Medical Practice Valuationby Keith Borglum CHBCMedicalPracticeAppraisal.com
Why Value a Practice ? Purchase/Sale Associate buy-in Marital Divorce Owner Exit/Breakup Insurance Litigation, non-compete, economic damages
Financial v. Emotional Value People feel “pride of ownership” in their businesses and see “value” in the effort made to start and grow it The market place primarily determines what financial value is represented in the business
Value v. Price Value is an opinion, not a fact Price is negotiated between two individuals each with a unique interest Many practices sell for a price aboveor below the appraised value A practice can have value withouta sales price, as in a divorce
Standards of Value Fair Market Value - to a hypothetical buyer Investment Value - to a particular buyer Fair Value - no buyer involved Liquidation Value - at “auction”
Premises of Value Going Concern - ability to generate income despite aninterruption in ownership Liquidation - income is interrupted,can be “forced” or “orderly”
Approaches to Value Asset - the value of the assembled components, aka adjusted book value, net asset value, accumulation value Income - the value of the benefit stream to the owner Market Comparison - what similar practices sold for
The Asset Approach Rarely used in small to medium sized medical practices, unless low income Rarely used for<50% ownership Rarely used in limited-asset businesses Sometimes used to value young ortroubled businesses
The Income Approach The favored approach by the IRS inRevenue Ruling 59-60 Usually favored for operating practices Dividend-paying capacity via net cash flow (the individual’s profit above labor) is commonly used
The Market Approach Compares the subject to prior similar sales The subject’s value must be adjusted to the comparable sales for time, place, facts Typically excludes liabilities, AR and cash
How to Value Goodwill Total value minus tangible assetsor By reportor By calculation
Market Comparison Similar Purpose - sale, buy-in, or divorce Size of practice by collections/group size Method of valuation used in prior transaction Overhead and profitability Year & Place of transaction Some studies include pre-2004 Medicare cuts Some states had short term inflated values resulting in federal litigation
Valuing Tangible Assets Fair Market Value under a Premise of Going Concern considers the used valueassembled in place. NOT liquidated auction value NOT depreciated tax value USUALLY excludes accounts receivable, cash and cash equivalents, and assumes liabilities will be paid-off
Market Value Summary Must adjust subject value toparticulars of the historicvalue of sold practices.
The Income Approach - Issues Best values the income stream above themarket-compensation of owner (ie “dividends”) Does not differentiate between tangible assetsand goodwill Requires an opinion of specialty future growth rate, not historic practice growth rate Requires an opinion of market-rate risk and return
The Income Approach - Normalizing Owner’s income must first be “normalized” to include benefits like: Auto & Entertainment Health, life, and disability insurances Exotic-locale Continuing Education Owner’s salary plus profits Pension and profit-sharing contributions Usually uses pre-tax rather than after-tax earnings
The Income Approach - Risk Small medical practice is high risk and requires high returns on investment Start with 20 year treasury bonds Add risk for S&P 500 Add risk for small size Add industry and specialty risk Add specific practice risk = Practice Risk ROI needed (“cap” rate)
Income Approach Summary(simplified) Normalized Income - Market Rate Compensation x Growth Rate / Cap rate = Fair Market Value
Asset Value If Income or Market Approaches indicate a value of less than the value of the assets, then use Asset Value as “highest and best”. If it is a going concern, use fair market value of the tangible assetswithout a cost of liquidation
Reconciling Value The values found by different Approaches usually differ from each other. You must apply logic, reason, and experience to then find a single value, or range of values.
Common Appraisal Errors Failure to normalize income properly Incorrect market compensation, failure to considerfull-time-equivalence schedule Failure to consider medical issues like Medicare planned payment reductions or capitation impacts Using after-tax instead of pre-tax income Unsupported cap rate/ risk too low Using divorce comps for sales transactions, or unadjusted Goodwill Registry medians
Critical Valuation Error Not applying a discount for a minority interest in many (not all) cases Full value requires “control” Lack of control creates a discount disproportionate to the reduced interest 49% of a $1,000,000 corporation may have a value near zero The 51% owner can do anything they please with the company and assets
Choosing an Appraiser Should be member of a legitimate appraisal association like IBA or ASA, and follow industry standards for reports, like USPAP Should specialize in healthcare –most appraisers either do mostly/only healthcare, or none at all There are levels of appraisal- choose the right level for your purpose If you need a practice broker, use a licensed broker, even just for advice.
Summary: What is a Practice Worth?It all depends on the facts!
Keith Borglum CHBCCertified Healthcare Business ConsultantLicensed Practice Broker & AppraiserFaculty or Consultant for many Medical Associationsmore info and CV atMedical Practice Appraisal.com You wouldn’t refer to an “unlicensed doctor”. So don’t use an unlicensed, uncertified “consultant”!