Fair Market Value in Cash or Cash Equivalents

May 26th, 2007 | Dental Practices | Market Approach

Caveat: I should preface my comments below by stating that this is not intended to be relied upon by others as statistical analysis –you have to do that analysis for yourself.

I have been evaluating dental transactions in the database Pratt’s Stats.  From my analysis of 230 post-1/1/2000 transactions, 102 had an answer to the question of whether or not there was a personal guaranty of a note given by the buyer in connection with the purchase. Of those, 56% had an answer of "no personal guaranty." 47 (20%) of the transactions reflected a down payment of 100% and the median down payment for the 230 transactions was 28.4%. This suggests to me that the notes given in those transactions do not represent a cash equivalent, even if secured by the underlying assets, since the seller would have to retake possession and incur the costs (e.g., legal fees!) of the repossession of assets.  This would be a difficult task, for example, for a seller who has retired and relocated. In addition, the notes are non-negotiable to begin with, negotiability is a requirement for being considered “cash-equivalent.”  Further, a bank or other lender in the business of making loans, as opposed to a seller financing the sale of his or her practice, is in a much better position to enforce collection activity.

This highlights one of the many problems with the market approach for a determination of fair market value in cash or cash equivalents – as required by the FMV definition accepted by all the major valuation and appraisal organizations and most Courts.  Converting a secured note absent a personal guaranty to a cash equivalent is a difficult task.  IF one could find empirical evidence of what a third party lender would charge for interest on a personal note lacking a guaranty but secured by equipment, then that would be a start.  Bear in mind that the majority of the value of a dental practice is typically intangible and not equipment.  Lenders generally do not loan unsecured money on intangible assets and certainly not without a personal guaranty – that is why only 44 of the transactions had down payments of 100%.  Absent a transaction involving a Dental Practice Management Company or similar operation, it is unlikely that another dentist purchasing a practice from the seller would have 100% of the purchase price lying around in cash.  Whatever the problems, you have to make some type of an adjustment to equate the underlying data to cash-equivalent.  The problem here is not with the data, which is pretty comprehensive as databases go and may well be the best, the problem is using it without studying it.

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