Relationship property – valuing professional practices

The principles informing the valuation of professional practice interests have been relatively settled for some years. While this does not prevent differences in opinion regarding the value of a particular practice, it is helpful in ensuring the approach to valuation is (or should be) similar. This article explores some of the issues around their valuation.

In most cases, the value for any practice goodwill is the substantive issue to be addressed. Case law supports the view that practice goodwill does not exist in highly specialist professional practices because any income is regarded as flowing from the skills and efforts of the practitioner[1].

Beyond that, professional practice interests are generally regarded as comprising a valuable asset for relationship property purposes. This is even when they cannot actually be bought and sold. For example, partner interests in multi partner professional practices are considered to have a ‘value in use’ derived from the benefit of enjoying the ‘fruits’ of the practice goodwill rather than a ‘value in exchange’ attributable to the goodwill itself[2].

So how are interests in NZ practices valued in a relationship property context?

When the entire practice is valued, a ‘sum of the parts’ approach tends to be the accepted method. This requires a valuation of the practice goodwill; the value of the practice net tangible assets, such as fixed assets and working capital, is then added to this. Other approaches may be equally valid but are less common. All methods assume a reasonable restraint of trade is in place[3].

The ‘super profits’ method is the prevalent approach to assessing practice goodwill. It requires an assessment of ‘super profits’, typically maintainable pre-tax practice operating earnings over and above a fair reward for the owners effort and skills, a return on any capital invested, and taxation. Those ‘super profits’ are capitalised at an appropriate multiple to derive a goodwill value.

Like all valuation approaches, the super profits method is an aide to assessing value and not intended to override the purpose of determining an appropriate relationship property settlement value.  This implies that the values selected for the future earnings, ‘fair reward’ and earnings multiple assumptions, amongst others, must be appropriate on both an absolute and relative basis.

Any practice goodwill value assessed should exclude any goodwill that is personal to the owner and unable to be transferred on sale. Some of the attributes that might be considered in evaluating the relative contributions of personal and practice goodwill include:

A non-compete or restraint of trade agreement could also indicate the existence of personal goodwill.

What’s the market doing?

The assessment of a practice goodwill value also requires consideration of the actual market for the subject practice. Faire J highlighted by exception the importance of this analysis in Williams v Scott:

“The real problem with this case is that this is no real check on the hypothetical calculations produced by the accountants who were called. There is no evidence of any analysis of the sale and purchase transactions. That a lawyer, experienced in legal practice, management and development, was not called to assist in this process is regrettable”[4].

The use of industry experts can also be helpful in other areas, including the assessment of a ‘fair reward’ for the owner, and the relative contributions of personal and practice goodwill elements.

This is an interesting time to be running, or contemplating the real or notional sale of, a professional practice. Like many businesses, professional practices are currently facing the significant and rapid effects of technology/automation, changes in working practices (outsourcing, freelancing, etc.), and generational differences accentuated by an aging population, amongst others.

However, it is always dangerous to generalise. For example, the ability to automate some accounting work appears to represent a serious threat to that profession, yet prices paid for recurring fee bases are currently at historic highs, for reasons including increased demand from returning expats, some industry consolidation, and an increased ability to outsource. Industry consolidation has also been a factor in recent GP practice transaction multiples.

The assessment of an appropriate value depends on the individual practice characteristics including the relative contributions of personal and practice elements to profitability. It will also depend on the attributes of the market into which that practice is sold. Every practice is unique, and must be considered in its own context.

This article first appeared in Volume 18 Issue 1 of The Family Advocate.