At least once during your career, you probably will have to put a value on your practice. The need arises more often than you might think – if you sell it, of course (more on that next month); but also for estate planning, preparation of financial statements, or divorce negotiations; or when an associate joins or leaves your office; or if you have occasion to combine or partner your practice with one or more others, as I will discuss in detail in a future issue.
As you might guess, a medical practice is trickier to value than an ordinary business, and usually requires the services of an experienced professional appraiser. Entire books have been written about the process, so I can’t hope to cover it completely in a few hundred words, but three basic yardsticks are essential for a practice appraisal:
Tangible assets: equipment, cash, accounts receivable, and other property owned by the practice.
Liabilities: accounts payable, outstanding loans, and anything else owed to others.
Intangible assets: sometimes called “good will” – the reputation of the physicians, the location and name recognition of the practice, the loyalty and volume of patients, and other, well, intangibles.
Armed with those numbers, an appraiser can then determine the “equity,” or book value, of the practice.
Valuing tangible assets is comparatively straightforward, but there are several ways to do it, and when reviewing a practice appraisal you should ask which of them was used. Depreciated value is the book value of equipment and supplies as determined by their purchase price, less the amount their value has decreased since purchase. Remaining useful life value estimates how long the equipment can be expected to last. Market (or replacement) value is the amount it would cost on the open market to replace all equipment and supplies.
Intangible assets are more difficult to value. Many components are analyzed, including location, interior and exterior decor, accessibility to patients, age and functional status of equipment, systems in place to promote efficiency, reasons patients come back (if they do), and the overall reputation of the practice in the community. Other important factors include the “payer mix” (what percentage pays cash, how many third-party contracts are in place and how well they pay, etc.), the extent and strength of the referral base, and the presence of clinical studies or other supplemental income streams.
It is also important to determine to what extent intangible assets are transferrable. For example, unique skills with a laser, neurotoxins, or filler substances (or extraordinary personal charisma) may increase your practice’s value to you, but they are worthless to the next owner, and he or she will be unwilling to pay for them unless your services become part of the deal.
Once again, there are many ways to estimate intangible asset value, and once again you should ask which were used. Cash flow analysis works on the assumption that cash flow is a measure of intangible value. Capitalization of earnings puts a value, or capitalization, on the practice’s income streams using a variety of assumptions. Guideline comparison uses various databases to compare your practice with other, similar ones that have changed hands in the past.
Two newer techniques, which some consider to provide a better estimate of intangible assets, are the replacement method, which estimates the costs of starting the practice over again in the current market; and the excess earnings method, which measures how far above average your practice’s earnings are (and thus its overall value).
Asset-based valuation is the most popular, but by no means the only, method available. Income-based valuation looks at the source and strength of a practice’s income stream as a creator of value, as well as whether or not the income stream under a different owner would mirror its present one. This in turn becomes the basis for an understanding of the fair market value of both tangible and intangible assets. Market valuation combines the asset-based and income-based approaches, along with an analysis of sales and mergers of comparable practices in the community, to determine the value of a practice in its local market.
Whatever methods are used, it is important that the appraisal be done by an experienced financial consultant, that all techniques used in the valuation be divulged and explained, and that documentation is supplied to support the conclusions reached. This is especially important if the appraisal will be relied upon in the sale or merger of the practice. I’ll talk about sales and mergers over the next several columns.