Thoughts on ways to improve the management of professional services firms

Monday, November 06, 2006

Professional Services - selling your practice: terms of sale

Many self-employed professionals or small independent practices assume that nobody would want to buy their practice. In fact there is a marketplace, albeit imperfect, for such practices. This post looks briefly at the mechanics involved in the most common sale approach.

The normal steps are:

  1. Buyer and seller define an agreed date for the acquisition.
  2. The seller agrees to continue to work for the acquiring firm for an agreed period to ensure smooth transition of the practice business to the new owner. This is normally a minimum of a year but can be longer depending on mutual interests.
  3. An agreed remuneration package is defined for the transition period. This is usually based on an agreed percentage of the fees flowing from the acquired practice client base taking into account overhead costs, any added service delivery costs and a profit margin for the acquiring firm.
  4. An agreed price is defined to be paid at some point in the future, often the end of the transition period, based on the performance of the acquired practice during the transition period. The price many be paid in a single payment or may involve several payments again linked to performance.

A simple example showing the maths in operation. Assume a small practice with a single professional coming up on retirement, own office and a secretary, fees say $200,000 with a pretax net of $120,000. This is the type of practice that might normally close or simply run down as the owner gets older.

The two parties agree that that the practice will be acquired on the following terms:

  1. The seller will receive 50 per cent of the paid fees he/she generates during the following year from both acquired clients and work done by the owner for other firm clients. Say this is $200,000. The acquired professional will get $100,000.
  2. The seller will receive a cash payment at the end of the year based on 60 per cent of billed fees generated during the previous year from the acquired practice adjusted for any potential bad debts. Say this is $220,000. The acquired professional will get $132,000.

Under this arrangement, the acquiring firm pays out $232,000 plus any added variable costs associated with the extra business but receives $220,000 in added fee income. This means that it has acquired an added fee base of $220,000 for a net cost ignoring any added variable costs of $12,000.

Assume that the seller would have kept the practice going for another twelve months and then closed. He/She has received $232,000 for the period, an extra $112,000 as compared to the closure option. Both sides have benefited.

I recognise that there are many variables involved. In a later post I will look at what is involved in making this type of arrangement work.

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