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‘It Depends:’ Calculating the Value of a Practice for Business Transactions
Wednesday, May 23, 2018 9:00 AM
A physician approached me the other day and asked what value I would give his practice. As a consultant who works with many practices around the country, I understand that this is not an uncommon — or unreasonable — question. However, my response is usually quite unfulfilling: “It depends.” I know it’s a response we all hate because it’s not a definitive answer, but it’s true in this case.
Calculating a practice’s value depends on several factors. It’s impacted by the various scenarios that would require a valuation, the different factors that should be considered, and how values could be calculated. All these factors went into my “it depends” answer that I gave my client.
To understand the complexity inherent to a valuation, let’s start at the beginning. What types of events generally require a valuation? Here are a few common scenarios:
- Acquiring a practice
- Merging with another practice
- Selling to private equity or another corporate entity
- An associate buying shares to become a partner
- Buying out an existing partner
- Buying or selling ASC shares
Each of these situations differ in the way a valuation is calculated: Corporate entities will typically pay different values than a physician; a merger may include current liabilities whereas an asset purchase may not; buying out an existing partner is different than acquiring a neighboring practice in the community. So, this may lead you to ask: What are the different components that make up a valuation?
- Tangible assets: Those items you own in your practice such as equipment, furniture, and improvements.
- Shareholders’ equity: The adjusted value of practice assets, less practice liabilities.
- Accounts receivable (AR): The amount of current AR in a practice that is collectable.
- Intangible assets (goodwill): A value that represents a practice’s continuing income stream. In other words, the worth of buying into a current income stream with an established brand versus building it on your own.
- Current earnings: Often referred to as EBITDA, this figure represents the cash value of earnings that would be available to the purchasing entity if acquired.
Depending on the situation, a valuation may include anywhere from one to all five of the above elements in the final valuation. Again, it depends on the nature of the valuation as to what elements may be included.
Beyond the elements used to create the valuation, there are additional factors that may need to be considered for a valuation. They include:
- Goals and objectives of the seller
- Nature and history of the practice
- Operational and financial efficiency
- Market share and dominance
- Competitive assessment
For example, if I was conducting a valuation for an established practice with strong market share in a competitive market, the value of goodwill for that practice may be higher than another practice with similar financial performance, but with lower market share and minimal competition in its market. Or, a practice may receive a higher valuation if its operational efficiency is strong, resulting in a larger profit margin than a comparable practice that has similar net collections but a less efficient office, resulting in a lower profit margin.
The Bottom Line
The bottom line is that determining the value of a practice does depend on different factors. Understanding the intent of the sale, current business operations, and the market all need to be considered. A valuation can be helpful in identifying the value of a transaction; however, the final value always comes down to what a willing buyer and willing seller can agree on. If the numbers and operational considerations are agreeable, then you have a deal.