How much is your practice worth? Often, it depends on who wants to know and why. Valuation professionals follow different methodologies tacks depending on whether a practice will be sold to another physician, valued for a divorce proceeding, or if practice partners just want to go their separate ways.
The traditional building blocks of practice value are:
- Hard assets – equipment, facilities, supplies, patient records, etc.
- Cash – what’s left after expenses, including physician compensation
- Accounts receivables – money due for professional services
- Goodwill –anything paid above the value of hard assets, cash and A/R
You can follow several pathways to put a value on these four items. The market value approach – what other practices in the area sold for recently – is dandy for houses but can be an exercise in uncertainty to compare medical practices in different parts of the country.
Another approach is to try and project future cash flow, the component most important to business investors. While it works well for many types of businesses, cash flow valuation is of little help to the typical medical practice owner since most have little cash left after paying for overhead expenses and physician compensation – in other words, medical practices do not retain earnings.
Physician owners tend to take whatever’s left after expenses as their compensation. If physician compensation is set at a fair market level for the same area but there’s never any cash left at the end of the year, then what’s it worth to an investor? Unless a physician earns substantially more than the fair market rate for his or her specialty and the area, that money is physician compensation, not profit. That’s why figuring in goodwill – the ability to make profits – is such a major component in determining practice value.
Very Basic Valuation
One way to determine if goodwill might exist for your medical practice is to figure out what it would cost to hire a doctor to take your place, assuming the same level of experience and expertise that you have. The difference between your compensation and that replacement doctor might be considered goodwill.
To get a quick, very rough estimate of what your practice might be worth in today’s market, try a ‘back of the napkin’ valuation. This bare bones approach looks at free cash flow and the rate of return a hypothetical investor might expect for buying your practice.
Step one is to determine your practice’s free cash flow. That’s the amount of cash left after paying operating expenses (staff and nonphysician provider salaries, rent, leases, loans, insurance, etc.) and the fair market compensation of the physicians. Say you have a three-physician care practice that pulls in $1.5 million after contractual adjustments. Operating costs are $900,000, leaving $600,000 for the three of you to divvy up. Suppose a fair market compensation figure for your professional services is $185,000 each, thus leaving $45,000 in total free cash.
Step two is to propose a required rate of return on investment (ROI). While 20-year Treasury bills may pay a little less than 5 percent now, investors who take large business risks will look for returns closer to a 20 percent return annually.
Step three is to divide the cash flow ($45,000) by the ROI amount (0.20). The result is the “total” value of the practice ($225,000). This includes “all” assets of the practice, including accounts receivable and goodwill. Keep in mind the is an extremely ROUGH valuation calculation – impact of taxes would have to be considered, all risks to future cash flows would have to be considered, future capital needs, etc.
Now remember, this kind of calculation may get you in the church, but it certainly won’t get you into the right pew! Depending on the buyer, you also may have room to negotiate on other issues, such as your practice’s location, the quality of its management, patient growth rate, payer mix and other factors. However, no matter how you appraise a medical practice, you still won’t know what it will bring on the market.
I often run into doctors who think their practice should sell for its appraised value, but that’s not always the case. If you want to get a good deal, start thinking about life after the sale and how you’ll have the chance to get paid for what you do as opposed to what’s left on the table after all of the practice costs and contract discounts are taken out.
The hardest thing to convey in presenting appraisals is that it’s just business. It’s not personal, but to some people, hearing what their practice is worth is like we’re saying their baby is ugly. And for now, buyers seem to be getting the upper hand in determining what your baby – your practice – is worth.