How to Value a Medical Practice—Art or Science?
What is medical practice worth? IT DEPENDS! And once you understand this sole fact, you can then begin to concentrate on how to get to the answer.
There is a great misunderstanding in the medical community as to what constitutes the value of a medical practice. Purchasers often think it is valued based on what they plan to bring to the table. Sellers often think it’s a simple formula that’s applied uniformly across the board.
While there are guidelines and formulas that are used to ascertain values, there are many unique and individual circumstances related to a practice that set it apart from all the others. These circumstances are where the valuator focuses on making assumptions that affect the value of the practice. These assumptions are applied numerically to the valuation “formulas” to determine a dollar amount that represents the value. For example, being the only medical practice of a certain specialty in an area affects value. The demographics of the patient base or physician referral sources can also impact value.
All valuations are not performed in the same manner. It depends on the purpose of the valuation. However there are two key points you should always keep in mind when valuing any medical practice:
Key Point #1: The strength of the practice’s income stream and what it produces for the owner(s) is what creates true value in a medical practice.
Key Point #2: The key to a successful valuation is deciding whether or not the practice’s future income stream will mirror its present income stream.
Standards of Value
There are many reasons and circumstances that might give rise to a need for a valuation. In many case, the purpose and use of the valuation may impact the value itself. Medical practices are most often valued for purposes of sale, for a divorce, for a practice buy-in or a buy-out, or arising out of a litigation matter. The standard (i.e. definition) of value must then be appropriately applied to any valuation and is therefore dependent on the purpose of the valuation. The most common standards of value are fair market value and fair value.
Fair market value is the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. Fair value results from state minority shareholder/partnership actions is therefore defined by the law and/or court decisions.
Methods of Valuation
After the standard of value is selected, information and data must be gathered for use in making judgments that help determine the value. In gathering much of the information, the valuator must understand the different methods of valuing the practice in order to obtain the right kind of information.
There are three common approaches looked at in every valuation—the Income Approach (based on cash flow or earnings), the Cost (or Asset) Approach (based on assets less liabilities), and the Market Approach (based on comparable sales or guideline companies). After calculation, the valuator then selects the one approach that best matches the facts and circumstances of the underlying valuation project.
It should be noted that, even after careful consideration of all the relevant facts and information, significant variances in value estimates can be derived for a closely held enterprise such as a medical practice. In reconciliation of these variances in the value estimates, it must be acknowledged that valuation is not an exact science whereby a given formula can be applied to a set of data and a conclusive result is determined. Rather, the informed judgment of the valuator operating in the context of reasonableness and common sense must be inherent in the valuation process, guiding the consideration of relevant facts in the determination of a composite estimate of value.
For more information on this issue, please call Anita Abrol or Tom Shade at 810-238-4617.
This article was written by Reed Tinsley, CPA, a Houston-based CPA, Certified Valuation Analyst, and healthcare consultant. He works closely with physicians, medical groups, and other healthcare entities with managed care contracting issues, operational management, strategic planning, and growth strategies. His entire practice is concentrated in the health care industry.