Valuation Tips for Physicians

Welcome to our web page designed specifically for the needs of physicians with respect to valuation. The text below includes links to other pages on our website where you will find detailed discussion of many of the issues mentioned briefly here.

At a variety of points during their careers, physicians are concerned about the value of their own or another physician’s practice. The first encounter with this issue is typically when a physician is offered an opportunity to buy into a practice with which he or she has been an associate.

Buying Into a Practice

The most basic issue, of course, is the purchase price. How that purchase price is calculated is of critical importance, as is whether the purchase price includes "goodwill" and if so, on what basis. Any special conditions imposed by the seller are equally significant. The impact of the buy-in payments on the buyer’s take home compensation and the period of time over which it must be paid are the remaining issues we will address.

Computation of the purchase price

If the seller has retained a valuation consultant, some form of report should have been prepared which should be made available to the buyer. Reports come in many formats. Formal valuations can be costly and in some cases not necessary for the purposes of the buy-in. A good compromise is a written report, which summarizes the salient features of the practice, describes the valuation methodology employed and the valuation conclusion. The report should include the quantitative exhibits so that the buyer’s representative can review the computations and provide advice.

In some cases, no valuation will be performed and the seller will develop a purchase price based upon prior experiences, conversations with colleagues, articles in trade magazines, or perhaps based upon nothing more than a particular need for cash. In other cases, the valuation "expert" will be nothing of the sort and the purchase price will be based upon anecdote, misimpressions, or the desires of the seller. Be particularly cautious of "reports" which consist simply of a valuation conclusion without documentation of the reasons therefore.

Although Rules of Thumb are not a substitute for a proper valuation, they are useful for providing a frame of reference as to what a practice may be worth. http://www.cpa.net/articles/thumb1.html

Inclusion of "goodwill"

Physicians often resent paying for goodwill, as they perceive it to be a personal asset. Certainly, personal goodwill does exist, and it is less common to pay for it. However, there is a separate class of business or practice goodwill that is distinct from personal goodwill and which represents a valuable asset of the seller, and a valuable asset to the buyer. This asset is described in detail at http://www.cpa.net/articles/Enterprise.html. You may also wish to read http://www.cpa.net/articles/separate.html

Whether or not a buyer has to pay for personal goodwill is directly tied to the presence or lack of a covenant not to compete, or noncompetition agreement. These agreements restrict the right of the physician to practice after leaving employment. At the time a physician becomes employed by a practice, he or she may sign such an agreement. If such agreement exists and it is enforceable under the laws of the state in which it was signed, the effect may be to assign personal goodwill to the employing practice. This is due to the fact that the physician cannot open a competing practice and take advantage of the patient relationships that have been developed. http://www.cpa.net/articles/covenants.html

The goal of buying into a practice is generally an expectation of an increased income as well as "permanent" employment and equal status in the practice. The longer the buy-in period, the longer the time before the increased income is realized. The key to a proper valuation is that the purchase price must be payable in pre-tax dollars over a period of three to five years. The length of the buy-in period is often a feature of the local marketplace and is also driven by the years of associate status before the buy-in commences. The total period of associate status and buy-in should not exceed seven years and is usually closer to five.

This is one of the most critical aspects of the buy-in negotiation, and one that we find is often not properly evaluated. For that reason, we have dedicated an entire article to it. http://www.cpa.net/articles/buyout.html

Many transactions involving small medical practices are cluttered with so-called Senior Doctor Rights or SDRs. Typically, the selling physician attempts to sell a ratable share (say 50%) of the value of a 100% interest while retaining that same 50% or even 60% of the value via the SDRs! To illustrate, assume that the entire practice is worth $300,000 on a 100% control basis, and the buyer is to purchase 50%. The price is $150,000, right? What if the seller retains the right to the office location, all patient charts and the phone number if the deal doesn’t work? Is the buyer’s 50% interest still worth $150,000? What if the seller has a veto over all practice decisions that cannot be agreed on? Is the buyer’s 50% interest still worth $150,000? SDRs represent a substantial diminution in the value actually acquired by the buyer.

1. If the buyer engages in a competing practice, the income shift payments are forfeited.
2. If the buyer engages in another practice outside the service area, a portion of the payments may be forfeited, or they may all be returned.
3. If the buyer chooses to terminate, a portion or all of the payments may be forfeited.

Managing Partner

As part of a buy-in, the senior doctor in a two-person practice is ‘granted’ managing partner status in the practice for a period of 10 years at an annual salary of $40,000. The true value of these services, assuming they are performed and performed competently, is $12,000. The difference of $28,000 can be discounted to a present value for the 10-year period of time.

Call Schedule Preference

A frequent and very contentious SDR is reduced or no call, the term used to describe evening and weekend coverage of the practice. One of the least desirable aspects of practicing medicine is getting called in the middle of the night or on a weekend afternoon. Exclusion from the call schedule has a significant value that should not be overlooked.

Governance

It is much more difficult to quantify an SDR discount for practice governance. Clearly, having veto authority in one individual can impact the ultimate flow of cash, even if the compensation arrangement is specified in employment contracts and is otherwise fair. The veto could be used to block acquisition of a potentially profitable item of equipment, a move to a better and potentially more profitable location, hiring, retaining or firing key, or more often non-key, employees, or generally creating a nuisance.

There are a number of other circumstances in which valuation plays a key role in the physician’s decision making process. The links below lead to discussions on the topic noted.

Negotiating the buy-out of a retiring partner in a two person practice: http://www.cpa.net/articles/buyout.html

Selling your practice to a Practice Management Company: http://www.cpa.net/articles/samesto.html and http://www.cpa.net/articles/ppm.html

Getting out of a "bad deal" with a hospital buyer: http://www.cpa.net/articles/unwind.html

Creating practice value through mergers: http://www.cpa.net/articles/mergval.html

Identifying value in practice improvement opportunities: http://www.cpa.net/articles/mgmt.html