Determining Your Practice's Worth Will Be a Key to Financial Survival

The Doctor's Office , June 4, 2009

Amid financial uncertainty, you may be trying to sell your physician practice, attract investors, or consider a merger. Do you know what the practice is worth? This will be important to find out, as valuations are becoming increasingly warranted for numerous reasons, such as facilitating hospital acquisitions; determining merger and acquisition and buy-in and/or buy-out equity; and complying to regulations relating to Stark laws, anti-kickback statutes, and IRS regulations.

Valuations provide objective and independent opinions on your practice's value, which is "driven by future earnings and the risks associated with those earnings," says Martin D. Brown, shareholder at Atlanta-based Pershing Yoakley & Associates, PC.

There are three main approaches you can take to determine your practice's fair market value (defined as the amount at which property would change hands between a willing seller and a willing buyer when neither is under compulsion and both have reasonable knowledge of the relevant facts), Brown says. These approaches are asset-based, market-based, and income-based.

The asset-based approach looks at the value of your hard, or tangible, assets as well as your intangible assets. Examples of tangible assets include medical equipment and furniture, whereas intangibles include accounts receivable and goodwill. This has become the most commonly used approach in the ailing global economy, Brown says. It is used when a practice sees historic losses, nominal cash flow, or minimal ancillary revenue, or when there's a breakup—also referred to as a "divorce"—of the practice.

The market-based valuation approach compares the practice to other similarly sized practices. It involves gathering information and valuation multiples—the method used to determine the current value of the practice, done by examining and comparing the financial ratios of relevant peer groups—based on recent sales of comparable businesses. It's also crucial to look at lease rates and adjust your practice's rate to the current fair market value.

However, practice administrators should know that the information is typically confidential, which can make it difficult to obtain and use any specific examples as a benchmark.

The income-based approach takes into account the discount and capitalization rates, both measured in percentages.

To find the discount rate, look at the interest rate used in determining your practice's current value of future cash flows. The capitalization rate, determined by subtracting the estimated long-term growth rate of the practice from the discount rate, should be used when calculating "the present value of estimated future earnings into perpetuity," says Brown.

The percentage rates for discount and capitalization typically are 18%–25% for a physician practice, 15%–19% for hospitals, and 16%–22% for ambulatory surgery centers.

The income-based approach is ideal for a practice that has been profitable and for which the future cash flow can be reasonably determined, Brown says. For example, if a practice projects that its net revenue will grow at a rate of 2% per year, this is the long-term sustainable growth rate.

It's important to first look at secure investments when determining your practice's value, then examine those considered riskier, which can include long-term investments. Look at healthcare industry–specific investments in particular, Brown says.

Also take into account valuations that are practice- and specialty-specific. When the practice and its perceived value is dependent on providers' individual skills and not necessarily the practice's location, the discount rate is increased, namely when considering a merger or outright sale. But in some circumstances, the practice could be more difficult to sell, Brown says, depending on issues such as its geographic location or the current payer mix the new owners would inherit (e.g., if the practice is paid in part through Medicaid reimbursements and subsidies).

When it comes to joint ventures (multiple-physician practices), having a controlling interest in the practice (more than 50% or a large enough percentage to block management decisions) increases its worth for the seller or buyer, whereas holding a minority interest brings the practice's value down, Brown notes, adding that healthcare valuations are often focused on minority interests.

This article was adapted from one that originally ran in the June 2009 issue of The Doctor's Office, a HealthLeaders Media publication.

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