How much is your practice really worth?

Physicians who have spent most of their working life building a practice often have no clue how much their business is worth. This lack of knowledge can affect retirement planning, create financial delays when applying for loans and allow inefficiencies to erode the overall value of the practice.

“I believe doctors should have this information so they know what their business as an asset is worth,” says Vincent M. Brinly, the CEO and director of valuation services at the Practice Valuation Group. “More often than not, it’s their most important asset; they need to know how to make it better, if possible.”

Knowing the value allows doctors to protect their investment with different forms of insurance that accurately reflect the total worth of their practice. Another advantage to having an accurate valuation done is to better connect a retirement plan that relies on the proceeds from a practice sale to the reality of the market.

“What someone thinks a practice is worth and what they can sell it for (are) sometimes different—and sometimes that difference can be a wide chasm,” says Brinly. “That’s why getting it valued by somebody who doesn’t have the blood, sweat and tears invested in it and is looking at it pragmatically from a third-party perspective is important.”

Getting started

Experts agree that the most important decision is who to hire to perform the valuation. Although there are several industry designations (see sidebar) to help identify people with the right training, it is important to ask a lot of questions before hiring a professional.

“Make sure they are health care specific, because business valuation can range from valuing restaurants to retail and all kinds of other industries,” says Valora Gurganious, MBA, CHBA, a partner and senior management consultant at Doctors Management, a practice management consulting company. “You absolutely want to select a valuation analyst with expertise in health care, because there are so many intangible goodwill and other categories of value that the individual has to be trained (in) specifically on how to assess that value.”

Ask how many medical practices they have valued, what specialties they were, and in which regions of the country they were located, Gurganious suggests.

“The most catastrophic mistake a doctor can make is finding someone that doesn’t specialize in medicine,” says Brinly.

Once the doctor has chosen an expert, the valuation process proceeds in a similar manner as a doctor approaching a new patient. First, the valuation analyst will take a case history, with the doctor describing the practice and his or her goals. Next comes the physical examination of the financial records. This would typically include the last five years of tax returns, a copy of the income statements, accounts receivable broken down by provider and a breakdown between Medicare and private payer.

“They’ll also want to know what the accounts payable looks like, including any liabilities the practice has in place, (such as) any loans, notes (and) contractual agreements plus any hospital or health plan affiliations,” says Gurganious. “Clearly, they’ll be valuing the tangible assets of the practice, which would include furniture, fixtures (and) equipment—both medical and business—including how it’s been depreciated and if there is any residual value.”

Brinly says that the analyst will review where existing and new patients are coming from, and examine all the contracts with doctors and nonphysician providers.

“They’ll take all that information and compare the practice to benchmarks to see how they compare to their peers in certain metrics,” says Brinly. “We come to a decision on what’s going right with the practice, what’s going wrong and how that affects value.”

The entire process from start to finish usually takes about four to six weeks. Typically, there is a site visit, which may include additional interviews with key employees, such as a practice manager or other physicians. When the process is complete, the analyst will provide a report that explains how the final valuation number was reached, and what can be done to increase the value.

Valuation costs can be a percentage of the valuation, hourly charges for time spent calculating it, a fixed fee or some combination of these. Brinly advises making sure costs and budgets are clear before the process starts.

Circumstances matter

The reason the valuation is being conducted can change the time and scope of the process. For instance, if a small practice is being sold to another physician because the current owner is retiring, the commitment of the remaining employees is important, as is a transition plan to introduce patients to the new owner.

“The owner may provide some kind of incentive to stay once the practice is sold,” says Gurganious. “Maybe (the employees are) offered a bonus at the end of 12 months after the transition of ownership — anything to keep the stability so the new owner has confidence that the practice will look the same or better than before. They don’t want to worry about half the talent walking out the door.”

Likewise, with patients, transition time can add value for the buyer of a smaller practice where the goodwill relationship between doctor and patient is the main asset. “There has to be a proper transition plan set up where the doctor selling is going to introduce the buying doctor to ensure patients continue to flow to the practice,” says Brinly. “If you don’t, then there’s really not much value and that unfortunately plays out when doctors haven’t prepared. The timing of the valuation is very important.”

If retirement is the selling doctor’s goal, the earlier the valuation the better, as it allows time to fix inefficiencies and to sell before the value declines. “I’ve had many doctors come to me and say they are ready to get out and hang up the stethoscope, but they are down to two half-days a week,” says Brinly. “There’s just not a lot to sell there. (They have) to plan out when it’s time and when they want to get out.”

For practices receiving an offer of a buyout from a hospital, an asset-only valuation may be performed, which looks solely at the tangible assets and not the doctor’s goodwill with patients, says Randy R. Bauman, the CEO at Delta Health Care, which advises both hospitals and physicians on sales transactions. Although having your own valuation done to compare it with the hospital’s offer may make sense, for smaller practices, the cost of the valuation may exceed any impact on the selling price.

“Physicians should remember that the hospital’s valuation isn’t subject to negotiation,” says Bauman. “They are limited to the value determined by their independent appraiser. Valuations can be updated to correct errors in the data provided (by) the appraiser, reflect additional information, reflect changes in quantities and other pertinent information, but a negotiation between two competing valuations is not going to happen.”

For physicians going through a divorce proceeding, separate valuations may be performed with one expert representing each side. However, according to Gurganious, it is common to have both sides agree on which expert to use with the stipulation that both sides will accept the findings.

Increasing value

If a physician plans on selling the practice, maximizing its value becomes paramount. A valuation report will indicate which areas need the most help, but there are steps a practice can take to increase its value now.

Gurganious recommends taking at least a year to start implementing plans that will increase profits. “You are always going to be more attractive if the cash that the practice kicks off is higher, so any ways that expenses can be reduced or new service lines added, that should be done,” she says.

Aesthetic lines that can be run by nonphysicians can be an attractive addition to a practice buyer, as is subleasing unused space.

Make sure the structure of the practice is set up so that the practice can run without the physician doing everything. “If they’ve got a strong management team, a strong clinical team, and everyone operates like a well-oiled machine, that is highly valuable to someone acquiring the practice because they can come in on day one and just fit right in and begin to make money,” says Gurganious.

And don’t forget about the obvious items that can make a bad first impression on both patients and buyers: walls that need painted, outdated flooring, a poorly designed website and equipment in need of repair. “Nobody wants to buy something that’s rundown,” says Gurganious. “Take that year and get the house in order, and from a fiscal standpoint, driving revenue is key, as is reducing expenses as much as possible.”

Experts say physicians need to be prepared for a valuation that may be lower than what they personally think it’s worth, especially those doctors running smaller practices.

“I think it’s understandable, because they have put in all of those decades’ worth of work,” says Brinly. “They started it from nothing, or they bought it from another doctor who was retiring and spent the next 30 years building on that.”

“I remind my physician clients that, in general, whatever value they have created through their hard work, they have taken home in compensation and profits over the years,” says Bauman.

By creating goals and timelines, physicians have more time to get the best return for their hard work.

“A practice has more value when you plan ahead,” says Brinly. “Selling the practice in the declining phase of its life cycle is not going to net you as much value as selling it in the growth or mature phase. The more you plan and get the valuation done early, the more time that you can make course corrections to increase that value.”