Value and Financeability

 

 Understanding The Difference Between What a Private Practice Is Worth and What a Lender Can Responsibly Finance

“My practice was appraised at $1 million. Why won’t the lender provide a $1 million acquisition loan?”

This question reflects an understandable, but important misconception. An appraisal and a lending decision address related financial issues, but they do not answer the same question. A practice can have meaningful economic value without supporting a loan equal to that value under a particular buyer’s circumstances and proposed repayment terms. Commercial underwriting evaluates the borrower’s ability to repay and whether the financing is appropriately structured not simply whether an appraisal supports the purchase price.

Appraised value is an estimate of economic value. Financeability is the ability to arrange acceptable financing for a particular transaction, borrower, and repayment structure.

For private practice owners, understanding this distinction is essential when planning a sale, purchasing another practice, bringing in a partner, or refinancing existing obligations. A well-supported appraisal can help establish a reasonable transaction value. It does not, by itself, establish how much debt the practice can support or whether a particular buyer qualifies for that financing.

The objective should be to build a practice that is not only valuable, but also capable of supporting a financially sustainable ownership transition.

Appraisal and Lending Answer Different Questions

 A business appraisal estimates the value of a defined business or ownership interest as of a particular date, using an identified standard of value and stated assumptions. Its scope matters: the report may address the operating business, the owners’ equity, selected assets, or a minority ownership interest. These are not interchangeable assignments.

When the standard is fair market value, the analysis generally considers a hypothetical transaction between informed, willing, and able parties who are not compelled to transact. It does not assume that a particular purchaser can borrow the entire purchase price.

Financing requires a different assessment. A lender must consider the actual borrower, the actual amount requested, the repayment schedule, available cash flow, collateral, and the risks associated with the transaction.

An investor may receive economic benefits through distributions over time and the eventual sale of an ownership interest. A loan, however, requires payments according to its contractual schedule. Value attributable to future benefits does not necessarily provide enough near-term cash to repay a highly leveraged acquisition within the proposed amortization period. The distinction between cash flows available to debt and equity investors and those available only to equity owners is recognized in business valuation terminology.

A conclusion of value is not a conclusion that the entire value can be financed with debt.

The reverse is also important: a loan amount supported by a particular repayment structure is not automatically the practice’s value. Debt service analysis is useful for evaluating financing feasibility, but it should not replace an appropriate business valuation.

Cash Flow Must Be Available not Merely Reported

For a private optometry practice, the central lending question is whether sufficient cash will remain after maintaining operations and appropriately providing for the doctor’s work and financial needs.

Gross collections do not answer that question. Neither does reported net income without further analysis. Two practices with similar revenue can have substantially different cash flow because of differences in doctor compensation, staffing, rent, cost of goods sold, and other operating expenses.

This is why normalizing cash flow is important. Normalization adjusts reported results for items that are unusual, nonrecurring, discretionary, owner-specific, or inconsistent with the expected operating structure. Those adjustments can increase or decrease earnings. The objective is to identify sustainable economic performance not to maximize the amount presented to a buyer or lender.

A practice’s historical profitability may depend on circumstances that will change after closing. The owner may pay themselves below-market compensation, perform substantial administrative work after hours, or rely on unpaid family labor. A related-party landlord may charge below-market rent. These arrangements require careful evaluation because a buyer may incur costs that are not fully reflected in the seller’s statements.

Seller’s Discretionary Earnings Are Not Automatically Available for Loan Payments

Seller’s discretionary earnings, or SDE, include owner compensation and certain other adjustments. That can make SDE useful for understanding the economic benefits available to an owner-operator. However, it does not mean the entire amount can be committed to acquisition debt. Doctor compensation, capital expenditures, working capital, and debt obligations still require consideration.

The analysis should distinguish compensation for working in the practice from the return on owning it. A buyer cannot reasonably treat necessary clinical labor as free simply because the buyer intends to perform that work personally.

At the same time, the analysis should avoid double counting. When appropriate doctor compensation has already been deducted in calculating business cash flow, the buyer’s household obligations should be evaluated against the resulting personal income and other available resources not automatically deducted again in full from the same business cash flow.

Similarly, adding back depreciation does not eliminate the need to replace equipment. Adding back historical interest for an operating-business valuation does not eliminate the principal and interest payments required under the proposed financing.

How Lenders Measure Repayment Capacity

 One common measure of repayment capacity is the debt service coverage ratio, or DSCR:

DSCR = Cash flow available for debt service ÷ Required debt service for the same period

The ratio evaluates whether cash flow covers required debt payments with an adequate cushion. A practice’s apparent coverage can change materially when proposed add-backs, doctor compensation, recurring expenses, or debt obligations are corrected.

A ratio of 1.00x means the defined cash flow exactly equals the defined debt service. It leaves no surplus within that calculation. A ratio of 1.25x means there is $1.25 of available cash flow for each $1.00 of debt service.

The definition of available cash flow matters as much as the resulting ratio. Ask the lender how it addresses taxes, owner compensation or withdrawals, equipment replacement, working capital, and existing obligations.

The calculations should also distinguish obligations that will remain after closing from debts that will be paid off. Required payments on retained equipment loans or seller financing cannot simply disappear from the analysis. Conversely, a loan being fully refinanced should not be counted as though both the old and replacement payments will continue indefinitely.

There is no single coverage assumption that should be presented as the universal requirement for every lender, practice, and financing program. Owners should obtain the applicable lender’s definitions and requirements before relying on a preliminary financing estimate.

A $1,000,000 Appraisal Does Not Necessarily Support a $1,000,000 Loan

Consider the following hypothetical acquisition:

Transaction component                                                                                                Amount

Appraised value and agreed purchase price of the practice                    $1,000,000

Initial operating cash required at closing                                                             $75,000

Closing and transaction costs                                                                                     $25,000

Total funding required                                                                                                     $1,100,000

Buyer’s proposed cash contribution                                                                      ($100,000)

Requested acquisition financing                                                                               $1,000,000

Assume the purchased practice includes the agreed operating assets and inventory, while the $75,000 represents additional operating cash not a second charge for assets already included in the purchase price. Also assume that no existing business debt will remain outstanding.

For this example, the lender determines that the practice has $160,000 annually available for debt service, after its required adjustments for compensation, operating costs, applicable taxes, and ongoing reinvestment needs.

Assume a hypothetical loan carrying an 8% annual interest rate, fully amortized through monthly payments over 10 years. Annual principal and interest payments on $1,000,000 would be approximately $145,593.

The resulting coverage would be:

$160,000 ÷ $145,593 = 1.10x DSCR

Now assume the lender requires 1.25x coverage for this same transaction. The proposed loan would not satisfy that requirement, even though the purchase price equals appraised value.

The annual debt service supported at that coverage level would be:

$160,000 ÷ 1.25 = $128,000

At the same hypothetical interest rate and amortization, $128,000 of annual payments would support approximately $879,162 of loan principal.

The remaining funding requirement would therefore be:

$1,100,000 − $879,162 = $220,838

Compared with the buyer’s proposed $100,000 contribution, the transaction would have an additional funding gap of approximately $120,838.

This example does not establish that the practice is worth only $879,162. It establishes that, under the stated assumptions, its cash flow supports approximately that amount of debt.

Nor is $879,162 the approved loan amount. Collateral, buyer qualifications, liquidity, documentation, and other lending requirements would still need to be satisfied.

Loan Terms Change Borrowing Capacity

The amount of debt supported by a given cash flow changes when interest rates or amortization periods change.

Using the same hypothetical $1,000,000 loan and $160,000 of annual cash available for debt service:

Illustrative loan structure                                         Annual principal and interest                      DSCR

8% interest; 10-year amortization                       $145,593                                                                 1.10x

10% interest; 10-year amortization                    $158,581                                                                  1.01x

8% interest; 7-year amortization                          $187,035                                                                  0.86x

The practice’s assumed cash flow is unchanged. The debt burden is not.

This demonstrates why a statement such as “the practice supports a $1,000,000 loan” is incomplete without the interest rate, amortization, and other repayment terms.

A longer amortization can reduce scheduled payments, but the appropriate loan structure must reflect the financing purpose and applicable lender or program requirements.

Owners should also distinguish the amortization period from the maturity date. A payment schedule calculated over a long period may still leave a substantial balance due at an earlier maturity. Similarly, an interest-only period may improve initial coverage without resolving the later repayment burden.

Ask for an analysis of the entire repayment structure, including payment increases and any balloon obligation not just the lowest initial payment.

 The Buyer’s Financial Position Matters

 The same practice may be financeable for one buyer and not another.

Credit analysis includes more than the target practice’s earnings. Management capability, payment behavior, liquidity, leverage, and other business risks also affect the assessment.

Consider two hypothetical purchasers offering the same price. One has sufficient funds for the required contribution, a separate reserve, and a manageable personal debt burden. The other would exhaust available savings at closing and needs substantial distributions immediately to meet existing obligations.

Even with identical practice financial statements, these buyers present different financing situations.

A lender may evaluate the combined financial position of the business, its owners, and related entities through a global cash-flow analysis. Other income can strengthen the overall position, while losses, guarantees, or obligations elsewhere can place pressure on the practice’s resources.

In preparing for that review, disclose the source of the buyer’s contribution. Funds borrowed elsewhere may create additional repayment obligations; they should not be presented as though they were unencumbered savings.

Likewise, do not assume income from a buyer’s current job will continue after the buyer leaves that position to operate the acquired practice. The financing plan should reflect the post-closing situation.

The question is not simply whether the practice is profitable. It is whether this buyer can acquire and operate it without creating an unsustainable financial burden.

Going-Concern Value Is Not the Same as Collateral Recovery

 An operating practice can derive substantial value from its reputation, patient loyalty, established workforce, systems, and ability to continue providing services. These are elements of goodwill and going-concern value. They are different from the proceeds that might be realized if the business ceased operating and its assets were sold separately.

That distinction matters to a lender. The appraisal may support the value of a functioning practice, but it does not necessarily establish that the lender could recover an equal amount after a default.

Both the marketability of pledged assets and the reliability of the primary repayment source need to be evaluated. Lenders do not typically  make commercial loans solely on the basis of collateral; operating earnings are ordinarily the primary repayment source.

This does not mean goodwill has no value or can never be financed. It means that a practice’s value as an operating business should not be treated as a guaranteed liquidation recovery.

Additional collateral may improve a lender’s protection, but it does not create operating cash flow. Similarly, a personal guarantee should not be treated as a substitute for understanding the repayment plan.

Owners should ask whether the lender’s concern involves cash flow, collateral support, or both. These are different problems and may require different solutions.

Transferability and Timing Can Affect Financing

Historical success must be evaluated in the context of the proposed ownership transition.

A practice may depend heavily on the selling doctor’s personal relationships, clinical reputation, work schedule, or referral sources. If the buyer cannot maintain the same production or patient relationships, historical cash flow may not transfer unchanged. Established systems, staff continuity, and goodwill associated with the practice rather than solely with the owner can help support that transition.

For example, a lender may need to understand how the buyer will replace the seller’s clinical hours, retain necessary employees, and manage the transition. A general statement that “the buyer will grow the practice” does not answer those questions.

The timing of cash flow also matters. Suppose a buyer expects a new service to become profitable in the second year, but loan payments and additional payroll begin immediately. The plan must fund the intervening period. Future earnings cannot pay a bill due before those earnings are generated.

A practical review should test less favorable outcomes as well. Consider a slower patient transition, higher staffing costs, or delayed collections.

Finally, an older appraisal may address conditions that have since changed. The valuation date, assumptions, and information supporting the report should be reconciled with current operations and the contemplated closing date.

Financial Documentation Can Determine Whether Earnings Are Financeable

An owner may understand why the practice’s financial statements understate economic performance. The lender still needs evidence.

An unusual expense may be a reasonable add-back, but it should be identifiable and supported. The same applies to family compensation, discretionary spending, and other proposed adjustments. Unsupported explanations can cause a lender to exclude adjustments or request additional information.

Prepare reconciled financial statements, tax returns, payroll information, debt schedules, and documentation of material adjustments. Explain differences rather than assuming a reviewer will understand them.

Clean financial reporting does not guarantee approval. It allows the lender to evaluate the actual economics more confidently. Incomplete or inconsistent information can result in reduced acceptable add-backs, additional conditions, a larger equity requirement, or a declined request.

Before challenging a financing conclusion, ask for a reconciliation between the seller’s cash-flow presentation and the lender’s accepted figure. That discussion is more productive than comparing two unexplained totals labeled “cash flow.”

Transaction Structure and Access to Cash Also Matter

 A practice may generate sufficient earnings, yet the proposed borrower may not have appropriate access to those earnings.

This is particularly important in a minority partner buy-in. Purchasing a percentage of a practice does not mean the buyer can use that percentage of every dollar of business cash flow for personal acquisition debt. The financing analysis should examine compensation, actual distributions, retained operating needs, and the buyer’s rights under the governing documents.

Appropriate credit-risk guidance emphasizes that a primary repayment source must be sustainable and under the borrower’s control. That principle makes access to distributions, not just an ownership percentage, important in a buy-in analysis.

Also review the lease, renewal provisions, assignment or change-of-control requirements, professional-ownership eligibility, and material operating agreements. Treat these as transaction-specific legal questions for counsel rather than assuming the appraisal resolves them.

An unresolved consent or ownership issue may prevent closing without proving that the underlying practice lacks value. Conversely, a lower purchase price may not solve a structural problem.

Working Capital and Liquidity Cannot Be an Afterthought

 A financing plan must allow the practice to operate after closing not merely complete the purchase.

In the earlier example, the $75,000 of initial operating cash serves a different purpose from the payment to the seller. It provides funds for the post-closing operating cycle. Omitting that requirement would make the transaction appear less expensive, but it would not eliminate the need for cash.

Consider the treatment of receivables. If the seller retains pre-closing receivables, the buyer should model the interval between paying operating expenses and collecting new revenue. The parties should also identify responsibility for inventory, accounts payable, and other operating balances.

Annual earnings alone do not show when cash will be available. Lenders usually review liquidity, balance-sheet changes, and receivable, payable, and inventory turnover, not merely income-statement profitability.

Build a monthly opening cash budget and preserve a realistic contingency reserve. Avoid using every available dollar for the down payment and assuming future collections will arrive exactly as projected.

At the same time, reconcile working-capital requirements with the appraisal and purchase agreement. Do not pay twice for an asset already included in the transaction, and do not confuse initial operating cash with recurring expenses already included in annual cash flow.

Different Lenders and Financing Programs May Reach Different Conclusions

 A financing decision also reflects the lender’s permitted products, experience, portfolio limits, and underwriting framework. NCUA’s commercial loan policy requirements address permitted loan types, trade areas, exposure limits, collateral methods, and approval processes.

Accordingly, a decline from one institution does not necessarily establish that no financing is available. However, a more favorable decision elsewhere does not eliminate the underlying risks.

Ask why the request does not qualify. A concern about the lender’s product fit differs from a concern that the practice cannot repay the requested debt.

Have the participating lender confirm current eligibility, valuation, equity, collateral, and closing requirements. An acceptable appraisal remains one part of the process, not an automatic approval.

How to Address a Financing Gap

 When an appraisal supports the price but financing falls short, first identify the limiting factor.

A larger buyer contribution can reduce required borrowing. A lower price can also reduce the debt burden. Supported operating improvements may increase cash flow, while an appropriate change in loan structure may reduce scheduled payments.

These options are not interchangeable. Increasing equity will not resolve an ownership restriction. Additional collateral will not create profits. A longer amortization will not correct unsupported earnings.

Seller financing also requires careful analysis. Consider a hypothetical arrangement with $120,000 of annual bank payments and $30,000 of annual seller-note payments. The combined obligation is $150,000, not $120,000. At an illustrative 1.25x coverage requirement, that structure would require $187,500 of annual available cash flow.

Before relying on a seller note, ask the senior lender whether it permits the arrangement and how it treats the required payments. Subordinating a seller’s lien and deferring payments are different arrangements. A deferred payment obligation still needs a credible eventual repayment plan.

When several informed financing reviews identify the same earnings weakness, revisit the transaction assumptions. The problem may not be lender conservatism; it may be that the expected performance or price needs reconsideration.

Likewise, an appraisal should not be defended regardless of new evidence. A review should address the quality of the data, appropriateness of adjustments, and reasonableness of the methods and assumptions. These are recognized elements of business valuation review.

Preparing a Practice to Be Both Valuable and Financeable

 Preparation should begin before a buyer makes an offer.

Maintain consistent financial reporting, document unusual expenses when they occur, separate doctor and staff compensation, and reconcile cash and debt balances. Keep support for proposed add-backs, equipment purchases, leases, and related-party arrangements.

Develop a realistic post-transition operating budget. Identify who will perform the seller’s clinical and administrative work, what that labor will cost, and how the practice will maintain continuity. Evaluate the transaction using current conditions rather than an idealized version of future performance.

Involve the lender early enough to evaluate the buyer, proposed structure, total funding need, and likely documentation requirements. Do not treat a preliminary discussion or an appraisal as a substitute for a written credit decision and satisfaction of closing conditions.

Keep the appraisal and financing analyses separate, but reconcile them. Ask advisors to explain differences in earnings definitions, valuation dates, included assets, debt treatment, and transaction assumptions.

Finally, retain adequate liquidity and stress-test the post-closing plan. The objective is not to borrow the maximum amount that produces an acceptable ratio on paper. It is to preserve sufficient financial capacity to operate the practice, compensate the doctor, maintain patient care, and repay obligations under realistic conditions.

The Bottom Line

A practice can be worth more than a particular buyer can responsibly borrow. A transaction can also require more funding than the practice’s purchase price alone.

Appraised value, purchase price, borrowing capacity, and total project funding are related, but they are not interchangeable.

A credible appraisal helps owners understand economic value. A sound financing analysis determines whether the proposed borrower and repayment structure can support the transaction without placing unreasonable pressure on the practice.

The most useful question is therefore not simply:

“Does the appraisal support the price?”

It is:

“Can this buyer acquire this practice, maintain its operations, receive appropriate compensation, preserve adequate liquidity, and repay the proposed financing under realistic conditions?”

Understanding both value and financeability helps owners negotiate more effectively, prepare more thoroughly, and pursue ownership transitions built for long-term success.

AUTHOR: Ken Ferreira is the President and CEO of Vision One Credit Union and is certified practice appraiser. Vision One Credit Union has been serving private practice optometrists since 1951 reinvesting over $500 million into private practices nationwide.

If you have any questions regarding this information or would like our feedback or assistance in reviewing your agreement, please feel free to contact Ken Ferreira, Chief Executive Officer at kferreira@visionone.org.

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