What is your exit strategy from practice? Recognizing the hurdles and challenges with retiring from private practice, this author shares pertinent pearls on practice valuation, liquidation, hiring an associate, mergers and private equity acquisitions.
An owner who formulates a strategic plan to grow and protect the value of his or her business for an eventual sale is actually creating an exit strategy. Any business owner can do this and this includes podiatric practitioners, whether one is in in a single specialty, private practice or a partner in a multispecialty medical group. Although a well-thought out exit plan enables successful retirement, a national survey by U.S. Trust revealed that as many as two-thirds of business owners (including owners over 50 years of age) have no such strategy.1
While those far from retirement age often feel that planning such a strategy is irrelevant, in reality, the ideal time to contemplate one’s exit strategy is even before opening a practice or joining a group. If developing such a plan is something that you have not yet thought about, whether you are young or old, a partner or an employed associate, now is a good time to develop an exit strategy regardless of your stage of practice.
The sole owner of a private practice or a partner in a group needs an exit strategy as an integral part of his or her financial and retirement planning. This plan will play a key role in determining the strategic direction one’s practice takes long before one retires. A practice is one of many assets that doctors may accumulate throughout their careers, careers in which those doctors have invested a significant amount of time and money. The practice has likely grown over the years, not only creating a revenue stream which supports one’s salary but also providing funds for distributions as profit each year, (making the practice even more valuable). For one who has not planned ahead, it is difficult to reap the full value of this asset at the time of retirement.
What Is A Practice Worth?
Similar to the value of any other asset, a medical practice is worth whatever a buyer is willing to pay and a seller is willing to accept. While value is determined with various standardized processes, the final price is negotiated. The final sale price may or may not be the same as the determined value. Medical practice valuation is similar to that of other businesses with profit being the most important determinant of value. The profit is valued at a multiple (a multiple of earnings based on expected growth in profitability and the amount of risk associated with that expectation) and is what enables a buyer to purchase a practice and go forward without the necessity of taking a significant cut in salary. The greater the amount of risk associated with a continuation of any profit, the lower the multiple. The greater the opportunity for growth in profit, the higher the multiple.
While revenue is an important factor in valuing a practice, those practices with equal revenues will have vastly different values if their levels of profit are markedly different. Simply understanding that profit, rather than revenue, is the significant factor one uses in determining value can assist a practitioner in planning his or her exit strategy early in his or her career. The planning focus is the same for your medical practice as it would be for any other business: profit and what can be done to increase it. This might entail adding associates, enacting a merger, teaming up with a management firm or reducing unnecessary costs through the institution of efficiency measures.
Even though tangible assets (such as equipment and leasehold improvements) have some independent “resale” value, their primary value comes from the fact that they are assembled into a system that produces profit. One way to think about this is to compare two practices that have the same revenue of $1,000,000 and profit of $260,000 (after accounting for each doctor’s $240,000 salary). Assume that one practice invested $50,000 in equipment and another practice invested $300,000 in equipment. Is the one with $300,000 in equipment worth $250,000 more than the other? No.
Clearly, this would be overvaluing that practice because the money invested in this additional equipment did not produce more profit. Any future buyer for this higher-valued practice would struggle to make payments on the equipment loan following the purchase. That being said, if key equipment is in obvious disrepair and needs immediate replacement, or the practice lacks an essential piece of equipment (such as a digital X-ray machine), the cost of purchasing that equipment will lessen the practice’s value.
Another thing to consider when negotiating a final sale price is opportunity cost. This is a cost that does not appear on financial statements. Every time one makes a decision, he or she chooses between alternatives, and there are always tradeoffs when choosing one over another. At the end of the day, one makes a purchase decision after consideration of any alternatives or the next best opportunity available. Both the buyer and seller may have opportunity costs to consider. The buyer may need to decide between employment and practice purchase options. The seller may decide between a practice sale and a merger. Whatever decision each makes will be at the exclusion of his or her next best opportunity: an opportunity foregone. I have encountered doctors with fixed prices in mind for their practices based on the amounts they needed to receive in order to retire. In cases such as this in which the basis of the sale price is on need rather than actual value, the doctor’s opportunity cost would be to continue to work and forego retirement for a while.
A significant matter having an impact on the value of many medical practices is that doctors often tend to take more time off and slow down in their later years of practice. This leads to decreasing revenue and profit. Given that only the most recent three to five years of operations are the time period generally used to value a practice, this declining trend in revenue and profit substantially reduces the value of the practice, making it more difficult to receive optimal value for the practice and a subsequently comfortable retirement. With a good plan in place, however, there are ways to avoid such a trend. Let us take a closer look at the various exit strategy options available to practice owners.
What You Should Know About Liquidation
After liquidation of a practice, the doctor will receive its minimum value. This is often the default option for those without a planned exit strategy. Liquidation assets for a retiring doctor include the collectable portion of the accounts receivable, any cash in the bank and the value of tangible assets (such as equipment and supplies). The accounts receivable and cash are the sources of working capital that were previously necessary to run the practice. Upon retirement, liquidation presents the opportunity to take this money out while not worrying about hurting the practice. One may sell equipment and supplies on the open market, but sales will likely be at a substantial discount.
I have encountered doctors who were unable to find buyers when they tried to sell their practices as an afterthought. They would tell me that they were basically going to liquidate and “walk away from practice.” I advised these doctors that they could approach practitioners in their local areas whom they respected and who might consider acquiring their phone numbers and medical records. This is often a win-win for both doctors because it gives the buyer an opportunity to increase his or her practice’s volume and revenue without acquiring the overhead of a second practice, and it enables the seller to obtain value over and above liquidation value from the goodwill he or she has built.
Essential Considerations In Hiring An Associate
The traditional exit approach for many practitioners includes hiring an associate. In addition to enhancing an exit strategy, an associate helps to grow a practice and gives the owner the opportunity to take more time off. These new doctors can create opportunities for the practice to offer a broader array of services, especially when associates have training in areas in which the owner may not have similar proficiency. In many cases, this strategy works extremely well with associates typically bringing new enthusiasm along with growth. As the practice grows, there is often a need to add more associates, eventually leading to a group practice.
For a number of reasons, having an associate in a practice does not always result in the hoped for end result, one in which the associate becomes a partner and eventually buys the practice when the founder is ready to retire. Some of the reasons for this are unavoidable. For example, an associate’s spouse may get a job transfer out of the local area or the relationship between the doctors does not work out due to bad “chemistry.” However, in many cases, with proper planning and good communication, one can proactively address many of the reasons why an associate might decline partnership or the opportunity to buy a practice.
When negotiating partnership, there are several obstacles to overcome. Aside from the fact that practices are often overvalued, there are three very common obstacles to successful negotiations (especially when there is a good relationship between the owner and associate).
- The financial challenges for a doctor buying into a practice are far different from those for one buying out a retiring doctor.
- An associate is often not credited with his or her sweat equity having contributed significantly to a practice’s growth in profit.
- An associate is often not given a significant “lack of control” discount when buying a minority ownership position (when the owner retains greater than 50 percent ownership in the practice).
Could A Practice Merger Help Facilitate A More Rewarding Exit Strategy?
Mergers present several opportunities for an exit strategy. As opposed to groups that grow internally by adding associates and locations, others grow externally through practice acquisition. Sometimes one accomplishes a merger through an outright purchase of a practice whose owner receives a cash buyout and either becomes an employee of the group or exits practice altogether. At other times, instead of one practice purchasing another, there is a comparison of the values of the practices that will comprise the merged group, and each entity receives a percentage ownership of the group based on its relative value.
Groups should have an exit strategy built into their partnership agreements, one that sets the parameters for calculation of the value of each doctor’s ownership upon his or her retirement. In general, it is much easier financially for these larger groups to buy out retiring partners than for one partner in a small practice to buy another out.
In addition to creating opportunities for exit strategies, practice mergers have the capability of increasing value for the owners. The immediate benefit of a merger is that it enables greater profit because the merging practices can spread a larger volume of patients and services over existing fixed costs. Over the long-term, as a group increases in size, it also offers more opportunity for ancillary income and negotiating better paying contracts. Some practices that merge have the ultimate goal of becoming “supergroups” or ones that can attain a regional presence large enough to negotiate these better paying insurance contracts.
When There Is A Private Equity-Backed Acquisition
Group practice entities, backed and capitalized by private equity firms, have begun buying podiatric practices. This presents a new type of exit strategy for an owner. The jury is still out on the long-term pros and cons of selling to such an entity, which makes it important for a “seller” to fully understand the firm’s business plan, how it can add value to the practice and the firm’s long-term strategy in the marketplace.
It appears that current strategies and objectives of these private equity-backed firms are different from previous attempts to consolidate the medical practice market. A big difference this time around is modern technology, which enables the management of practices from “afar,” the ability to utilize electronic medical records which improve quality beyond the capabilities of an independent physician association (IPA) and the opportunity to participate in value-based care models.
A primary goal of the monetary support provided by private equity-backed firms is to allow these management groups the opportunity to increase physician productivity while reducing costs, thus, creating higher profit margins. With access to capital provided by these firms, groups are able to grow rapidly, add locations and ancillary services, and capture the data needed to achieve better outcomes. This then enables meaningful discussions with payers in the pursuit of more equitable fee schedules. Unlike some exit strategies that may not be in the best interest of those doctors who are not partners in a practice, private equity firms can incentivize younger associates to stay with a practice and increase productivity by offering future partnership opportunities upon the exit of the original founders/owners.
Obviously, the COVID-19 pandemic is likely to have a negative impact on valuation, practice growth and exit strategies, at least, in the short term. One recent difficulty is the lack of available employment for young DPMs who are fresh out of residency and this is especially pronounced in the private practice arena.
The advent of COVID-19 may, however, eventually create opportunities for employment as well as exit strategies for older DPMs, especially those doctors who have had no exit plan in place. According to data from James Christina, DPM, the Executive Director of the American Podiatric Medical Association (APMA), it is estimated that of the 21,814 licensed DPMs, 7,199 are baby boomers (born between 1946 and 1964) and 1,099 DPMs are ”traditionalists” (born between 1922 and 1945).2 This equates to 38 percent of practicing DPMs being above the age of 56 with a large percentage in their 60s and 70s. Business owners at this age should definitely have an exit strategy in place.
Even though the possibility of purchasing a practice is not typically something that new practitioners consider, there may be a win-win opportunity for those who are willing to consider this option. Young doctors may accomplish this either through purchasing a practice outright from a doctor who wants to retire or by working in a practice in which the owner wants to begin slowing down now in preparation for retirement in the next five years. I feel that owning a practice or being a partner in one will continue to be better options than working as an employee, and this is something that is unlikely to change anytime soon.
Dr. Hultman is the Executive Director of the California Podiatric Medical Association (CPMA). He is a consultant for Medical Business Advisors and the former CEO of Integrated Physician Systems (IPS). Dr. Hultman is the author of Reengineering the Medical Practice (1994) and The Medical Practitioner’s Survival Handbook (2013).
Dr. Hultman discloses that he is Director of Data Analytics for Talar Medical (a podiatric specific GPO) and that CPMA provides marketing support for DPMGPO (a non-profit podiatric specific GPO developed by the Los Angeles Podiatric Medical Association).
1. 2016 U.S. Trust Insights On Wealth And Worth. Available at: http://doingmorethatmatters.com/wp-content/uploads/2016/09/US_Trust-Wealth-and-Worth-Study-2016.pdf. Published 2016. Accessed October 31, 2020.
2. Personal communication with James Christina, DPM.