Selling your practice: How to determine its value

In the first installment of our three-part series on selling a practice, we discussed reasons to sell, preparing your practice for sale, options other than selling, timing, and the universe of potential purchasers.

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This article will discuss the concept of practice valuation and how to go from abstraction to dollars or how to make dollars and “cents” of the process of putting a dollar value on a urologic practice.

For a young physician transitioning into a practice, the decision could end up becoming the largest financial transaction that doctor will ever make. And to a retiring physician, practice valuation may decide the amount of sweat equity built over a career.

What is your practice worth?

Needless to say, every urologist believes their practice is worth far more than any young urologist or hospital is willing to pay. After all, they have worked a medical lifetime to nurture, build, and create. They have amassed several thousand patients who have been loyal to the practice and might continue as patients of the future practice. So how does the retiring doctor decide the value of the practice, “cast his net” to the marketplace, and hope to find a willing buyer who will not only pay the asking price but transition the practice smoothly into the buyer’s practice?

In a pure sense, the value of any asset is what a potential purchaser is willing to pay. In medical practices, as we discussed in part 1 of this series, the universe of potential purchasers is limited. That universe could include a newly recruited physician, a larger single- or multi-specialty group operating in the area, the local hospital where you primarily practice, and other local hospitals where you may or may not maintain some level of privileges.

From a value standpoint, the price each of these potential purchasers will be willing to pay varies based on the specifics of the situation, regardless of what a valuation or practice appraisal might indicate.

For example, once your plans to retire become known, why would a young physician agree to pay $X for your medical records? They know both your patients and your referral base will seek urologic care somewhere once you have retired. A little advertising and persistence with your referral base may cost a lot less than the amount you are asking and, after all, the patients are there for the taking.

A hospital may take a similar tack but more often will be willing to pay a fair market value for your practice. Hospitals, however, can't legally pay more than fair market value as determined by an independent appraiser.

Next: Valuation methods

Valuation methods

The valuation of any business is generally looked at in three ways: market, asset, or income. For perspective, it is often helpful to think of these in the context of real estate, such as your personal residence or a rental home.

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Market approach. Anyone who has bought or sold a personal residence understands this concept. The "market" in real estate is simply what someone is willing to pay. Appraisers look at comparable sales of similar homes and come up with a range of values.

If you own your office real estate, the market approach is one method a real estate appraiser will likely use to establish a fair market value. Beyond any office real estate, the market approach is generally not applied in the valuation of medical practices.

There isn't a database of comparable sales that you can refer to for a range of values. While resources available for sale on the Internet claim to offer either surveys of prices or a rule of thumb to calculate a value, don't waste your time or money. The "market" is still what someone is willing to pay in your situation or the value determined by an independent appraiser that a potential hospital purchaser will engage. Even in third-party valuations, the "market" approach is seldom used in valuing medical practices because of the lack of reliable and comparable sales information.

The asset approach simply values the individual assets of your practice based on their current market value.

The individual assets of a medical practice include what are referred to as tangible and intangible assets. Tangible assets are those you can touch, see, and feel. They primarily consist of your furniture, equipment, and any office real estate you own.

The fair market value of used furniture and equipment is most often valued using a replacement cost approach. The value of these items is limited and generally starts at 50% of the cost of purchasing new furniture or equipment of the same utility and then goes down from there based on age and condition.

Major equipment items that might be found in a typical urologist's office, such as an ultrasound or urodynamics machine, often have a market value based on similar items for sale or recently sold in the secondary equipment market.

Other tangible assets might include your accounts receivable (A/R). A/R represents payment for work you've done that hasn't been collected yet. Most purchasers aren't interested in paying for A/R and assuming risk of collections. Generally you should expect to retain your A/R and work out an arrangement for their collection by the purchasers, often for a small or nominal fee, after you have retired.

Intangible assets include all of the things most physicians value in their practice: their name, phone number, reputation, referral base, trained staff, and medical records-in short, the propensity of patients to return to your practice. Sometimes this intangible value is referred to as goodwill or "blue-sky" value.

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Some purchasers may be willing to pay for some of these intangible assets while others will not. Unfortunately, the trend today is for sellers not to be able to reap any value on these intangible assets.

Next: The income approach

The income approach is based on the premise that the value of any business resides in the income the business generates for its owner. In other terms, the value under the income approach is a multiple of the cash flow the business generates after expenses.

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In our real estate analogy, a home that rents for $30,000 a year is worth more than one than rents for $15,000 a year. The higher the income stream, the more a potential purchaser is willing to pay. It is important to note that the value of that income stream most often exceeds the value of the underlying home itself because of the future income potential.

This is the essence of intangible value or goodwill: the value of the business-the rental home in our example-is more than the value of the underlying tangible asset (the home itself). That difference is the goodwill or intangible value. Stated another way, the goodwill value is the value of the future earnings potential in excess of the underlying tangible assets.

The problem in applying the income approach to a physician practice is that, unlike a rental home, there generally isn't any income left after you pay yourself. Any "profit" has always been part of your personal income and any future income stream is dependent on you. If you are retiring, the future income stream will be uncertain and fully dependent upon your replacement, who will be doing the work.

Virtually no physician practice has an earnings stream under the income approach because the physicians take any earnings home each year.

Many health care appraisers take the position that if a practice has no earnings, then it has no intangible value. This means that intangible assets such as your name, reputation, trained staff, and medical records have no value.

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Other health care appraisers take the view that, even lacking earnings, certain intangible assets have value based on the principle of substitution. This principle holds there is value in buying something that already exists rather than building it from scratch. A good example would be a trained office staff that knows your practice and patients and has expertise in urology coding and billing and the clinical services you provide.

Next: Estimating your practice's value

Estimating your practice's value

A basic understanding of valuation methods is important because, as noted, the perspective of value will vary among potential purchasers. The value estimated using the formulas and calculations in the figure provided should give you a good overview of the value potential of your practice. Recognize, however, that every potential purchaser will have their own perspective and approaches on how these assets are valued and what they are willing to pay for them.

Conclusion

The entire process of selling a practice can be daunting for any urologist. However, the valuation process is part and parcel of making a successful transfer of assets that is equitable to both buyer and seller. We have highlighted key the steps in putting a value on your practice. In the third and final article, we will discuss how to provide a seamless transition between buyer and seller.

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