Selling Your Practice? You Need to Understand Valuation | The Doctor Weighs In
Practice valuation can make or break a business sale because for many physicians, attaching a dollar value to their practice is a touchy subject.
Practice valuation nomenclature has changed over the years. Practice values used to be referred to as a percentage of collections. But today’s most common reference point is a multiple of earnings before interest, taxes, depreciation, and amortization ( EBITDA).
Traditionally, a solo practitioner thought of earnings as the total remuneration from the business in a given year. The reality, however, was that a portion of those earnings was compensation for the physician providing clinical care and a portion represented profit generated from the business.
Historically, valuations were largely considered the total earnings of the owner. Whereas investors focus on the profits of the business as a basis for valuation. Further, investors consider the actual cash flow of the practice on a debt-free basis as the best predictor of their return on investment. This has led to the focus on EBITDA as a measure of a practice’s performance. Further, this is how most other businesses are valued.
What is the right multiple?
There is no easy answer to that question because the multiple is meant to assess the following:
- the opportunity of the investment
- its relative riskiness
- whether it provides a reasonable rate of return for investors
There are many factors that influence multiples, including location, trained staff, stable or growing revenue stream, payor mix, condition of the facility, mix of services, patient demographics, and profitability.
-Valuing group practices
For group practices, having a pipeline for future growth is important. However, the most significant influence on the multiple is historical growth.
It is also important to recognize that higher multiples are applied to those businesses that have a qualified management team in place. This management supports continued growth and ensures replicable earnings. Documented policies and procedures to scale the business also contribute to the higher multiples.
Business owners often focus exclusively on the multiple. They don’t recognize that equally as important as the multiple is the number the multiple is being applied to — the EBITDA.
-Valuing a solo practitioner’s office
The traditional valuation of a solo practitioner’s office is based on the historical performance of the business as a predictor of future performance. The typical adjustments applied to the historical financials are to:
- Bring owner compensation to fair market value
- Account for nonrecurring and discretionary expenses.
In contrast, the valuation of a group practice is typically done on a prospective basis. This involves forecasting the performance of the business. It includes making adjustments for owner compensation, nonrecurring expenses, and discretionary expenses.
The purpose of forecasting for group practices is to help a prospective investor see the true investment opportunity which may not be reflected in the historical financial performance.
For example, if a group acquired a practice partway through a given year, the historical financials only reflect that partial additional impact on revenue and EBITDA. The EBITDA adjustment in this example is to show the prospective investor the impact of the acquisition for a full year.
Understanding different buyers
The other nuance in today’s marketplace is the different perspective on earnings from different types of buyers. A private equity firm is generally looking to make an investment in a business or partner with the founder of the business.
They, therefore, will want to keep as many members of the management teams in place as possible to operate the business and drive performance. However, they may make a downward EBITDA adjustment if they feel additional management team members are needed to continue to grow and support the business.
Conversely, strategic buyers (those who have existing group practices and experience in the industry) may make upward EBITDA adjustments for synergies including:
- duplicative management team members or third-party vendors
- more favorable lab and supply contracts
- more favorable payor contracts
Generally speaking, a private equity firm will likely pay a higher multiple but on a lower EBITDA, whereas a strategic buyer will likely pay a lower multiple on a higher EBITDA.
Fair Market Value
If you are considering selling your practice, make sure you understand terms and appraisal definitions.
For starters, value isn’t an absolute number. A medical practice’s tangible and intangible assets can be grouped into two broad categories:
- physical assets
- non-physical assets
Oftentimes a physician will ask their accountant to appraise the business. But the physician may be surprised to find that the “book value” given by the accountant is far different than the “ Fair Market Value (FMV)” that he could actually receive at the time of sale.
It is not that the accountant is incorrect at all. Rather, the accountant and the physician may be operating under a different set of terms and definitions, without knowledge of each other’s perspectives.
Realizing that there is no absolute sales price is the essence of FMV. When determining valuation, look for a price range with a reasonable floor and ceiling.
Practice appraisers use FMV as the standard to derive a reasonable value for a practice. FMV means an arm’s length transaction between an unpressured, informed buyer and an unpressured, informed seller.
Other types of valuations to be aware of include:
The BEV of a practice equals a combination of all assets (tangible and intangible) and the working capital, of a continuing business.
The value of “owner’s equity” equals the combined values of all practice assets (tangible and intangible) less all practice liabilities (booked and contingent).
WCV equals the excess of current assets (cash, A/R, supplies, inventory, prepaid expenses, etc.) over current liabilities (accounts payable, accrued liabilities, etc.).
Other Article by this Author:
The Importance of Succession Planning for Your Medical Practice
What Are the Best Growth Options for Your Practice?
Practice valuation can make or break a business sale
Valuation can make or break a business sale because for many physicians, attaching a dollar value to their practice is a touchy subject. This is especially true if they have spent years building it from a fledgling start-up practice to a profitable business entity.
If you are considering a transition, aside from the valuation of your business, it is critical to understand the other terms necessary to close a transaction. In many cases, there are legal provisions that can have significant economic consequences and therefore should be considered when looking at the “value” of the business.
Left unchecked, the valuation process can quickly devolve into a pricing routine that is rooted in personal attachments and other subjective inputs rather than solid data based on marketplace realities.
Using an experienced consultant will ensure that you negotiate the best price and transaction terms for your given situation.
Nick Hernandez, MBA, FACHE, is the CEO and Founder of ABISA, a consultancy specializing in solo and small group practice management. He has consulted with clients in multiple countries and has over 20 years of leadership and operations experience. His emphasis has been on developing and maintaining a strong relationship with physicians and identifying areas for business opportunity and support. He holds MBA degrees in both Operations Management and Information Technology & E-Business Management from Wake Forest University. He is also Board Certified in Healthcare Management and has been named a Fellow of the American College of Healthcare Executives.
Originally published at https://thedoctorweighsin.com on May 24, 2019.