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by Keith Borglum CHBC
There are many occasions when knowing what your practice is worth is important information. The most common reasons for getting a practice valuation has always been for purposes of practice sale, buy-in, pay-out or for marital divorce.
Value should not be confused with price. Value is determined, price is negotiated.
"Value" is an economic term that sets it apart from price. Value is a creation of individual opinion. Value is what the practice is worth to an individual, given that individual's unique thoughts, wants, needs, purchasing-power, use, supply, and demand.
"Price" refers to the amount for which a practice actually sells. Successful negotiation between two individuals, each with their own perceived value, regarding the transfer of a practice, results in a price. Sometimes a value is needed, when there is no sale, such as in dovorce proceedings.
Divorce court has its own rules about valuation of goodwill, whether it exists, or whether there is a distinction between "professional goodwill" and "personal goodwill". These rules apply on a state by state basis, so I will defer further discussion of "divorce" goodwill here.
The true test of practice market price is what a willing buyer actually pays a willing seller with neither party being under any undue outside influence, with both persons in possission of all the facts. Unfortunately the greatest undue outside influence usually encountered is ignorance, either on the part of the physician or his/her advisors. Applying too high a price to a practice can cause a seller to lose his practice through not being able to sell it, or cause great financial hardship on a buyer for paying too much. Applying to low a price loses the seller money.
"Goodwill" and "intangible value" are often used interchangeably, although they can have different meanings under valuation theory. The value of intangibles, described in the Goodwill Registry as "goodwill ", includes a favorable location; going concern value; use of seller's name; favorable leasehold; covenant not to compete; compensation for past managerial and entrepreneurial services; patient lists; credit records; patient care contracts; employee contracts; as well as assignment of future incomes from the practice. An evaluation of the printed report identifies the value of Goodwill as a percentage of annual revenues, but this view can be very misleading to the uninformed reader relying on it for valuation. Acquiring the underlying Registry database allows the analyst to view the data in various ways comparing revenues, goodwill, earnings, location, year, etc. The Registry data also includes non-sale data that should be excluded, like valuations for taxes, estate-planning, and divorce, other undisclosed non-sale reasons, etc.
The Registry reports data over the past 10 years. Many practice transactions are reported in the Registry with a 10-year median goodwill value of the past year's collections. The simple view of Registry sales data does not identify trends, up or down. It is erroneous to think that current business value in a market that has fallen has the historic average or median value. Upon close scrutiny, we can find that a mere evaluation of the median or average goodwill value of the past decades' transactions to gross revenues (ie collections) has little or no relevance. For example using the stock market as an illustration; a stock whose value has fallen from $10 to $3 over the past decade does not currently have the average or median value of around $6. It has a current value of $3.
The Registry also has problems with homogeneity of comparable data. We don't know the productivity, hours, weeks, fees, ancillary services, regulatory issues faced and other issues of the sold practice.
It is earnings that are pre-eminent in identifying value in businesses. The Registry reports earnings as "seller's discretionary earnings" (“SDE”) which includes the owner's compensation for labor. This provides a different perspective that what was available in the Income Approach which excludes compensation for labor in finding "dividends".
What is most appropriately used now in valuing medical practices is usually the Income Approach, which generally doesn't distinguish between goodwill value and asset value. It only cares about the return available, particularly in excess of what the fair market compensation is for that practice. As an example, a hypothetical family physician can readily find employment at $150,000 per year full time. A practice that only earns $100,000 would have no value to him or her, and likely little to no goodwill value. A well managed practice with midlevels and ancillary services that earns a similar owner $250,000 per year would have value, including goodwill value. That extra $100,000 per year is worth something, and appraisers' job is to figure out how much.
An important factor in valuation is why and how a value is achieved. Good valuation reports generally contain background information and documentation so the protocols followed are clear to the lay person and data can be confirmed.
Practice valuation is an inexact science attempting to reach a reasonable value opinion, therefore even knowledgeable people can differ in their opinions. You should demand to have your appraiser present the resources used and the currency of their data bases, and their credentials. I frequently run into bad appraisals, the vast majority over-valuing the medical practice, because medical practices tend to be worth less than similarly profitable other professions. It is logical to think that a field so heavily mired in insurance reimbursement, discount contracts, and government regulation is worth less than non-encumbered fields like accounting, law, architecture, engineering, etc. Most appraisers either specialize in medical practices or shy away from them due to the complexity of the issues.
When you ask "What is my practice worth?" a definitive answer may be elusive, but common sense, professional judgment and statistical analysis can result in a usable opoinion.
Reprinted with permission from CALIFORNIA MDs BUSINESS ADVISOR.
Phone 1-707-546-4433 for consulting and appraisal information.
Author Keith Borglum CHBC is a consultant, medical practice appraiser, and licensed practice broker with Professional Management and Marketing, 3468 Piner Road, Santa Rosa California 95401.
Member or former member of the National Society of Certified Healthcare Business Consultants, Society of Medical Dental Management Consultants, American Medical Association's Doctors Advisory Network, American Academy of Family Physician's Network of Consultants, California Academy of Family Physician's Consultants on Call, and the Institute of Business Appraisers.