Physician Practice Valuation: Measurement, Terms, and Trends

As a business appraiser and consultant, I have witnessed numerous acquisitions by hospitals, physician practice management companies, and publicly-traded companies ("healthcare buyers") of medical practices. These transactions have multiple elements that need to be analyzed in order to estimate the total value of the transaction, including:

1. The value of the practice being purchased; and

2. The physician compensation expected to be paid after the close of the transaction.

Contract details, including the term, the baseline for determining physician compensation (typically relative value units, or RVUs""), non-compete agreements, termination and exit clauses, and other contract provisions are also important considerations that must be analyzed when "valuing the transaction." Reviewing only the physician practice valuation multiples - such as purchase price to revenues, earnings before interest and tax (EBIT), earnings before interest, tax, depreciation and amortization (EBITDA), and sellers' discretionary earnings (common valuation multiples) - provides an incomplete analysis of the transaction if one doesn't also consider the compensation the physician will receive after the transaction.

When buyers are for-profit hospitals, physician management, or publicly-traded companies, often the physician compensation post-transaction will increase the physician's compensation. Thus, to the physician seller, the transaction has greater value than just the value of his or her medical practice.

Trends

The Goodwill Registry published by The Health Care Group provides information on goodwill multiples that have been paid for medical practices (segregated by medical specialty). By reviewing the goodwill valuation multiples for internal medicine groups for the years 2003 through2013 we find that since 2010, the goodwill to revenue multiple for internal medicine practice has declined from 18 percent of revenue in 2010 to 10 percent of revenue in 2013, declining slightly each year.

Additionally, the goodwill to seller's discretionary earnings (SDE) multiple (this measures seller's discretionary earnings available to him or her) has also declined from 48 percent of SDE in 2010 to 25 percent of SDE in 2013, declining each year. Thus, on a pure practice valuation review, we might conclude that internal medicine practice values have decreased. However, when practices are valued for purchase by a hospital or other healthcare entity, the post-transaction physician compensation must be used in the valuation model used to value the practice. Thus, if the expected post-transaction compensation is a higher compensation than previously taken, this effectively reduces the cash flows that are calculated, discounted, and summed up to determine value (and the value determined is lower).

I have recently valued practices both small (less than five physicians) and large (more than 45 physicians) where the valuations of the practices have increased during the course of the negotiations. These were desirable practices, and in one case there was a "bidding war." As healthcare buyers hope to expand and gain market share, practices identified as desirable are targets and buyers may be willing to increase the offering price; however, the values must still be supported by a market value valuation that is commercially reasonable.

Many physician practice valuations are performed for the purpose of having younger employees buy into existing practices. Practice valuations for this purpose still reflect strong valuation multiples especially if the practice is profitable and relative low risk.  Such practices may be well established, enjoy good reputations, employ quality physicians, have existing referral networks, have an assembled staff, and more. Additionally, in many cases, the employee buyers will become minority interest holders in the practice with the majority owner physicians(s) staying on. In this example, the goodwill of the practice remains fully intact because the majority equity owner remains and the referral and patient base stays.

Summary

The practice of medicine has become much more business oriented and controlled by regulatory bodies including insurance companies, Medicare, and the U.S. government. New requirements, such as meaningful use for EHRs, quality reporting, HIPAA compliance, etc., are making medical practices more complicated and expensive to operate. Accordingly, many physicians have chosen to merge or be acquired to expand their resources to meet the new demands.

When measuring the value of a physician practice:

• We cannot generalize about physician practice valuation multiples because like any business, there are many variables including profitability, risks, desirability, and other factors that affect value.

• To say generally that there is little to no goodwill in physician practices is not reality, because employees looking to buy practices or an equity interest are paying for goodwill that they anticipate will remain with the practice.

• If goodwill is not present in a physician practice valuation that is performed for the purpose of the practice being acquired, this may be due to the new physician compensation that is offered. Excess cash flows of the practice used in the Income Approach valuation (typically a discounted future earnings model) are "wiped out" by the additional compensation being paid to the physician post-transaction.

As with any business valuation, a practice valuation must look at the specific financial attributes of the practice, internal and external risk factors, and the future outlook for the practice in order to determine value.

Monica H. Kaden, MBA, ASA is a principal at Fischer Barr & Wissinger LLC, a leading accounting firm in New Jersey. Kaden has been performing business valuations for two decades and has focused her valuation practice in the healthcare industry.  She specializes in valuing medical practices, ambulatory surgery centers, and other healthcare entities.  E-mail her here.