Observation on Reasonable CompJanuary 29th, 2009 | Dental Practices | Income Approach & Methods | Reasonable Comp | Valuing Goodwill
A colleague and I had an exchange on reasonable compensation today and it reminded me of a point I often see missed in valuation of small businesses and professional practices: the compensation assumption in a CCF or Excess Earnings Model is PERPETUAL and increases at the growth rate used to determine the cap rate. As such, any measure of reasonable comp based on entry level salaries is likley not relevant for a capitalization model and can also lead to significant error. This is due to the fact that professionals can experience a fairly rapid increase in salary from their intial year as they "ramp up" and reach a normal level of productivity in the workplace.
For physicians, some of this difference can be gleaned from the Merritt Hawkins Annual Survey as well as the difference in reported salaries in the MGMA data using All Physicians, Partner/Shareholder Physicians and Physicians with 1-2 years experience.
Similarly, a low initial salary followed by a "low or no" buy-in and high partner income can also be explained by a combination of recruiting demand and higher-than-entry-level long-term compensation expectation. The low buy-in price reflects the new professional's high perpetual income expectation and as such a lower level of profit or excess earnings from ownerhship.
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