Key Principles For Assessing Practice Value

By David Edward Marcinko, MBA, CMP, and Hope Rachel Hetico, RN, MHA, CMP

   • contemporary dislocations by third
parties, Medicare and commercial payers;
   • retail clinics and changes in supply/ demand and specialty trends;
   • the rise of ambulatory surgery centers, walk-in clinics and specialty hospitals;
   • outsourced care and medical tourism;
   • alterations in resource based-relative value units, ambulatory payment classifications (APCs), diagnosis-related groups (DRGs) and newer Medicare-severity diagnosis-related groups (MS-DRGs); and
• the Medicare Modernization Act, HIPAA, OSHA, the EEOC and other regulations.

   One must also consider the impact of current employee trends to high-deductible health care plans and private concierge medicine. Another considferation is employer shifts away from defined benefits plans to defined contribution plans.

Aggregating Or ‘Normalizing’ Financial Information: What You Should Know

   In addition to possibly conducting employee interviews, one must gather appropriate financial information in order to properly value a practice. As a starting point, interested physician buyers should be able to see the following information for the most recent three-year period.

   • Practice (corporate) tax returns
   • Equipment/automobile leasing and/or tax depreciation schedules
   • Accounts receivable aging schedule
   • Consolidated financial statements (P&L, cash flow, balance sheet and retained earnings) for the practice
   • Prior buy-sell and/or non-compete agreements

   It is especially important to eliminate one-time, non-recurring practice expenses. These are adjusted for excessive or below normal expenses on the profit and loss statement. Such “normalization” can produce a big surprise for benchmark proponents and formula-driven advocates when a selling doctor runs personal expenditures through the practice that a buyer or court would not consider legitimate. Of course, one is less likely to encounter such shenanigans when the valuation is conducted according to professional USPAP and IRS style guidelines.

   For example, we recall one doctor who painted his home and wrote it off as a valid business expense. Deleting other major expenses such as country club memberships make a practice look more profitable. This is good news if you are selling it. It is bad news if you are getting a divorce.

   Conversely, you may have to defend legitimate business expenses that an appraiser may seek to normalize. For example, doctors may pay for a vehicle through their practice. If they use the vehicle to travel between multiple offices and hospitals, the expense may be legitimate.

   Also realize that the appraiser may also add expenses that have not been incurred. For example, the appraiser may add an office manager’s salary if your spouse is in that role for free. This produces a lower appraised value and is common in small podiatry practices. Honorarium is another example that does not figure into value calculations.

   Of course, normalization is a sophisticated and time intensive process. However, the expert earns his or her professional fee, and defends the resulting valuation range when challenged.

Keys To Selecting The Right Valuator

   The most important credentials to look for are fiduciary level experience, specificity and independence. Some doctors mistakenly turn to those who may have never appraised a practice before. Just because an appraiser has initials behind his or her name, it does not mean he or she understands the peculiarities of medical specialties, especially podiatry. Agents, brokers, solicitors and other intermediaries are not fiduciaries.

   We believe that physicians looking to assess a practice for possible sale/purchase should only select an independent health economist, who will be your advocate under Securities Exchange Commission (SEC), IRS or other relevant managerial accounting guidelines.

   Moreover, be very wary if the valuation is not done in an independent manner or, worse, performed for both parties simultaneously.


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

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