What’s the real investment value of a practice?

When you purchase assets like a public stock, treasuries or gold with cash it is easy to calculate the return on your investment. Your yield would equal today’s value minus your original cost. Then divide that by the original cost and again by the number of years you’ve owned the asset. If you bought gold for $10,000 three years ago and today it is worth $15,000, your yield is 50% or about 16% per year. ($15,000 - $10,000) div $10,000 div 3 = 16%) These are considered passive investments because you have no control over how they perform.

How would you calculate the return on an investment that required no cash down? Imagine buying gold using a 100% loan and repaying the money with some reasonable interest and still having something left over. Using the example above with a loan having interest of 8% per year you would still keep about $2,500. That’s a huge return considering there was no cash investment. Your risk of course is in repaying the loan if the investment drops in value. However, you have invested nothing of your own money.

Imagine now that you can actively “work” the investment to increase the yield. How much more could you earn?

This example illustrates the often overlooked opportunity of purchasing a practice. There are little to no other opportunities where you could buy something using 100% borrowed funds, pay it off from the profit of that investment and have the control to increase the profit.

For example, based on the assumption below a buyer could increase their investment by 50% over 5 years without using any of their own money. Further, they would earn about $70,000 in the first year after debt payments. With an assumed 10% growth rate per year they would earn $130,000 after debt payments by the 5th year. Plus they will have an asset worth $120,000 more. Allowing for the balance of the loan remaining the net equity would equal more than $200,000. This means that at the end of the fifth year if the practice was sold for the same multiple value the buyer would yield $200,326 after paying the remaining loan balance. That’s in addition to the annual salary. Of course after the debt is paid off in 10 years their annual income would increase to about $160,000.

Assumptions

Annual growth - 110.00%

Purchase price - $200,000

8% Loan over 10 yrs - $200,000

In example two below, if the buyer was able to achieve a 15% growth rate their earnings would increase to $170,000 after 5 years with a 100% return on the initial purchase price. (i.e. the practice is worth)
 
Assumptions
Annual growth - 115.00%
Purchase price - $200,000
8% Loan over 10 yrs - $200,000

A smaller office with less profit initially, still offers excellent equity and income after the 3rd year. Over 5 years with a 15% growth rate per year, a buyer could resell the office and earn $227,000 after paying off the remaining debt. The buyer still receives a salary during this period. Admittedly, the salary in years one and two are lower than average, but over the long term the buyer would have earned $550,000 plus the equity in the practice. This is completely accomplished without any cash investment whatsoever.

Assumptions
Annual growth - 115.00%
Purchase price - $187,500
8% Loan over 10 yrs - $187,500

In all cases you have the control to increase this yield by improving efforts your business skills. Owning a practice can be challenging at times, however, there is no other opportunity that allows one to leverage your money and have the investment itself payoff the debt. Even in today’s market, lenders still provide up to 100% financing.