When comparing your business to benchmarks, ensure that you have a basis for comparison with like pharmacies. It is not suitable to use Australian Averages as a measure of comparison, or just state averages as they are too generalised to provide any valuable point of comparison.

When valuing pharmacy, the Capitalisation of Future Maintainable Earnings approach is the commonly accepted method of valuing the business. Using this approach, the valuer will identify the Net Profit of the pharmacy before Interest and Taxes. Then adjustments and add-backs (based on professional judgement and comparable evidence) are applied to achieve the Adjusted Net Profit. This figure is divided by a percentage value known as the Capitalisation Rate to achieve the value of the pharmacy. The current average Australian capitalisation rate is 15.73%.

Often this percent will be referred to as the Return on Investment. This is incorrect. If you buy shares, you obtain a dividend, (the dividend yield), and the growth in the value of the shares, (the capital gains), to calculate Return on Investment. If you buy an investment property, you obtain rental income, (the rental yield), and the growth in the value of the property, (the capital gains), that equates to the Return on Investment. In the same way, pharmacy provides a net profit on operations, (the capitalisation rate), and growth in the business value, (the capital gains). Hence the percentage used to calculate the value of the business from the adjusted net profit is not the Return on Investment, but rather the annual yield (or capitalisation rate).

When valuing a pharmacy, it is important to identify why the pharmacy is being valued and what information is available for the valuation. Determining why the business needs to be valued will affect the type of valuation required to value the business. For instance, if the pharmacy is re-locating and you require finance to fund the relocation; a valuation on current figures may not be sufficient. Rather, a Brownfield Valuation based on forecasts will provide a more accurate measure of what the business would be worth in the new location.

Additionally, the valuation is only as reliable as the data used to provide the valuation. As general practice, Medici Capital requires 3 years of full financial information for a Comprehensive Valuation. This ensures that we account for any fluctuations in the pharmacy and can truly identify the underlying growth of a business. It also allows for the elimination of single period specific events. As a buyer, you should be cautious of the fact that a seller will likely improve the performance of the business in the final year of operation preceding a sale. For this year, the financial information may look fabulous! However, ensuring you obtain sufficient information over a period greater than one financial year will ensure that you can verify if the growth in the recent year's figures is justified in the underlying financial figures.

Medici Capital specialises in Pharmacy Valuations. We conducted the first pharmacy goodwill loan in 1995 with Macquarie Bank and since then, determined the valuation protocol for pharmacy valuation and the lending policies for many of the leading financial institutions across Australia. We are currently accredited with all the financial institutions (including banks, finance companies and wholesalers) Australia - we can conduct accredited valuations Australia wide.

We provide a wide range of pharmacy valuations that cater for differing levels of analysis and different valuation purposes. Our Indicative Valuation can be conducted on-line and, (once submitted to Medici Capital), can produce a one-page report within 20 minutes. Our Market Appraisal of Value (MAV) is the equivalent to that currently produced by accountants and/or brokers. It relies on a single year's Profit & Loss Statement and can be completed in one business day. Our Comprehensive Valuation is the most analytical pharmacy valuation on the market. Compiled from 3 years of financial information and a specially qualified valuation questionnaire, it will provide a full examination of the business value including complete risk scoring for the business and can be completed within 5 business days from the receipt of the information. In the event that you are changing the business or starting a pharmacy with no trading history, we can conduct a Brownfield or Greenfield Valuation to examine the potential upside of the new business or new aspect of the business. All our valuations can be conducted within the same business day if the case is urgent and full disclosure is received. However, none of our valuations should take longer than 5 working days - provided full disclosure is obtained.

As a pharmacist, you should understand that there are many different reasons why you may need to have a pharmacy valued. Understand why the pharmacy should be valued and how the approach should be dictated by the reason for the valuation. It is important that the valuation provide some form of investigation into the business; but at the same time, it is only as reliable as the information on which it is based and does not verify the financial information.

As a practitioner and business owner, learn to understand the principles of valuation and what a valuation is trying to achieve. Then harness what the valuation provides to identify strengths, weaknesses, opportunities and threats in your business.

Contact Medici Capital today on 03 9853 7933 to discuss how your business should be valued today!

10 Comments
Reader
8 years ago

Nice Article


Vince Delmonte
9 years ago

After reading through the article, I just feel that I really need more information on the topic. Can you share some resources please?


Oscismipt
9 years ago

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9 years ago

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Medici Capital
9 years ago

Thanks for the comment, but we're not on Twitter. Stay tuned here for more developments.


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9 years ago

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8 years ago

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