How much is your practice worth? The answer depends on the underlying facts and circumstances. While there are guidelines and formulas that are applied, each practice has its unique set of circumstances and individual characteristics that the valuator must focus on. Additionally, all valuations are not performed in the same manner. The approach and methods applied depend on the purpose of the valuation.
There are several reasons a physician may need to need to know the value of his or her medical practice. Here are just some of them:
• Sale to another physician. The sale of a medical practice may be to an outside physician or group practice;
• Buy in/buy-out. In cases where an employed physician is going to buy into a group practice a value must be determined to come up with a fair asking price for the new owner. When a retiring physician is going to be bought out of a group practice, a value must be ascertained to determine what the departing physician’s share is worth;
• Acquisition by a hospital or by a physician practice management company. Though this is not occurring as much as a few years ago, some hospitals and/or physician practice management companies (PPMCs) are still looking to purchase physician practices. Oftentimes, the PPMC’s have their own method for coming up with value, but the physician will want to make sure he/she is getting a fair price. In the case of hospitals, most are nonprofit and require an independent valuation to meet regulatory scrutiny. These transactions are often subject to review under Internal Revenue Codes, Medicare fraud and abuse standards, the Stark Law, and private benefit/private inurement issues. The valuator must have adequate knowledge of these issues and be careful not to overvalue the practice;
• Practice Merger. In cases of practice mergers, it is important for the parties to determine how to handle the equity interests of the owners of the newly merged group. Each practice is valued to determine the worth of the individual entities going into the group;
• Divorce. The value of a physician’s practice virtually always comes up in the case of a divorce. In these cases, the valuator must have knowledge of pertinent state law and precedent cases. The value will undoubtedly be subject to scrutiny in the courts;
• Other. Other reasons include retirement planning and estate planning.
Whether you are looking to buy or sell a practice, entering into a buy-sell agreement, considering a merger, going through a divorce, performing financial planning, or for some other purpose, knowing what your medical practice is worth requires the skills and expertise of an accountant or other financial practitioner who understands the process of valuing medical practices. Here are some guidelines:
First and foremost, avoid rules of thumb. A typical rule of thumb may be that a business is worth one to four times its net earnings. In this case if the net income of a practice is $400,000, the practice would be worth anywhere from $400,000 to $1,600,000. The disparity is tremendous. Rules of thumb should be used as a sanity check only. An experienced valuator can apply a rule of thumb to the end result of his valuation to determine if it falls within reason based on his valuation knowledge and history.
In the case of a practice sale to a hospital or other outside party, the most widely applied standard is fair market value. This is generally defined as the amount at which property would exchange hands between a willing buyer and a willing seller, neither being under compulsion to buy or sell and both having reasonable knowledge of the relevant facts. To avoid regulatory challenge, fair market value must be used.
New physician buy-ins and physician retirements may be determined differently. Typically an agreement is drafted and agreed upon by all parties and stipulates the formula to be used. It may be fair market value, net book value or even some other definition of value. It may even be tied into the balance of accounts receivable or annual compensation. Most often it is designed to minimize the tax costs to all parties involved.
How is fair market value determined? There are generally three approaches to estimating the value of a medical practice, i.e., an asset approach, a market approach and an income approach. An asset-based approach determines specific tangible values. A market based approach compares recent sales of similar practices. An income-based approach analyzes a practice’s earnings expectation and cash flow associated with those expectations. The income-based approach is the most commonly used method in valuing a medical practice. The resulting value derived at under this approach includes all assets of the entity both tangible and intangible.
The tangible value consists of all the operating assets of the practice minus liabilities. Assets include accounts receivable, furniture, fixtures, and medical equipment.
The accounts receivable are worth their estimated net realizable value. Estimated net realizable value takes into account average collection ratio, aging and payer mix. Furniture, fixtures and equipment can be valued by independent appraisal or can be based on original cost depreciated on a straight line basis over estimated useful lives. It’s important to note however that even if an asset has gone beyond its depreciable life it may still have value to the practice. What is that 12-year-old exam table worth versus having to go out and buy a brand new one?
The intangible value includes many things associated with the value of the practice as a going concern. It is often broadly referred to as goodwill though it includes many things. Among these intangible items are the value of a trained work force already in place; the practice’s image and reputation among patients, referral sources and payers; the likelihood that individuals will continue as a patient of the practice even if the physician changes; the value of the patient records and established database. It may even include the practice’s location. The intangible value is associated with recurrence of practice earnings and is the most difficult factor in determining a practice’s value.
Most often, a discounted cash flow method is used to determine practice goodwill. It is an income approach which says “how much is the future stream of earnings of this practice worth today?” It is the strength of the practice’s income stream that creates true value.
It is important to remember that there is no simple answer to the question ‘how much is your practice worth?’ While there are some basic guidelines, the determination of practice value must be made on a case by case basis considering each set of unique circumstances. Depending on your need you should contact a specialist experienced in medical practice valuations.
Lisa A. Patenaude, CPA, is senior manager of Health Care Services Division at Meyers Brothers Kalicka, PC Certified Public Accountants and Business Consultants in Longmeadow; (413) 567-6101