Medical Practice Valuation Rule of Thumb

by Keith Borglum CHBC

Medical Practice Valuation Rule of Thumb - a simplified model
1. Add the Officer Salary and deducted Personal Benefits for the owner back to Profits (retirement, travel, exotic CME, etc)
2. Add back non-expense tax benefits like Depreciation. Add back Interest, as if free of debt.
3. Subtract paying the physician owner(s) at Fair Market Value, as if employed elsewhere.
4. Multiply the remainder (i.e. pre-tax "Dividends" or "EBITDA") by 1.3-2x if EBITDA is less than $1,000,000. If greater -and depending on the specialty, location, and circumstances- the multiple might be as high as 5-10x.
5. This equals the approximate value of the practice by the Income Approach.
6. If EBITDA is zero, default to the Asset Approach.

There is a lot of scuttlebutt in physician lounges at hospitals about the demise of “goodwill value”, and the worthlessness of the value of medical practices. In a lot of individual cases with low or average incomes that is true, but not always.

It is “dividend paying capacity” (similar to EBITDA in non-capital-intensive practices) that is the primary underlying concept to the value of investments, even more so in a climate of stagnant equity-inflation. Dividend paying capacity is determined through the use of the net cash-&-benefit flow to ownership after subtracting the equivalent market-rate compensation of one owner as if the owner were employed, and the remaining cash flow was available to shareholders/investors. In the case of a physician owning a practice wherein other providers are employed to provide medical services, it is the cash-flow to the owner above the work performed. With an “owner-operator” physician working full time in the practice seeing patients, it’s the income above being compensated for that work.

Think about this example. A family physician with two NPs wishes to retire. She has taken plenty of practice-management courses at AAFP and has a smooth, well-run, well-managed practice with a stable, well-trained staff. Her annual net pre-tax income is $340,000 for a 36 hour work-week. You are a new physician, or an established one unhappy with your employer, and looking at job opportunities. Without relocating, the only jobs available pay $240,000 at best. Buying the seller’s practice and working there full time as the seller’s replacement earns you $100,000 more per year than taking a job. There is logically some value to the extra $100,000 per year “dividends”, whether you buy the practice and work there, or buy it as the practice-next-door and employ someone else to be the working physician.

Determining how much the annual $100,000 is worth to you is where the “65% ROI” or 1.5x Multiple comes in. There is a valuation concept called the “build-up rate”. Simply put, it finds that riskier investments need to provide a higher return; so you “build up” the required ROI from low risk to high; from 20 year Treasury Certificates, to the long term S&P 500 rate, to smaller public company rates, to the risks of small owner-operated professional service businesses. It is common to see rates of return of 20-35% for pretax earnings after owner's compensation for professional practices like accounting, law, architecture and engineering not subject to Medicare or insurance company reimbursement or with clinical malpractice risks. Private medical practice ownership should therefore logically provide a return to ownership in excess of 20-35% for its greater risk, which when calculated we find to be usually 65% or more. Another way to look at the investment, is that the purchase of a practice –100% financed– should pay for itself with extra earnings over no more than 5 years, above compensation for labor.

It is a buyers’-market and a great time to invest in practices if you are confident in your management skills. ObamaCare may be hard to continue to execute in the current economy and political environment. Baby-boomers are requiring more care for the next 20 years, demand for physicians exceeds supply in most of the country, and many boomer physicians are retiring, so many excellent practices are selling below value or going unsold and just closing up for lack of a buyer. As a multi-state-licensed practice broker and appraiser, I regularly see practices going unsold with double to quadruple the income of average practices. That’s with $400,000-$600,000 annual incomes in primary care, and over $1,000,000 in specialty practices! I get calls on a daily basis from MBAs and non-physician business-persons wanting to buy my medical practice listings and employ physicians to work there, not knowing that they can’t, due to state prohibitions on the corporate practice of medicine wherein only physicians can be the owners.

100% bank financing at excellent rates and terms is readily available for practice purchases by physicians, even for residents or fellows with education debt, so I rarely see seller-financing any more.

I put a lot of blame for low practice values on the lack of business-ownership training for physicians during training and at medical conferences. Most of my buyers are foreign medical graduates, or domestic graduates with 3-5 years' practice experience whom are unhappy in their employment and want to control their practice environment.

Private practice is not for everyone, nor is private practice ownership, nor entrepreneurial practice ownership. But for those physicians willing to take and manage the risk, the financial rewards can add greatly to the professional rewards.

Phone 1-707-546-4433 for consulting and appraisal information.

Author Keith Borglum CHBC is a licensed medical practice broker, appraiser, and Certified Healthcare Business Consultant practicing nationwide for over 25 years. He is an Editorial Consultant to Medical Economics, author of the book Medical Practice Valuation Appraisal Guidelines & Workbook, and has been faculty for a number of national medical associations. Additional information on the topic is available at his website at www.MedicalPracticeAppraisal.com.

Permission is granted to reprint or quote any portion of this article provided that the author, firm, phone and city are named and two copies of the quoting journal are immediately mailed to the author at 3468 Piner Road, Santa Rosa CA 95401.

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