At some point, there will come a time to sell your practice. It could be in part to a partner or as a whole to another group or hospital. In any case, the practice will need to undergo a valuation, which is a detailed and complicated process, oftentimes confusing because let’s face it, it is not like you sell your practice every year.
In general terms, the process of determining the price that a medical practice will be sold, or bought, for is referred to as valuation. You are literally putting a specific value on the business, or certain parts of it, so you can sell it. We cannot just randomly assign numbers on how much a medical practice is valued at, or how much an owner’s interest in a practice is worth. There has to be a valid basis behind the estimate of the economic value of a business. In the same vein, there is a set of procedures on how these estimates are arrived at. This is called a medical practice valuation. One thing that can help you on your path is to understand some of the basic tenants of practice valuation.
If you are considering selling your practice, make sure you understand terms and appraisal definitions. Oftentimes, a physician will ask their accountant to appraise the business, but the physician may be surprised to find that the “book value” given by the accountant is far different than the “Fair Market Value (FMV)” that he could actually receive at the time of sale. It is not that the accountant is incorrect at all. Rather, the accountant and the physician may be operating under a different set of terms and definitions, without knowledge of each other’s perspectives. Realizing that there is no absolute sales price is the essence of FMV. When determining valuation, look for a price range with a reasonable floor and ceiling.
For starters, value isn’t an absolute number. A medical practice’s tangible and intangible assets can be grouped into two broad categories: physical assets and non-physical assets. Examples of physical assets include accounts receivable, leaseholds, medical equipment and furnishings, medical records, and real estate. Examples of non-physical assets include buy/sell agreements, goodwill, managed-care contracts, restrictive covenants, and staffing. Estimates of value differ significantly, depending on the purpose of the appraisal, the acumen of the appraiser, etc.
Astute appraisers will consider a host of questions:
- What is the value of the practice for purchase or sale?
- What is the value of a practice for merger?
- What is the value of practice assets for a joint venture with a corporate partner?
- What is the value to establish buy-in or buy-out arrangements for partners?
- What is the value of practice assets for purchase or sale, apart from ongoing operations?
To answer these questions, physicians must understand how practices are valuated.
Informal terms of valuation
The “asking price” is often arbitrary and difficult to substantiate and typically is reduced by a significant percent during negotiations. The “creative price” is derived by way of creative financing. For example, the practice may provide the down payment. The “emotional price” may involve either a motivated buyer or seller, who pays an under- or overinflated price for the practice. The “friendly price” is reserved for associates, partners, or other colleagues. The “realistic price” is one that both buyer and seller believe is fair.
Formal terms of valuation
Practice appraisers use FMV as the standard to derive a reasonable value for a practice. FMV means an arm’s length transaction between an unpressured, informed buyer and an unpressured, informed seller. The “business enterprise value” of a practice equals a combination of all assets (tangible and intangible), and the working capital, of a continuing business. The value of “owner’s equity” equals the combined values of all practice assets (tangible and intangible), less all practice liabilities (booked and contingent). The “working capital value” equals the excess of current assets (cash, A/R, supplies, inventory, prepaid expenses, etc.) over current liabilities (accounts payable, accrued liabilities, etc.).
The big picture
Valuing a medical practice is more of an art than a science and you must always keep in mind that the “Asking Price” is NOT the purchase price. Quite often, it does not even remotely represent what the practice is truly worth. Naturally, a buyer’s valuation is usually quite different from what the seller believes their practice is worth. Sellers are emotionally attached to their medical practices. They usually factor their years of hard work into their calculation. Unfortunately, this has no business whatsoever being in the equation. Never, ever buy a practice just because the price is right; first and foremost, be certain that the practice itself is right for you and that it is integral to your future strategy. Remember that valuations are not scientifically based; they’re subjective!
Nick Hernandez, MBA, FACHE
Nick Hernandez, MBA, FACHE is the CEO and founder of ABISA, a consultancy specializing in strategic healthcare initiatives.
Since founding ABISA in 2007, his emphasis has been on developing and maintaining a strong relationship with physicians and identifying areas for business opportunity and support. The company’s client list includes physician groups, hospital systems, healthcare IT organizations, venture capitalists, private equity firms, and hedge fund managers.
Nick is a graduate of the United States Naval Academy and a former Captain in the U.S. Marine Corps. He holds MBA degrees in both Operations Management and Information Technology & E-Business Management from Wake Forest University. He is Board Certified in Healthcare Management and has been named a Fellow of the American College of Healthcare Executives.
He is a frequent guest lecturer and is often quoted in the national media. He has consulted with clients in multiple countries and has over 20 years of leadership and operations experience. Nick is a Subject Matter Expert in business strategy, practice management, telemedicine, health IT, and oncology.