How much is your practice worth? Often, it depends on who wants to know and why.
Practice valuation professionals — often CPAs with specialized training — follow different tacks depending on whether a practice will be sold to another physician, valued for a divorce proceeding, or if practice partners just want to go their separate ways.
The traditional building blocks of practice value are:
- Hard assets — equipment, facilities, supplies, patient records (the cost of the files themselves, not the information in them), etc.;
- Cash — what’s left after expenses, including physician compensation;
- Accounts receivables — money due for professional services; and
- Goodwill — anything paid above the value of hard assets, cash, and A/R.
Appraisal professionals can follow several pathways to put a value on these four items. The market value approach — what other practices in the area sold for recently — is dandy for houses. But it can be an exercise in uncertainty to compare medical practices in different parts of the country.
Another approach is to try and project future cashflow, the component most important to business investors. While it works well for many types of businesses, cashflow valuation is of little help to the typical medical practice owner. Most have little cash left after paying for overhead expenses and physician compensation, explains Jim Sacher, a CPA with the accounting and consulting firm Skoda Minotti.
“Partners tend to take whatever’s left after expenses as their compensation,” he says. “If physician compensation is set at a fair market level for the same area but there’s never any cash left at the end of the year, then what’s it worth to an investor?”
Sacher explains that unless a physician earns substantially more than the fair market rate for his or her specialty and the area, that money is physician compensation, not profit. That’s why figuring in goodwill — the ability to make profits — historically was a major component in determining practice value.
Reed Tinsley, a Houston-based CPA, says goodwill isn’t that useful anymore as an indicator of what a practice will sell for. It’s losing ground because hospitals are moving back into practice-purchasing mode. They are setting the standard.
“Goodwill is tied to the performance of the practice,” Tinsley says. “The hospitals are now saying, ‘Why should I pay for that performance upfront when I can get you on the payroll for a small amount, see how your practice goes and pay you through compensation with performance incentives?’”
There’s another reason that hospitals won’t offer any goodwill for your practice: the Feds. Thanks to the Stark and anti-kickback laws, this intangible form of measuring the new owner’s profit opportunity just sounds too much like paying for future referrals. And that’s strictly forbidden.
Unfortunately, the practice values that physicians assumed would still apply when they were ready to sell were built on the concept of goodwill. Without it, the value of a medical practice is primarily found in its tangible assets: equipment, supplies, facilities, furnishings, etc. And those values depreciate during the valuation process, often by using a 10-year scale that leaves just a fraction of the original value after a decade of use.
Wait, you may be saying, ‘I have lots of patient records and very nice accounts receivable (A/R) to pass on to the new owners.’ Sorry. You’ll probably need to collect that A/R yourself — most buyers aren’t interested in handling your collections. Besides, you may need it for payables, like existing leases, if the purchaser doesn’t want them either.
As for medical records, don’t expect a windfall. Sacher says the Internal Revenue Service’s guidelines for setting medical record values between $12 and $22 is fairly accurate and widely followed. That’s about what it would cost in staff time and materials to rebuild the paper file. So, a family physician with 3,000 active (no more than three years old) patient records might hope to get $66,000 from a very generous buyer. Other specialists may be able to get credit for records as old as five years. All the same, buyers know that in most communities patients can choose other physicians and that insurance plan changes may steer them to find other providers anyway. Besides, in a legal sense you don’t really “own” your patients’ medical records, they do.
With goodwill off the table and cashflow equations usually of little help in establishing value, physicians must carefully scrutinize any valuations made of their practices. As they do, it helps to seek expert advice to be sure that every credible shred of value is accounted for.