How much is your medical practice worth?
Buying or selling a medical practice is a lot like buying or selling anything else. Both parties in the transaction want to know they’re getting a fair price. And just like any other product or service, the price is determined by a variety of factors. For example, if you’re buying a car, you want to know the year it was built, how many miles it has, any major mechanical problems, the sale price of comparable vehicles, and so on.
When it comes to purchasing or selling a medical practice, there are 4 significant elements that determine its value: tangible personal property and other assets in excess of liabilities, patient accounts receivable, the office building, and goodwill. Let’s examine them in more detail.
TANGIBLE PERSONAL PROPERTY AND OTHER ASSETS LESS DEBTS
For most primary care practices, the value of the furniture, equipment, and other assets, minus the amount owed for loans and payroll taxes, is relatively small and may amount to less than $25,000 per doctor. Most medical equipment and office furniture have used market values, which are very difficult to determine. For items where no used market price exists, I generally encourage clients to use a mechanical method. For computers, facsimile machines, copiers, and similar items with short technologically useful lives, reduce the initial purchase price by one-fifth per year. For desks, chairs, examination tables, and other furniture with longer useful lives, reduce its original cost by 1/10 to 1/14 per year. Supplies inventory also may have significant valuation, and the items in inventory should be valued at their historic cost. In addition, prepaid expenses and security deposits are considered assets. Prepaid malpractice insurance may be significant. If insurance has been paid in advance for a term of 12 months, and only 2 months of the policy’s life have elapsed, the remaining 10 months’ premium should be included as an asset (5/6 of the premium).
PATIENT ACCOUNTS RECEIVABLES
Patient accounts receivables are one of the largest assets of a medical practice. The amount owed by patients and insurance companies will not be entirely collectible due to contractual allowances with payers, and some will not be collected from patients. There are several ways patient accounts receivables can be analyzed to estimate their collectability. If patients have medical insurance, the insurers pay according to their fee schedule. The amounts charged in excess of the schedule usually are contractual allowances, which need to be written off. If services are not covered by a patient’s medical insurance, their payment depends primarily upon the patient’s or guarantor’s financial responsibility. To determine collectible patient accounts receivable, multiply the number of services that have not been paid for patients covered by an insurance plan by the amount to be reimbursed.
Services provided to insured patients should be assessed as to their collectivity. Practices with many lower income patients often have large uncollected accounts receivables. Practices located in affluent communities may enjoy better collections from self-pay patients. It’s been my general experience that collections from self-paying patients in primary care practices are less than those from the worst insurance reimbursement. Review the aged accounts receivable trial balance, which lists each patient by insurer and time since charged.
In valuing patient accounts receivables, assign no value to accounts that have been turned over to collection, or on which no charge or payment has been made in the prior 6 months.
The above method is thorough, but very time consuming. In some situations this much effort is not warranted. A much quicker and often reasonably accurate method of measuring patient accounts receivables is to multiply the gross patient accounts receivable (excluding uncollectible accounts) by the percentage of charges collected by the practice in the last year.
If a practice has a long-term lease at a favorable rate from an unrelated landlord, there can be an argument that this lease has value. If doctors in the group own the office, it is often in the form of a separate real estate entity, and leased to the practice. Real estate should be appraised at the time of the transaction. Any mortgage balance would be subtracted from its fair market value to determine the equity.
Medical practices can have many intangible assets, including patient medical records, a workforce in place, and covenants not to compete. Such assets are usually referred to as “goodwill.”
What gives a practice goodwill? The biggest factor usually is the expected earnings of the practice. Why are some publicly traded stocks more interesting to investors than others? Invariably, the companies that have the highest expectations for future earnings are going to be more valuable—and thus have more highly valued intangible assets.
The following chart shows the most recent national average income for family physicians (without obstetrics), general internists, and pediatricians. It was compiled using data from the Medical Group Management Association, the National Society of Certified Healthcare Business Consultants, and the Medical Economics 2009 Continuing Study.
I have valued practices for family physicians, internists, and pediatricians with net incomes between $400,000 and $500,000 per doctor. Their practices have a lot of goodwill driven by these earnings. On the other hand, I’ve seen practices in these specialties in which the physicians earn much less than $100,000 per year. In these practices there is generally not much goodwill.
Goodwill is clearly the most subjective element in valuing a medical practice. Other factors that influence goodwill include the level of competition, types of patients, work habits of the doctors, third-party payer mix and fee schedules, practice location, other employees, and marketability.
If a practice is located in an area where the patient-to-doctor ratio for the specialty is at or below average (especially if the doctors earn a better than average income) goodwill is likely to be more valuable. Someone who tries to start a new practice or join another practice is less assured of earning a typical income for that specialty.
In an area with a shortage of physicians in particular specialties, it is easier for a new doctor to start a practice or join another and earn a good income. In those areas, even if physicians earn better than average compensation for their specialty, there may be little goodwill in the practice. Often these practices are in medically underserved areas, because they are not traditionally desirable places for physicians to live and work. They may be in rural areas without a lot of educational, social, or cultural attractions. They could be in inner city areas with a lower socioeconomic patient base and higher crime rates.
Practices with a large number of patients with chronic illnesses can have more goodwill than practices with fewer such patients. For example, an internal medicine practice with a greater than average number of diabetic patients will likely generate more income from these patients (and thus have greater goodwill) than practices whose patients are generally healthy.
There is a direct correlation between a doctor’s income and the time he or she spends working. Medical care generally is reimbursed based on the number of services provided. The greater the number of hours, and the more patients treated, the more services are provided.
There are certainly differences among individual doctors in a group in the same specialty regarding their time worked. However, the group establishes expected work schedules and practice mores. It’s unusual for workaholics to coexist in practices alongside dedicated 9-to-5ers.
Practices with many Medicaid or self-pay patients generally will have lower collections than practices that are able to attract patients with desirable insurance coverage. Two practices could be providing the same services to the same number of patients, and the one with the better payer mix will likely have more goodwill.
The nonphysician employees of the practice affect its goodwill. The most obvious examples are practices that employ physician assistants (PAs) and nurse practitioners (NPs). In most states, PAs and NPs are required to work under the supervision of physicians. Practices that use PAs and NPs appropriately should see the practice’s income benefit from this. In other words, the PAs and NPs generate income in excess of the amount needed to pay them and cover their associated overhead.
The good news for primary care physicians in family practice, internal medicine, and pediatrics is that their practices tend to be very marketable. It is my general experience that a doctor buying a practice from another primary care doctor can usually expect to retain at least 85% of the practice’s patients.
The referral nature of specialty and subspecialty practices presents valuation issues. When a physician buys the solo practice of a doctor dependent upon referrals, the transition of the patients is less certain. However, the larger the specialty or subspecialty practice being purchased, the more assurance the buyer has that the referral relationships and patients will stick with the practice upon their transition to a new owner. Practices that provide ancillary services generally are more valuable than those that don’t.
One of the best sources of medical practice transactions and other valuations of goodwill in medical practices is the Goodwill Registry. The above chart shows the current mean, median, and low and high ranges of goodwill reported for family practice, internal medicine, and pediatric practices.
While the Goodwill Registry expresses goodwill as a percentage of the practice’s revenue, physicians should not assume that their practice’s goodwill is equal to the average for their specialty multiplied by their gross income. Goodwill and the other assets of medical practices should be evaluated by a professional knowledgeable in medical practice valuation. Merely multiplying a specialty average goodwill percentage by gross revenue is akin to treating a patient over a telephone and only knowing he has a self-reported temperature of 101 degrees.
An increasingly thorny issue confronting medical practice appraisers is the valuation of electronic health records (EHRs). In the next 25 years, it’s pretty clear that EHRs will be as prevalent in medical practices as computerized billing systems are now. In virtually every industry, the cost of new technology decreases with the passage of time, while the capability of the new technology increases. Consider how much computers cost and what they could do 25 years ago compared with their cost and capabilities today.
It is common for EHR systems to cost around $50,000 per doctor. Invariably, there is a period of implementation in which the explicit and implicit costs are substantial and the benefits are small. But after successful implementation, the practice enjoys more thorough and efficient medical records systems, which should help to improve its billing and revenue and ultimately its bottom line.
Depending upon where the practice is with respect to EHRs, their impact on goodwill can be notable. For example, if a practice does not currently have EHRs, appraisers typically will include the cost of their purchase and implementation in their projections.
Practices with an EHR system may be showing a lower current income than they had prior to acquiring the system, but it may be apparent how the practice will benefit financially from this in the future. This would also be reflected in the appraiser’s projection.
Some practices have successfully implemented EHRs and are enjoying the financial benefits of using them, in the forms of better reimbursement from third-party payers, and the bonus for e-prescribing, for example. These practices may be earning better incomes than they had prior to the implementation of the EHR system, which influences the valuation of the goodwill.
How are EHR systems evaluated? While the appraiser would want to consider their historic cost and their current replacement cost, typically there is significant depreciation to EHRs, so the value of a used system in an arm’s length transaction could be very low. The practice usually acquires the software and receives a license of 50 years or more to use the software as long as it continues to pay its monthly maintenance charge. The EHR provider invariably charges to add a provider to its software license. A realistic value of the EHR system may be the cost of adding a new provider to its existing software license, multiplied by the number of providers currently licensed to utilize the system. Since EHRs are fairly new assets for medical practices, this approach may not be used universally, and other approaches could be considered.
For many physicians, the purchase or sale of a practice will be one of, if not the, largest and most complex transactions they will ever undertake. Understanding the factors that go into pricing a practice can help ease the process, and ensure that both buyers and sellers feel they got a fair deal.