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What you don't know about the value of your practice could hurt you, says physician-turned-financial-advisor David Marckino. Here's a valuation primer for both buyer and seller.
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 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:
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.
There are certain mistakes I see buyers make repeatedly when they purchase a practice, especially for the first time. Here are the most common:
Sometimes buyers and sellers can negotiate creative terms that may affect the price. For example:
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.
Buyers, don't assume you'll pay what you consider fair-market value for a practice. You may pay more or less, depending on the circumstances. For these reasons you need to understand the different kinds of prices and values that could be attached to any practice:
As Dr. Farmer realized the hard way, medical practice valuation is much like practicing medicine itself - a combination of art and science. Certainly, this article alone doesn't tell you everything you'd need to know to conduct your own appraisal.
But it should be clear now that what you are really looking for in the appraisal process is a price range, with a reasonable floor and ceiling, not a single magic number. After all, once the due diligence has been performed and all the numbers have been crunched, the next step in the sale process is just good old-fashioned negotiation. A good rule of thumb is to pursue fundamentals over fads, seek wise counsel when required, and always remember: caveat emptor.
This article originally appeared in the July/August 2005 issue of Physicians Practice.