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Healthcare Finance
Back to the Basics in Practice Valutation
The information is endless regarding practice valuation. You can read about it, go to seminars, and access various websites that will give you amounts for which practices have sold. As in everything today, the amount of information available is endless (not almost endless). One needs to be able to “sift” through this information and separate out what is useful.
In casual conversation you hear the value of professional practices based on a percent of volume. Some want to use this information as the “standard” by which their own practice should be valued. The most typical situation is the established practitioner that wants to bring in a younger associate. In having represented both sides of this type of transaction it is clear that the sellers usually want too much and the buyers do not understand the term “goodwill.”
The process of evaluating a professional practice usually starts with computing the value of the tangible assets (accounts receivable, equipment, etc.) and then subtracting any related liabilities. The next step is the computation of the intangible value (goodwill). Stating the “goodwill” value as a percent of gross volume will continue to be the norm. However, it should only be expressed this way after there is an assessment of the “excess earnings” of the practice. The intangible value (goodwill) equals the present value of the future stream of excess earnings. Do practices really have “excess earnings”? The term is a little misleading for those people not involved in business valuation. In looking at a private medical practice with the physician’s earnings at a level equivalent to that of an “employed” physician you would conclude that there are no “excess earnings.” Conversely, a practice with physician income above the level for an employed physician would have excess earnings equivalent to the difference between the actual compensation and the salary level of an employed physician. Once the future “excess earnings” are determined they need to be discounted back to the valuation date using an interest rate that has factored into it the potential risk of the future income stream. In other words, if a practice were facing declining reimbursement levels you would use a higher discount rate then if the reimbursement rates were remaining constant or going up. The more risk (for what ever reason) the higher the interest factor.
Once the total value is determined of both the tangible and intangible assets one needs to multiply by the percentage of the practice being sold. This amount is then reduced by discount factors (marketability and minority discounts) are the most common. For example, assume a sole practitioner has a practice value of $600,000 and that he or she was looking to sell a 25% interest to a prospective Physician. The value of the 25% interest would be something less then $150,000 (perhaps 30% to 40% less). The reason being, the new doctor, does not have control of the decision making process of the practice. The decision making process of the practice has a direct influence on the profitability as well as issues relating to selling or merging the practice.
The most important thing to realize with practice valuation is that each practice is different in many ways. Therefore, using published guidelines, although it is “quick and dirty,” will usually not result in an accurate value. You can determine an accurate value only after one assesses a multitude of different factors relating to the practice.
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