Blog Article

Practice Valuation Methods

Over the past several years, a trend has emerged of physician practice acquisitions and subsequent employment of the physicians by health systems. As these transactions continue in the marketplace today along with changes in the healthcare industry and the reimbursement models, small independent physicians find running a practice ever more daunting.

According to a recent study¹, from 2012 to 2015, health systems acquired 31,000 physician practices in the United States. In 2012, one in seven physician practices were owned by a health system, while by mid-2015, one in four physician practices were owned by a health system.

This is similar to physician practice acquisitions that took place in the 1990s, as health systems moved to obtain patient referral streams from such physicians. In this frenzy of activity, health systems and other entities paid significant amounts for goodwill from such practices only later, due to huge operating losses, to be divested by the health systems and turned back to private practices.

Today, while merger and acquisition activity is robust, valuation of physician practices typically takes the form of one of a various number of valuation paths and while some are used more widely than others I thought it prudent to look at these valuation methods to better understand how medical practice valuations are derived.

Income Approach

Based on the idea that a practice’s value is its ability to produce future income or wealth, the income approach is derived by capitalizing past earnings of the practice. This approach determines the expected levels of cash flow for the practice by looking at prior period earnings, normalizing them for abnormal revenue and expenses and then multiplying normalized earnings by a capitalization factor. A capitalization factor is defined as the normal rate of return a purchaser would expect from the practice.

Discounted future cash flow is another approach where instead of an average of past earnings, an average trend of projected earnings is used and then divided by the capitalization factor.

The challenge here is that physician owners often retain all available earnings of their practice as compensation, thereby leaving little profit to the practice. Generally, little value can be derived under the income approach since the physician compensation essentially eliminates all excess earnings generated by the practice. We do, however, see the Income Approach still frequently relied upon to value healthcare ancillary businesses such as diagnostic centers, physical therapy clinics and ambulatory surgery centers.

Asset Based Approach

Asset based approach totals up the investments of the practice. The going concern method simply nets all the practice assets against outstanding liabilities. While the liquidation method determines the cash that would be received if assets where sold and liabilities paid off.

Assets in many physician owned medical practices exist in the name of the owner and separating assets from business and personal use can be challenging. In many cases, the acquiring entity will decide upon what they are willing to pay from a cost approach perspective, which more often than not dictates the scope of the valuation.

Market Value Approach

Market value approach to valuing a medical practice attempts to establish the value of your practice by comparing your practice to similar ones that have recently sold or been acquired. This approach works best if there are a sufficient number of similar practices by which to compare. Because most physician owned practices are individually owned, attempting to find public information on prior sales may be challenging.

Although the income approach is the most commonly used method for valuing physician owned medical practices, for most practices some combination of these valuation methods will prove to be best at setting a fair selling price.

Greg Cutrona, Principal at AssuranceMD is a CPA with extensive healthcare experience in financial services and business valuations. If you are interested in learning more, email gcutrona@assurancemd.com.

¹ Avalere Health and the Physicians Advocacy Institute