How Much Is Your Practice Worth?

Neil Chesanow

Disclosures

October 17, 2017

In This Article

An Eye-Opening Example of a Valuation

The traditional building blocks of practice value, says Reed Tinsley, are hard assets (eg, equipment, facilities, supplies, patient records); cash (what's left after expenses, including physician compensation); accounts receivable (money due for professional service); and goodwill (anything paid above the value of hard assets, cash, and accounts receivable).[7]

But in many practices, the hard assets may not be worth much. It depends on the specialty. "If you're an ophthalmology practice, the hard assets could be worth $400,000," Kropiewnicki says. "If you're a pediatric practice, your hard assets may only be worth $10,000. Other specialties fall somewhere in between."

Goodwill is generally the most subjective and variable asset in valuing a practice. An ophthalmology practice grossing $1 million a year may have a goodwill value of 30%, or $300,000, Kropiewnicki figures. "But in a family practice, you're not going to have $1 million in gross revenue. And the goodwill value won't be 30%. It's probably going to be somewhat less than that. Primary care practices don't have a lot of value unless there's a lot of ancillary services being provided."

"The accounts receivable is of value," Kropiewnicki notes. "If you're selling your practice, you don't usually sell your accounts receivable—although sometimes in private equity deals they do buy it, because they're trying to get their cash flow up and running right away. Then the doctor sells the accounts receivable for a fair collectable rate, depending on what percentage of charges he collects."

"In my practices nowadays, a 50% collection rate is not abnormal," Kropiewnicki says. "So for a $1-million practice, accounts receivable should be worth $200,000-$300,000." For a primary care practice, that figure will be considerably less.

That leaves the primary yardstick of value: free cash, otherwise known as "profit." But a physician practice may not have much—or any—free cash.

"Physician owners tend to take whatever's left after expenses as their compensation," Tinsley points out. "If physician compensation is set at a fair market level for the same area, but there's never any cash left at the end of the year, then what's the practice worth to an investor? Unless a physician earns substantially more than the fair market rate for his or her specialty and the area, that money is physician compensation, not profit."

You can create profit by taking a cut in compensation, he says. If you make, say, $200,000 a year, you could reduce that to $150,000. That would leave you with $50,000 in profit. But not many doctors are willing to do that.

To give you an rough idea of what a small practice might be worth in today's market, Tinsely uses a three-step process to come up with a back-of-the-envelope valuation by way of example.[7]

The first step, he says, is to determine cash flow—what's left after paying operating expenses (eg, staff and nonphysician provider salaries, rent, leases, loans, insurance) and the fair market compensation of the physicians.[7]

"Say you have a three-physician practice that pulls in $1.5 million after contractual adjustments," Tinsley says.[7] "Operating costs are $900,000, leaving $600,000 for the three of you to divvy up. Suppose a fair market compensation figure for your professional services is $185,000 each, thus leaving $45,000 in free cash."

The second step is to propose a required rate of return on investment.[7] "Investors who take large business risks will look for returns approaching a 20% return annually," Tinsley says.

Finally, Tinsley divides the cash flow ($45,000) by the return on investment amount (0.20) to get the total value of the practice.[7] In this hypothetical example, it comes to $225,000. "This includes all assets of the practice, he says, including accounts receivable and goodwill." In addition, the impact of taxes, risks to future cash flow, future capital needs, and other factors would need to be considered as well.

$225,000 for a three-doctor practice! That's all?

Yes, that's it. Doctors are often in a state of disbelief when they learn how little their practices are really worth, Tinsley told Medscape.

"The hardest thing to convey in presenting appraisals is that it's just business," he says. "It's not personal. But to some people, hearing what their practice is worth is like we're saying their baby is ugly."

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