Key Principles For Assessing Practice Value

Author(s): 
By David Edward Marcinko, MBA, CMP, and Hope Rachel Hetico, RN, MHA, CMP

   When it comes to purchasing a podiatry practice, there are a variety of factors that one must consider in evaluating the worth of the practice. Assessing the value of a practice is fraught with potential landmines if one does not go into the process with a strong understanding of some key principles to medical practice valuation.

   According to the Dictionary of Health Economics and Finance, practice valuation is the “formal process of determining the worth of healthcare or other medical business entity at a specific point in time and the act or process of determining fair market value.” Fair market value is defined as “ … the price at which a willing buyer will buy and a willing seller will sell an asset in an open free market with full disclosure.”

   The Internal Revenue Service (IRS) Revenue Ruling 59-60 clearly states that fair market value “is essentially a future prophecy and must be based on facts available at the required date of appraisal.”

   Unfortunately, one cannot directly observe the value of a medical or podiatry practice as there are a number of underlying issues. Obviously, the buyer and seller are pursuing oppositive objectives, and this reality is not necessarily conducive to facilitating clarity on those issues.

   Accordingly, let us consider a few mistakes that are commonly made by physicians who are considering the purchase of a medical practice.

A Guide To The Myths And Realities Of Medical Practice Valuation

   • Valuations are material representations providing a range of transferable worth.
   • Valuations are reproducible estimates based on economic assumptions.
   • Valuations are not “back of the envelope multiples” using specious benchmarks.
   • Valuations are defensible and should be “signed off” by the completing firm attesting to origination guidelines and in accordance with the Uniform Standards of Professional Appraisal Practice (USPAP) and IRS formats as needed.
   • Financial accounting value (book value) is not fair market value.
   • Professional valuators represent only one party. The buyer or seller-owner is the client.
   • Unbiased valuators do not provide financing or equity participation schemes.

Knowing The Distinctions Among Engagement Types

   The Institute of Medical Business Advisors uses three levels that approximate engagement types for the industry. These levels are comprehensive valuation, limited valuation and ad-hoc valuation.

   A comprehensive valuation is an extensive service designed to provide an unambiguous opinion of the value range. It is supported by all procedures that valuators deem relevant with mandatory onsite review. This gold standard is suitable for contentious situations like divorce, partnership dissolution, estate planning and gifting, etc. The written opinion of value is applicable for litigation support activities like depositions and trial. It is also useful for external reporting to bankers, investors, the public and IRS, etc.

   A limited valuation lacks additional suggested USPAP procedures. It is considered to be an “agreed upon procedure,” which is used in circumstances in which the client is the only user. For example, one may use the limited valuation when updating a buy-sell agreement or when putting together a practice buy-in for a valued associate. This limited valuation would not be for external purposes. No onsite visit is needed. A formal opinion of value is not rendered.

   An ad-hoc valuation is a low level engagement that provides a gross and non-specific approximation of value based on limited limited parameters or concerns by involved parties. Neither a written report nor an opinion of value is rendered.
   The ad-hoc valuation is often used periodically as an internal organic growth/decline gauge.

Are You Following Industry Standards And Rules?

   Specifically, when it comes to USPAP transactions involving physician practices, the following points are implied by the industry and the IRS.

Comments

As a healthcare practice appraiser and broker myself, I agree with much of what Dr. Marcinko states, but not all of it. I expect this would not be surprising to him since he acknowledges that appraisers often disagree.

Many of us healthcare appraisers believe that the Discounted Cash Flow method is no longer the most relevant income approach in small professional practices, due to the impossible requirement to predict future reimbursement in healthcare, year-by-year, for years in advance. To quote Gary Trugman, CPA, a leading author on the topic and faculty for the course for appraisers Valuing the Very Small Business: “Attempting to use a discounting model for a very small business would be like throwing darts at a target from six miles away. There is no way you can hit the target.”

I also dislike the Excess Earnings Method for small professional practices, even though some courts still require it so I then have to include it. Judges don’t always make the right decision. That’s why we have higher courts. The IRS now appears to agree per IBA News, Jan 2011: “The IRS disapproves of the use of the EEM in its Appellate Conferee Valuation Training Program. Moreover, RR68-609 approves of the EEM ‘only if there is not a better basis available’ ”.

Personally, I prefer the Single Period Capitalization Method espoused and taught by the Institute of Business Appraisers. I also prefer to calculate capitalization rates rather than using rules of thumb like “divide by 20%”. I think 20% is too low a risk number for calculating cap rates in today’s healthcare market, resulting in an inflated value.

I disagree that the age of the doctor has impact in determining the “market rate of compensation." I believe that skills, services-mix, productivity and the market are what count, irrespective of one’s age.

I think that the Goodwill Registry does have some worth in calculating the value of a podiatry practice. It is not an “older source” in that its data is not current. It is older in that it has been around longer. Its data is added to annually. True, podiatry is underrepresented therein but it does provide perspective of the overall trends in the U.S. market of values of insurance-based surgical and non-surgical practices. It can be easily misused by the uninformed reader, for example, limiting consideration to its one component of value as a percentage of revenues. Obtaining the underlying database provides many more insights into sales prices as ratios of earnings, regionalization, currency and size. I wish more podiatrists and their advisors would submit transaction data to make the registry more robust in podiatry.

I am a licensed broker and appraiser. I disagree with Dr Marcinko that brokers cannot be fiduciaries. I also think that they often should not and cannot be fiduciaries, and that they should be entirely independent in their opinions, such that they have no bias to either the buyer or seller. In those cases, then one can perform an appraisal for both the buyer and seller together, even if they are a broker. A good example of this is when I am selected by a court mediator or arbitrator, and my opinion is for the court, not for the parties involved, even if I am also engaged to broker the practice.

Expressing bias for the buyer or seller, or parties to litigation, is an ethics violation in a Fair Market Value appraisal. When I perform a valuation, I find the same number no matter who pays me. I get paid in advance to eliminate any possibility that the client can influence my opinion by withholding payment. When I broker a practice, I am usually on an hourly fee rate rather than a commission, I never negotiate on behalf of the parties, and always have both parties represented by independent healthcare transaction specialist attorneys for individual advocacy, and state and federal compliance of documentation. That said, I agree that not all appraiser-brokers practice the way I do, and every profession has its share of scoundrels, and conflicts of interest can occur.

I caution readers to not confuse “value” with “price." A practice can have value without having a buyer, for example, in divorce or a location undesirable to the current crop of candidates. Value is an opinion based on a set of assumptions. Price is the result of negotiation between two specific parties, each with their own needs.

Best wishes.

Keith C. Borglum
Certified Healthcare Business Consultant
Licensed and Certified Business Broker specializing in healthcare since 1983
Author and Faculty to many medical associations and publications

Add new comment