Valuing Your Medical Practice for Sale

The sale of a practice is something every physician eventually faces. Though you are not a business appraiser, you are the person most knowledgeable regarding the practice’s assets and liabilities. In addition, your personal decisions will be a factor in the sale price of the practice.
You will want to understand how your practice should be valued, the information that is needed, and what appropriate valuation methodologies should be employed in the valuation. A familiarity with the valuation process and making some decisions ahead of time are integral to a successful practice sale.
The health care market
In the last decade, the market has gone through a number of changes, which physicians looking to sell their practices should keep in mind. The following points were made by Merritt Hawkins, a well-known physician recruiting Company, in its latest annual survey “2011 Review of Physician Recruiting Incentives”:
1. Hospitals are employing physicians in greater numbers. 56% of Merritt’s physician searches for 2010/2011 featured hospital employment of the physician. According to Merritt’s, physicians are seeking the stability of employment, while hospitals are seeking to align with physicians in response to health care reform.
2. Salaries have almost entirely replaced income guarantees as a compensation model. Only 9% of physician searches conducted in 2010/2011 featured income guarantees (down from 21% in 2006/2007).
3. Reimbursement cuts and declines in elective procedures have significantly reduced the volume of search assignments for certain specialists. Radiologists, cardiologists, and anesthesiologists, all among Merritt’s most requested searches four to five years ago, were ranked 17, 18 and 19, respectively, in 2010 and 2011.
4. Demand for physicians is not confined to traditionally under-served rural areas. A number of assignments of Merritt Hawkins in 2010/2011 took place in communities of 100,000 or more while 22% of assignments took place in communities of 25,000 or less.
A selling physician must consider these marketplace factors when pricing his or her practice. Health care markets are different all over the country and are defined by a variety of factors including economics, demographics of population, and existing health care entities (e.g. number of hospitals, competing physicians and major insurance companies). The practice value is impacted by the specific health care market that exists in the geographic area of the practice.
The elephant in the room is health care reform, which is already affecting the health care industry, with further changes and more impact expected in the future. The threat of material reductions in Medicare reimbursement due to the Sustainable Growth Rate (SGR) formula utilized by Medicare continues to be a significant risk lowering the valuation of physician practices.
Valuation approaches
Your practice is comprised of tangible assets (those you can touch) and intangible assets (professional goodwill, personal goodwill, patient charts, workforce in place, etc.). You can choose to sell your practice inclusive of all the net assets (tangible and intangible) or just some of the assets.
There are three primary methods used in business valuation, which are the asset, income and market approaches. However, the market approach is used less often, and a hybrid approach, called excess earnings, is used more often.
Asset Approach
Examine the fair market value of the tangible assets and liabilities of the practice. This is typically a floor value of the practice as this approach does not include the practice intangible assets.
Income Approach
Analyze the practice’s historical income over a multi-year period and expected future income of the practice. The historical income for the period reviewed is adjusted for owner perquisites, non-recurring items, and other normalization adjustments. A practice value is determined using this normalized income stream and a capitalization rate determined by an appraiser.
Excess Earnings Approach
A hybrid of the aforementioned approaches: use both the net tangible assets of the practice as well as the income expectation of the practice to generate a value.
The income and asset approaches are considered more meaningful than the market approach when valuing medical practices. The market approach is based on transactions that have occurred, which may or may not be relevant to the subject medical practice being valued. Medical practices, even in the same specialty, can be very different, due to location, payor mix, overhead, staff, etc. Due to so many variables, market transactions that provide little to no detail regarding practices sold can generate erroneous valuation results.
The asset and income approaches are based on the specific financial information of the subject medical practice. If the subject practice is profitable, the income approach is the best method because it captures all of the intangible assets of the practice (patient charts, professional and practice goodwill, workforce in place, etc.). The asset approach typically considers the net tangible assets (such as accounts receivable, medical equipment, etc.) of the practice, and the intangible assets must be added to value the whole practice.
The excess earnings approach, which is the hybrid approach, is commonly used by appraisers who value professional service businesses (physicians, lawyers, accountants). This approach first derives a value of the net tangible assets, and then derives a value for the practice’s intangible component.
Risk factors
An important component of a practice valuation is risk assessment, based upon the practice’s risks as well as industry risks. The appraiser will typically consider the present value of future normalized income discounted or capitalized using a risk-adjusted rate. Here are some of the factors considered in a risk assessment, according to BVR’s Guide to Physician Practice Valuation (pages 116 to 117):
Recurring patient base
Referral practice or not
Total receipts
Payor mix and quality of contracts
Quality and longevity of staff
Number of active patients
Number of competitors (the market)
Ease of entry to the market
Recruiting salaries
Risk of reimbursement changes
This analysis is important in determining the practice’s future cash flows and the risk of achieving and sustaining those cash flows.
Benchmarking your practice
It is useful for the owner-physician to understand how his practice compares to other practices in the same specialty. This information can be obtained from sources such as Medical Group Management Associates (MGMA) and specific medical specialty societies. Health care consultants review certain financial indicators and ratios when evaluating the financial condition of a Practice.
The ratios and financial indicators are then compared to industry statistics comprised of the same medical practice specialty to assess profitability, efficiency, liquidity, leverage and other operating risks.
Other consideration
What is total overhead expense as a percentage of collected revenue? Is this in line with industry statistics? If overhead is too high, what costs can be reduced to increase profitability?
If your overhead is too low, just be sure that the practice is efficient. Does the practice need to make investments in medical equipment, computers or more staff?
Is the practice current in its use of technology, such as electronic medical records, e-prescribing and electronic billing and collections?
Is the practice location desirable? Is it in an underserved or over-servedover-served area? Many young doctors are more interested in living in over-served areas versus underserved, and they may be willing to pay more to be in a more desirable location.
How does your physician compensation compare with other physicians in the same specialty, in the same geographic location?
Personal considerations
In addition to considerations about the practice itself, you need to take into account some personal preferences before selling your practice:
How long are you willing to work in the practice to assist with introductions to the new physician?
If a physician buyer desires to purchase your practice, are you willing to accept payment over several years if the physician needs the time?
What are your true objectives in selling the practice: to leave quickly, to leave at the point required to get the maximum selling price for the practice; to stay and work as an employee; to staying for a short period (a few weeks) and then leave?
Are you willing to send out an announcement to your patients to introduce the new physician?
Potential physician buyers
Physicians in the community, multi-specialty groups, hospitals and newly-trained physicians are all potential buyers. It is beneficial for you to prepare information regarding the practice, in the form of a brochure, schedules with financial highlights or a summary appraisal by a certified business appraiser.
Other sources include medical practice brokers and magazines that spotlight practices for sale. Word of mouth, contacting residency and fellowship program directors in your area are important ways to spread word of a practice for sale.
Advantage of having electronic medical records
At present, electronic medical records (EMR) are a value driver to be current in technology. With the Medicare stimulus package providing payment for EMR implementation, for many physicians it makes sense to incur the cost to implement EMRs (and show meaningful use in order to receive government reimbursement).
Young physician-buyers look most favorably upon a practice that has EMRs, as these younger physicians have grown up in the era of technology and anticipate using EMRs.
Patient base, payor mix and location
The physician-buyer will want to know your patient and payor mix. A natural question is what percentage is each payor in the practice (Medicare, Medicaid, commercial payors and self pay).
If your practice has a diverse payor mix, there is little reimbursement risk to a particular payor. If Medicare reimbursement is reduced by a significant percentage, which is a perpetual yearly threat from the Centers for Medicare and Medicaid Services, then this is a potential risk factor to a physician-buyer.
Location is important to the extent that patients prefer to go to a physician located in a pleasant area. However, your location doesn’t necessarily translate to a higher value for your practice.
This article is intended to provide guidance to physicians hoping to sell their practice. It is important for these physicians to consider what they want from the sale (price, lifestyle, etc.). Most practices are saleable in some form or another. An established practice with a track record of profitability and strong patient base will be saleable to a buyer.
Due diligence and effort made by the selling physician can lead to a successful sale of a practice. Gear up and be excited because the practice you have worked hard to develop can be sold allowing you to move on to something different.
Monica Kaden, MBA, ASA, is an accredited senior appraiser (ASA) with the American Society of Appraisers. She specializes in valuations of medical practices and small- to medium-sized businesses, typically for matrimonial and shareholder litigation cases, estate and gift tax valuations, selling and buying business interests and mergers and acquisitions. She is a principal of the Fischer Barr & Wissinger, LLC accounting firm.