Medic Management Blog | Thought Leadership

Methodologies and Processes used in Valuation of a Medical Practice

Written by Ronnen Isakov | Apr 14, 2023 5:29:50 PM

A recent American Medical Association (AMA) survey suggests that physicians today are less often working in physician-owned practices and more often seeking positions at hospitals, health systems, insurance or corporate-owned medical groups. Just over 49% of the national survey’s 3,500 respondents were working in private practice as of fall 2020, a drop from the 54% reported in 2018. This difference is the largest shift the AMA has observed between polls since kicking off its biennial surveys in 2012. It's also the first time the proportion has ever dropped below 50%.

It is not hard to see that the healthcare industry’s increasing merger and acquisition activity, physician job changes and the new crop of young physicians entering the workforce have had a major impact on the number of independent physician owned practices. On the other hand, despite the decrease, almost half of all practices are still independent and physician owned.

For the most part, the healthcare industry is still a fragmented market. Health systems remain motivated to acquire practices to maintain market share and increase patient access and throughput. Private equity buyers continue to pursue a strategy of purchasing practices at beneficial multiples, allowing them to improve profit margins by streamlining operations and using provider scale to achieve efficiencies and negotiations with payor contracting for financial profitability.  

If you are actively considering selling your practice, and you’re starting to have conversations with Hospitals, Health Systems, Private Equity or other players in your markets, it is important understand the meaning of valuing your medical group. This is likely one of the most substantial decisions you will make in your career, so it is important to have a thoughtful and well-planned approach.

First and foremost, a business valuation provides owners with insightful information and details relative to calculating their practice’s risks and performance, when compared to its peers. In simpler terms, a business valuation can provide a business owner with both qualitative and quantitative information regarding the opportunities and the opportunity costs associated with selling their business.

Below, we’ll detail the methodologies, processes and requirements involved in valuation of a medical practice.

Valuation Methodologies

Practice Value is determined by some combination of the following three most common approaches:

  • Market Approach – A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold in prior periods (e.g., what did other similar practices sell for?). This is often referenced as the Merger and Acquisition (M&A) Method. After analyzing the risk and return characteristics of the comparable public companies and/or the target companies relative to the subject practice, appropriate valuation multiples are applied to the operating results (e.g., revenue, EBITDA, etc.) of the subject practice to develop indications of value. While the market approach to valuing businesses can be very helpful if your competitors are public companies or companies with public information, this approach will likely be difficult to implement if your competitors do not have readily available information, which is the case for most community-based medical group practices.
  • Asset (Cost‐based) Approach – A general way of determining a value indication of a business, business ownership interest, or security using one or more methods based on the value of the assets net of liabilities. For physician practices that are not expected to generate positive cash flows, application of the Income Approach and Market Approach may result in a value below that of the market value of the practice’s net assets, therefore this approach is most often used when a buyer is only interested in valuing the Tangible and Intangible Assets of the Practice. In the Adjusted Book Value Method, a common form of the Asset Approach, the market value of each balance sheet asset is determined, including the value of any off-balance sheet assets (e.g., accounts receivable if cash basis accounting is used), and then netted against the market value of liabilities.
  • Income Approach – A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated future economic benefits into a single present amount. Often referred to as either the Discount Cash Flow Methodology (DCF) or the Capitalized Cash Flow Method (CCF), it is a common methodology that allows valuations to account for Normalization of practice earnings at a multiplier range or discount based on cash flow analysis.

Regulatory Requirements

There are additional key terms for providers to be aware of around valuations when in discussions with hospital or health systems that receive Governmental funding (Medicare & Medicaid), as well as other potential suitors that must meet regulatory and compliance criteria. The most common legal and regulatory requirements around valuation of medical practices or employment compensation revolve around the following:

  • Fair Market Value (FMV) – The price at which property would change hands between a willing buyer and willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.
  • Anti-Kickback Statute (AKS) – The AKS makes it a felony to offer, pay, accept, or solicit payment for the referral of, or the arranging for, the referral of items, services, or patients reimbursed by any federal or state healthcare program.
  • Ethics in Patient Referrals Act (Stark Law) – The Stark Law prohibits a physician with a financial relationship with an entity that provides certain “designated health services” from referring patients to the entity.
  • Commercial Reasonableness (CM) – Where an arrangement appears to be a sensible, prudent business agreement from the perspective of the parties involved, even in the absence of any actual or potential referrals.

Valuation Requirements

As part of the due diligence process, an independent, third-party valuation firm will be retained to perform the Valuation of both the medical practice and, if the physicians will be working as employees of the purchasing entity post transaction, the employed compensation agreement between the buying entity and the group. This is to ensure that the entire agreement between the two parties meets the AKS Statutes, FMV and CM requirements.

The valuation firm will perform a  “deep dive” into practice operations and an overview of the group to get a better understanding of the practice itself, the assets and liabilities of the practice, the historical revenues and expenses of the practice and a projection of expected ongoing operations, including associated risk factors. This will require some work on the part of the practice as well to gather a list of items for the valuation to take place.

Items required to perform this deep dive could include, but are not limited to:

  • 3 years of Historical Financial Statements, including current year’s activity
    • Balance Sheet
    • Income Statement
    • Cash Flow Statements, if available
  • General Ledger Detail for past two years
  • Detail Fixed Asset Listing of the practice
  • A staffing roster including position/role, FTE Status, total wages, employee benefits
  • 2-3 years of W-2s/1099/K-1s
  • 2-3 years of Practice Management (PM) billing reports including CPT data, total charges, total collections by provider and place of service
  • 2 Years of detailed Aged Accounts Receivable reports by Payor 
  • Active Patient Report (any patient seen in the practice over last three years)
  • Detail of any practice liabilities, including operating and capital leases
  • Ancillary Service Detail including Drug, Lab, Pharmacy Contracts, etc.
  • Any business projections that have recently been performed

Conclusion

Having a strong understanding of the valuation process and methodologies is important for physician owners evaluating a potential transaction. From there, finding the right fit and engaging a valuation advisor can make navigating the process significantly easier and, ultimately, lead to more optimal outcomes. While a practice transaction can be one of the biggest decisions in a physician owner’s professional career, having the right knowledge and the right partners can help you proceed with confidence. 

 


Ronnen Isakov is Managing Director Advisory Service of MMG Healthcare Solutions / Medic Management Group. His background includes extensive work in areas including business advisory, valuation, network optimization, transaction support, and project management.