Are you considering selling your practice - or merging it with another? Thinking of buying?

If you are, you're hardly alone. Despite the decline of the big physician practice management companies of the 1990s, the merger-and-acquisition market remains robust for small, private practices, as they respond to the continuing financial squeeze being placed on them.

But if you're going to buy or sell, make sure you understand the value of the practice. What you don't know about the worth of the practice could really cost you.

That's a lesson George Farmer, a primary care physician in Florida, learned the hard way. He asked his accountant to appraise his business, and when he was ready to sell, his attorney brother-in-law drew up the sales contract for him. Farmer was pleased it quickly sold for its full asking price.

What he didn't know, but would soon discover, to his horror, is that accounting value or "book" value - the figure his accountant gave him - is far different than the fair-market value that he could have received for his long years of toil.

Was the CPA wrong? Not really. Was the doctor incorrect? No. Both were merely operating under a different set of terms and definitions, without knowledge of each other's perspectives. Whether you're valuing a practice for sale or considering becoming an owner, it is critical that you understand how medical practices are valued.

Here's a primer.

For sellers

For starters, you should know the difference between tangible and intangible assets. These can be grouped into two broad categories: physical and nonphysical. The former includes real estate and leaseholds, medical equipment and furnishings, and accounts receivable. The latter includes goodwill, restrictive covenants, and your staff.

With that in mind, sellers should take these steps before the appraisal process even begins:

• Choose an appraiser who understands the managed healthcare industry. Beware of those with undefined "years" of experience. Appropriate professionals may include those from the American Society of Appraisers, Institute of Business Appraisers, National CPA Healthcare Advisors Association, Institute of Medical Business Advisors, International Business Brokers Association, and the American College of Healthcare Executives.
• Gather all of your consolidated financial statements for each of the past three to five years (practice balance sheet, statement of cash flow, net income statement, and statement of operations).
• Eliminate one-time, nonrecurring expenses, adjusted for excessive or below-normal expenses.
• Consider the depreciation of your tangible assets, especially if practicing your specialty involves a good deal of expensive instruments or equipment.

You'll need to understand the basic assumptions used in financial projections: inflation factors, capitalization rates, discount rates, specialty growth or decline rates, time-value of money principles, reimbursement rates, etc. You need not become an expert on these principles - that's what your appraiser is for - but you should have a working knowledge of them.

For buyers

There are certain mistakes I see buyers make repeatedly when they purchase a practice, especially for the first time. Here are the most common:

• Believing the seller's representations. Always be skeptical and verify data.
• Using up all available cash to make a purchase without keeping a reserve for potential contingencies. Don't stretch yourself so thin that you're practically bankrupt on your first day in business.
• A desire to change practice culture too quickly. Assuming you intend to continue treating your predecessor's patients, be careful about making too many changes at once. Your patients are new to you, but many have been coming to your office for years. Changing doctors can be traumatic enough; they may not be ready for more.
• Failing to realize that managed-care contracts can be lost when a new owner comes in, or may not be transferable.
• Failing to visit the practice on-site.
• Failing to understand that an assembled and available workforce has real value.
• Getting trapped by the paralysis of analysis. Money cannot be made by continually checking out a medical practice, only by actually running one. If you are of this ilk, realize that practice ownership may not be right for you. Therefore, purchase the practice after a reasonable due diligence period, move on to the next evaluation, or become an employed doctor.

Creative terms

Sometimes buyers and sellers can negotiate creative terms that may affect the price. For example:

• A letter from the selling doctor to all the patients of record, introducing the new physician. This can be much more valuable than the new doctor attempting to introduce herself.
• The seller providing some type of formal confirmation that the practice is not involved in any type of litigation.
• Death and disability insurance if there is any seller financing involved.
• A letter of intent with good-faith deposit placed into an escrow account until contractual matters are completed and the sale is brought to a close.

Important definitions

The value of anything is a relative concept, and to some extent a matter of perspective.

Sellers, just because you and your appraiser can demonstrate a particular value for your practice with hard calculations doesn't guarantee you'll find someone to pay you that much.