How To Value A Buy-In/Buy-Out

Author(s): 
By Steven Peltz, CHBC

   Right now, many senior residents and fellows are facing the next step in their career, namely joining a practice. The idea of getting paid more than what they have received for the past few years along with working in a practice brings them a sense of excitement and foreboding.    After the interview process and mutual acceptance by each party, the discussion eventually turns to the topic of partnership. The owners only want to hire someone who will become an owner of the practice and will eventually buy them out. The owners explained in great detail the process of buying in for the new podiatrist and then explained buying out the owners. At the end of the evening, the new DPM has a headache and wonders if he or she went from the frying pan into the fire.    The owner of any business knows it takes time and energy to build up that business. These business owners create equity in their practice, similar in concept to what you get as you pay off the mortgage on your home. However, the value of the equity in a business is not easy to quantify. The value of a business to the owner is usually much greater than the value of the same business to a potential purchaser. The value of an ongoing business supplies the owner with an income for his or her family. One problem that may surface is that the owner feels emotionally attached to the business. To the owner, starting the practice, building it and seeing it flourish results in an emotional attachment. This may cloud what should be an analytical, non-emotional process.

What One Will Hear During The Initial Buy-In Discussion

   If you ask three valuation experts to value a practice, do not be surprised if you get three different values. Do not look for what is fair. Fair is subjective and what is fair to the buyer may not be fair to the seller and vice versa. If the seller feels the price is too low for the practice and the buyer feels the price is too high, the valuation may be close to an acceptable number. If everyone agrees on a valuation process and the process ends up with a price that the buyer decides is too high and walks away, no one wins. Start the process with an objective, open mind and then work to find out what is acceptable to both parties.    The new DPM begins looking for a practice sometime in October of the year before he or she graduates. He or she finds a practice owned by a DPM, who explains that he or she would like the buyer to work for three years as an employee and then begin the buy-in process. During the three years as an employee, the new DPM will receive a base salary that increases each year along with a productivity bonus if he or she meets certain benchmarks.    The seller explains that at the end of the potential buyer’s third year (or earlier if he or she wants it), the practice’s accountant will discuss the buy-in process and provide a number based on the latest financial information. The formula for the valuation of the practice will be equal to the collections for the past 12 months.    For the sake of a discussion example, the selling DPM’s gross collections total $650,000 before he or she hires the new podiatrist. Now let us consider a few key discussion points.

Comments

KBorglum's picture

The business practice of podiatry has changed a lot since the authoring date of 2005. Since then, we have had the Great Recession and Obamacare, just to start.

Practice values have dropped a lot since 2005. In most cases, that doesn't mean there isn't any "goodwill value." It is just harder to generate or find. Many group practices are still using antiquated buy-in and pay-out formulas.

Most podiatry practice values now are approximately 1.5 times the income available ABOVE compensation for labor of the physician (i.e. a 65% cap rate on pre-tax dividends as defined by IRS RR59-60). The logic is that without "excess" income, there can be no return on investment or even a return of the capital investment. A knowledgeable candidate would simply take employment and invest his or her capital elsewhere at less risk.

Calculating "normalized income" is a task best left to a professional appraiser or CPA. Calculating the ROI on the investment, which yields the value, is the area of most controversy. Most "general" appraisers don't have experience calculating the excess risk of government policies and clinical malpractice risks.

Also, in buy-ins and pay-outs, there MUST be consideration given to discount for lack of control. Less control means more risk and less value. Again, leave this to the pros.

You can see more articles on this topic at MedicalPracticeAppraisal.com by healthcare specialist appraiser & broker Keith Borglum, CHBC, CBB

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