Achieving a ‘Fair Value’ in Practice Equity: What You Need to Know
For many practice owners, deciding to retire, sell equity, or exit a firm is a significant milestone. A common sentiment we hear during these transitions is, “We just want to ensure a fair value for everyone involved.”. It’s a noble goal, but determining what’s truly “fair” can be complex. Some parties come to an agreement independently, while others seek an external expert to ensure all sides are well-informed and no one is disadvantaged.
The market sale misconception
A common misunderstanding is that the value someone receives when selling an entire practice in the open market should equate to what a partner pays to acquire equity. While market forces certainly inform valuations, these are fundamentally different transactions with unique considerations and outcomes.
Valuations are purpose-driven. For example, a valuation for a deceased estate will likely differ significantly from one for equity transfer within a partnership. Context matters, and so do the nuances of the specific transaction.
The perpetual agreement pitfall
We also encounter proprietorship agreements that mandate a fixed value—such as a specific multiple or cents in the dollar—to determine equity transfers. While these agreements provide clarity, they often fail to reflect the natural ebb and flow of a practice’s value over time.
No other asset retains a fixed value indefinitely. Why should practice equity be any different? Assuming the value you paid upon entering a partnership will match the value upon your exit overlooks the dynamic nature of business performance.
Why goodwill isn’t always good
In larger professional firms, the recognition of goodwill has often been replaced with capital contribution models. This shift was partly driven by affordability issues—new partners couldn’t justify the cost when goodwill was valued at dollar-for-dollar revenue.
In some cases, the underlying performance of the firm didn’t support the valuation, with insufficient returns or unrealistic payback periods. Rather than reevaluating the approach to determine fair value, many firms simply disregarded goodwill altogether.
Reverse-engineering desired outcomes
Another common scenario involves firms tweaking their valuation methodology to arrive at a predetermined outcome. For instance, if a partnership agreement stipulates a specific multiple but applying it yields an unsatisfactory figure, firms may adjust the multiple to align with their desired result.
This practice raises the question: is the outcome truly “fair,” or is it simply convenient? A fair valuation reflects the firm’s actual performance and circumstances, not an artificially adjusted calculation.
The role of equity holders
Firm value is rarely static. It fluctuates based on the decisions equity holders make and their impact on performance. Those who hold equity during times of growth or contraction naturally benefit—or bear the consequences—of those decisions.
Equity holders should embrace accountability for the firm’s trajectory during their tenure. Sound decisions contribute to ongoing profits and sustainable equity value, while short-sighted moves can erode both.
Practical steps toward fair value
If you’re navigating an equity transfer, consider these key steps:
Establish an indicative value early: Even a preliminary valuation can provide a clearer picture of likely outcomes, helping all parties make informed decisions well in advance. Discovering an unexpected value at the last moment often leads to frustration, delays, or deals falling through.
Prioritise long-term value creation: Equity value is shaped by the collective decisions made during your tenure. Build a firm that supports fair outcomes not just for current stakeholders, but for future ones as well.
After more than 50 years and thousands of valuations of professional firms, we’ve seen countless approaches to determining goodwill value – some sound, others misguided. Here are some insights to help demystify the process and ensure fair outcomes for all involved.
Achieving a fair equity transfer requires clarity, accountability, and the right expertise. If you’d like assistance with your firm’s valuation, we’re here to help.
With over 50 years of experience, we provide expert valuation and consulting services tailored to meet your unique needs. Contact us today.
