How to Value a Medical Practice

Doctors buy and sell more than 2,000 medical practices a year. Whether you're a buyer or a seller, setting a value on the practice is a necessary step. The buyer and seller may have a gut feeling, but if they can't back it up with metrics, the deal they strike may be a bad one.

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There are several ways to value a medical practice: the value of the assets, the value of owning rather than working for the practice and the value of similar practices that have recently sold. What's essential is that the buyer and seller can show that the price reflects the practice's fair market value.

For a new doctor or one relocating to a new area, buying a practice or becoming a partner makes good sense. Rather than starting from scratch, you enter an established operation with a roster of patients and hopefully a good reputation in the community. If you have a prospective purchase in your sights, do a basic assessment to see if it's worth a full evaluation.

• Is the medical practice in a growing area?
  
  
• How stiff is the competition?
  
  
• Do the hospitals in the area own a lot of practices? If they do, they'll probably refer patients to those doctors and not you.
  
  
• Are you ready to run your own business? If not, do you have advisers who can show you the ropes? Would buying into a partnership where you're not flying solo be a better alternative?
  
  
• Do you feel the practice has enough staff to meet demand? Will they stay on if the practice changes hands? Is everyone working there comfortable with your vision for the business?
  
  
• Look at the practice's financial history. Are the books in order? Are there any major expenses? If the doctor already has a value in mind, ask how he derived it.
  

If you don't think the practice is right for you, you can skip the number crunching of medical practice valuation multiples and other methods for setting a price. Move on and look for a better purchase.

For the doctor who is ready to sell, it's a good idea to think in advance about what will make the practice look desirable.

• If you're flying solo as the only doctor in your practice, the practice's biggest asset once you go is your patient roster. This attracts mostly institutional buyers or new doctors starting out, and the sale price is typically the book value of your assets.
  
  
• If you can build your practice into a business — one that can function even without you — then it's much more attractive. Even if you bring in the same amount of profit, it will command a better price than a one-person shop. If you can show buyers you have a track record of growth, that's even better.
  
  
• Go over your finances. When buyers come calling, you'll want to have the numbers at hand to show that your practice is worth investment.
  
  
• Know your next step. If you're looking to take on a partner or stay involved in the business in some other fashion, your goals are different than if you're looking to retire.
  
  
• Have a backup plan. If you do stay on and the new owner or partner doesn't work out, what's your fallback plan?
  
  
• Do you have good reviews online? If not, work to get them. Reputation counts for a lot.
  

The better you are prepared, the better negotiations will go when selling your practice.

Both buyer and seller need to be clear about what's up for sale before they set a value on it.

• Selling stock, if the practice is incorporated, and selling membership interest, if it's a professional LLC, has the same effect: The new owner buys the business with all its liabilities and assets.
  
  
• Selling the assets: The owner might decide to downsize to a smaller practice of some sort, so she sells off most of her equipment, office buildings and goodwill. Buyers can pick up the assets for less than the cost of the practice, but for that reason, it's usually a poorer deal for sellers.
  
  
• The seller is offering to merge into the buyer's larger medical company: The selling company ceases to exist, becoming part of the buyer's operation.
  

Pricing a practice would be simple if there were a medical practice valuation calculator: Just plug in some metrics, press the button and presto — you get a price. However, there is no medical practice valuation calculator nor even one standard method for making a valuation. Instead, there are several methods from which to choose.

Using medical practice valuation multiples or multipliers is one simple method. Take the practice's annual revenues and multiply them by 1.5 or 2 to set a value. This is sometimes described as the medical practice valuation rule of thumb because it's a quick judgment.

It's not necessarily the best judgment, though. In the modern medical economy, most practices sell for less than their annual revenues. The rule of thumb may not apply.

One alternative to using medical practice valuation multiples is the one often used for selling homes. Look for comparable recent sales of medical practices and use those prices as the basis for the fair market value. For example, if a practice of similar size sold for $300,000 but your practice has equipment that is easily worth $100,000 more, you can justify a $400,000 price.

Unlike houses, it's not as easy to find sources for comparable medical practice sales. There are, however, databases for which you can pay, such as the Goodwill Registry for medical practice sales. This provides extensive information on sales, valuations and goodwill pricing.

Another alternative to medical practice valuation multiples is for the buyer to ask the value of owning the practice rather than just working there as a doctor. For example, if the seller offers the buyer a chance to become a partner or a stockholder in a privately held corporation, how much is that worth?

• Determine how much a partner or stockholder makes from his investment.
  
  
• Compare that to the salary of nonowner physicians who are employed there. If all the physicians are partners, look at average figures for employee doctors in the same field.
  
  
• Multiply the difference by the projected earnings.

For a sample medical practice valuation report, assume the doctors working at the practice for sale make $150,000 each. The two partners take home $200,000 each. The total ownership interest for someone buying out both partners is $100,000. Multiplied by the next four years, you'd have $400,000.

Another way to derive a valuation is to price the practice based on the assets.

• Tangible assets are everything physical the practice owns and intends to sell, such as computers, office furniture, X-ray machines, drugs on hand, office supplies, medical reference books and the building itself.
  
  
• Cash in the practice's bank accounts
  
  
• Goodwill is an intangible asset that reflects the expectation that patients will still use the practice after it changes hands.
  
  
• Noncompete agreements, managed care and other contracts and employees who are willing to stay on with you

Goodwill consists of several elements that vary from practice to practice. It includes the reputation of the practice, but it may also reflect things such as the location. It's also described as whatever you pay for the practice over and above the value of the assets. Some experts argue that since the practice's reputation derives from the doctor's standing, changing ownership can't transfer that part of goodwill.

Buying a medical practice isn't like buying a bookstore or a bakery. The federal government has a number of rules that, for example, reject future referrals from the former owner as a factor in price setting. To ensure there aren't any kickbacks like that, the buyer and seller have to justify the deal based on fair market value.

Given all the factors in play, however, it's quite possible that instead of one definitive fair market value, the number crunching will produce a range of values. Goodwill is key here. The buyer and seller will have to justify the price they set on goodwill, but they have a lot of flexibility in setting it.

As long as the selling price is within a range of fair market values and the buyer and seller can prove the value is justifiable, it should stand up to scrutiny from regulators.

When a hospital buys a practice, the purchase may be purely a number-crunching exercise. When individual doctors invest in a new practice, other factors come into play besides money.

• Some doctors want to be near family. Others want to be where they can mountain bike or surf or where the winters are warm enough that they'll never shovel snow again. Buyers who want to live in a particular location are more willing to pay a high price than someone who doesn't care about location.
  
  
• Both parties should be ready to negotiate. Even if they're eager to make a deal, they should try to make the best deal possible.
  
  
• The fewer surprises, the better. Buyers should be looking at expenses such as medical malpractice early in the game to see if that changes things and not treating those costs as an afterthought.
  
  
• If the seller wants to stay on at the practice, how much independence does she want? If it's a partnership, is everyone on the same page about the new partner's role and responsibilities?
  
  
• Review the paperwork. The seller probably needs to make several years of records available, such as tax returns, accounts receivable and bank deposits. The buyer needs to go over them thoroughly. This will take time, so start early.
  
  
• It's also important to take time to handle the financing. Ideally, the buyer should make time to get several competing offers and compare them.
  
  
• How big of a practice does the buyer want? More patients means more money, but it can also mean more paperwork and a bigger management structure. Buyers should have a clear idea about the size of the practice they want to own.
  
  
• What are the payment terms?
  

Once a prospective buyer expresses serious interest, a good first step is to sign a nondisclosure agreement about the details of the negotiation. If things go well, step two is a letter of intent spelling out the deal and setting a timeline to either close or give up. At this point, neither party should be negotiating with other buyers or sellers.

Next comes the detailed review of the seller's financials. If the seller is planning to still be part of the practice, he may want similar information from the buyer. If everything looks good, the parties move on to serious negotiation. Then comes the time to draw up the documents that formalize the deal.