17 Apr Key Person Risk in Specialized Industries

Written by: John Milnes, CVA

(3-4 minute read)

An owner or key employee’s responsibilities play a critical role in how a business is valued. This is particularly true for specialized industries (including but not limited to healthcare, law, and accounting) due to the knowledge and expertise required to provide these services. When analyzing these industries, it is important for an appraiser to consider the following:

Size of Practice

A single-owner operator is typically more profitable than a practice with multiple operators due to lower overhead costs. However, a practice that is run by a single doctor, lawyer or accountant (as opposed to multiple professionals) is typically riskier due to higher personal goodwill. Single-owner operator practices are susceptible to customer attrition upon purchase as customers tend to be apprehensive about leaving their long-term specialized service practices which poses a higher risk. Practices that operate with multiple specialized personnel tend to have less personal goodwill as patients/clients may have a relationship with multiple members of the staff (owners or key employees) and would be willing to consult with more than one individual on a given visit. This ultimately reduces the risk of the business and simultaneously increases the multiple.

Qualifications

Businesses such as medical practices, law firms and accounting firms are typically run by individuals who have received certifications and designations that allow them to operate their practice, which reduces the potential buyer pool for the business. It is important to note that certain industries and states do have different rules regarding who can own a specific type of business. For example, non-physicians (such as business professionals or investors) can legally own medical practices, however, they are restricted from making medical decisions or practicing medicine. [1] Additionally, as of 2022, 47 of the 50 states require a dentist to own a dental practice (varying restrictions regarding management agreements) yet Iowa, South Carolina, and Utah reported no restrictions concerning who can own a dental practice. [2] While there is still inherently risk in relying on minimal key employees, it does increase the buyer pool which simultaneously drops the risk compared to other medical practices of similar size.

Non-Competes / Transitional Services

As previously discussed, specialized industries are highly susceptible to customer attrition upon purchase. Therefore, non-compete agreements and transitional training periods should be analyzed. Non-compete agreements will prohibit the previous owner from setting up a competing practice nearby using information, training, or patient/customer contacts that were provided by the practice. For example, a non-compete agreement would be necessary during the partner buyout of an accounting practice involving two owner-operators. With a non-compete agreement in place, the departing owner would be unable to set up their own practice and draw clients away from the existing business, resulting in decreased sales and earnings for the subject business. Additionally, transitional services can assist a buyer to familiarize themselves with the current customer base, which, in turn, can reduce customer attrition.

Conclusion

The risk of depth and quality of management and personal goodwill considers the risk if the owner or key employee, such as a general manager, leaves a company. Larger practices with multiple operators have a lower risk of customers leaving if the current owner or key employee leaves. It is important to ask: how important is the current owner to the business? Less risk is applied if the owner is less important and more risk is applied if the owner is considered to be essential.

[1] https://dklawg.com/business/healthcare-law/non-physicians-owning-a-medical-practice/

[2] https://www.usdentalpractices.com/helpful-resources/can-a-non-dentist-own-a-dental-practice