A medical practice valuation (especially from a consultant!) may seem like a black box: some data goes in and a number comes out. Fortunately, the components and process are a little more transparent than that. Nevertheless, there is still a certain amount of art, as well as some science, in developing such a business valuation.
In this Article …
- Purpose of a medical practice valuation
- Medical practice valuation methods: Asset approach
- “Hard” (tangible) assets
- Intangible assets include goodwill and other hard-to-value factors
- Medical practice valuation methods: Income approach
- Goodwill in a medical practice valuation
- Two factors currently affecting goodwill
- Stark laws and medical practice valuations
- Other factors to consider in a medical practice valuation
- How to get started on getting a medical practice valuation
Purpose of a medical practice valuation
There are many reasons for developing a medical practice valuation:
- Older physicians are planning to retire, and want to receive the value of the medical practice from a new physician owner.
- A solo physician or group practice are considering taking on an additional physician or physicians, and want to structure an equitable buy-in for a new partner.
- A physician member of a group practice wants to sell his or her shares to other shareholder physicians in the group. A subset of this reason is the death of a shareholder where the estate will receive the proceeds of the sale of the shares.
- A physician wants to sell a medical practice to a hospital, and become an employee of the hospital or a hospital-based group practice.
Regardless of the reason for a practice valuation, there are many similarities as well as unique differences to medical practices that influence the valuation methods and the outcome.
Medical practice valuation methods: Asset approach
In prior years, practice valuation methods were fairly straightforward. There were tangible and intangible factors, as well as multiples based on gross annual revenue or net income after expenses. And there were differences based on selling specific assets of a medical practice or selling a corporate entity that contained the medical practice.
“Hard” (tangible) assets
Tangible assets of a typical medical practice include things like:
- The furniture, fixtures and medical equipment in use in the office,
- The medical records, whether digital or paper,
- Prepaid expenses such property insurance premiums and electronic health record software fees, and
- Options to renew (or cancel) a lease in the current practice location.
Intangible assets include goodwill and other hard-to-value factors
Goodwill is a real asset, but it is among the most difficult to value these days. More about this later.
Current location may be a favorable intangible asset, as can participation in managed care networks. Of course, such participation may be physician-specific, with a new owner not able to join an existing network.
The value of the accounts receivable (AR) at a point in time is an asset in the middle between tangible and intangible. With good historical data on amounts billed and collected each month, plus the aging curve (the percentage of AR collectible each month following the original billing), it should be possible to calculate the net value of the accounts receivable at a point in time. Of course, this is important when the seller may be retaining the AR vs. including it in the value the buyer is purchasing.
Medical practice valuation methods: Income approach
The Income Approach was also relatively straightforward in prior years. Information on both the billed charges (gross income) as well as collections was used to identify a potential multiple of those amounts as a sale price. Specialty practices usually commanded a higher multiple than primary care practices. The net income from a practice was also used to estimate the valuation of the practice. Practices may also list the current and future cash flow of the practice when listing it for sale, but that figure may or may not include practice expenses.
Just perusing the listing of medical practices for sale shows sellers asking plus or minus 1.0 times the claimed cash flow of the practice as the offering price. Some sellers quote more and cite reasons for using a higher multiple. This includes factors such as location and payer sources. It is fair to say that although the income approach may be a data point, it is by no means the only factor to consider when selling or buying a medical practice.
Goodwill in a medical practice valuation
Goodwill is defined by Investopedia as an “intangible asset that is associated with the purchase of one company by another. It represents value that can give the acquiring company a competitive advantage.”
In the past, goodwill was generated by the longevity and good patient care and service provided by a physician practice. Physicians who purchased practices paid more than the value of the hard assets because they counted on patients continuing to come to the office, even if a new physician was providing care. This worked because the medical records were there and patients had received good care and service in that office before. So part of the value to the buyer was the potential future income stream from existing patients.
Changes to the organization of health care services in general, and medical practices in particular, have moderated the ability of sellers to make the case for significant goodwill premiums. And buyers understand this factor is also attenuated these days.
Two factors currently affecting goodwill
Patients are often in managed care plans where there are powerful incentives to obtain care from in-network physician practices. New physicians may not be able to join a network in which the selling physicians participated.
A hospital purchasing physician practices may not see much value in goodwill. The hospital may think its own reputation and marketing efforts will be adequate to attract patients. Consider a situation where the physician sells a medical practice to a hospital, and then remains to work in the practice for a salary. The hospital may think offering a reliable income and relieving the physician of the efforts to manage the business activities of the medical practice is sufficient compensation.
Stark laws and medical practice valuations
A physician is selling a medical practice to a hospital and then continuing to work in the practice, sending patients who need care to the hospital that purchased the medical practice. When a physician making referrals to a hospital also has a financial relationship with that hospital, the hospital must comply with the Stark Law and regulations governing that type of relationship.
The Stark Law prohibits financial arrangements between hospitals and referring physicians unless the arrangement meets an exception. One exception covers isolated transactions like the sale of a medical practice to a hospital when the selling physicians will be making referrals to the hospital.
There are several standards related to meeting this exception:
(1) The amount of remuneration under the isolated financial transaction is –
(i) Consistent with the fair market value of the isolated financial transaction; and
(ii) Not determined in any manner that takes into account the volume or value of referrals by the referring physician or other business generated between the parties.
(2) The remuneration is provided under an arrangement that would be commercially reasonable even if the physician made no referrals to the entity.
(3) There are no additional transactions between the parties for 6 months after the isolated transaction, except for transactions that are specifically excepted under the other provisions in §§ 411.355 through 411.357 and except for commercially reasonable post-closing adjustments that do not take into account the volume or value of referrals or other business generated by the referring physician.
Consultation with legal counsel is always recommended when the sale of a medical practice to a hospital is anticipated.
Other factors to consider in a medical practice valuation
The terms of an actual sale/acquisition can also affect the final value of a medical practice.
- Is the buyer planning to finance the purchase of the medical practice? If so, is the seller in a position to extend credit to support the purchase?
- Are there tax implications for the seller that could be mitigated with the terms of the sale? For instance, receiving payments from the buyer over time vs. in one tax year?
- Is the medical practice being sold as a corporate entity, e.g., a corporation or a limited liability company? Is the entire corporation being acquired, or only selected assets?
- Does the sale include sale of real estate that houses the existing medical practice?
- Is there an assignable lease or electronic medical records system with a transferable license?
How to get started on getting a medical practice valuation
We have listed a lot of the most important factors and issues that can come up when commencing the valuation process. You can certainly make a list of these things and start to document your resources as well as objectives in completing an analysis. And of course, you can always seek professional help to make sure you find all the value you can and get advice on the terms that are negotiable.