Background
When it comes time to value a practice, many rely solely on their accountant to tell them the value of their practice. While helpful in some ways, this can also be dangerous. Some accountants rely primarily on the tried-and-true ‘book value’ method (assets minus liabilities) along with the shareholder’s total income and practice revenue stream, to determine an end figure. Such an approach can be wrong on many levels. And third party assumptions only add to the confusion – I recently worked with a client that had 8 providers generating well over $4,000,000 in revenue each year and their lawyer said “with all that money coming in, the practice is worth millions”. Guess what? He was wrong.
Gone are the days where hospitals would hand over a blank check to acquire a practice. Today, there may be more integration of physicians with hospitals through models like Accountable Care Organizations, but Stark (and other) regulations limit what can be paid to physicians for their practices. The methods I use here are for evaluating buy-ins, buy-outs or sale to another practitioner, rather than contemplating hospital or venture capitalist purchases.
The trick to a fair shareholder valuation formula is to keep it simple. Think of conveying the calculation to, say, a new physician that is thinking about joining your practice and buying in. If the process takes more than a minute to explain, it is likely that it is more complicated than it needs to be.
Valuation Philosophy
The approach I take to determine practice value is to establish what is the added benefit of owning the practice versus being employed. If a shareholder makes $250,000 for a given year and an employed physician at the same practice makes $180,000, the added benefit for owning the practice is $70,000. Makes sense? Much like the stock market, my approach then projects that value by a multiple of years. While Apple, Chevron and Microsoft stock prices may be based on the expected 10-15 years of earnings, I remain conservative with a multiple of 2 to 3 1/2 years projected earnings when valuing a medical practice. Multiplying that $70,000 by 3 years results in a calculated value of $210,000. Seems pretty straight forward so far, right?
Formula
Not so fast. If the practice has more than one shareholder, and one or more employed physicians, the process to determine the value is still pretty simple:
- Determine the average of the shareholder earnings
- Compare shareholder earnings with the average compensation for the employed physician(s) in your practice.
- If all physicians are shareholders, find regional or national averages for employed physicians for comparison. Then multiply the variance times the number of shareholders to determine the Valuation Basis.
- Multiply the Valuation Basis times the number of years of projected earnings.
However, there may be a variety of adjustments to the formula that may need to be made including:
- Taking average shareholder salary for previous 2 or 3 years.
- Adjusting Average Shareholder Compensation for end of parity payments that expired December 31, 2014 (if averaging over several years).
- Adjusting Average Shareholder Compensation based on whether meaningful use monies have already been received.
- Adjusting Average Shareholder Compensation based on whether the shareholders may have previously taken lower salaries to fund practice projects that are expected to generate additional earnings in the future.
- Adjusting the Years of Projected Earnings or Average Shareholder Compensation to account for upcoming large capital expenditures.
- Adjusting for a variety of nuances in the shareholder compensation formula.
As with any process that involves money, there needs to be open dialogue on how to handle the six possible adjustments to the formula listed above. But keeping it simple, and then adjusting for nuance from there, should allow you to determine a reasonable value for your practice for purposes of buy-in, buy-out, or sale to other practitioners.
