Many dermatologists focus a lot of time and energy on building and maintaining their practice, never thinking the day will come when they will want or need to sell it. But that day will arrive at some point. The sale may involve handing off part of a practice to an existing partner, or selling the practice as a whole to another group or hospital. Whatever the circumstances, one of the first processes you will have to undergo is a valuation. Determining the value of a practice, or part of one, is a detailed and complicated procedure, especially if you have never done it before. Understanding some of the basic tenants of practice valuation can help avoid confusion along the way.
Know the Terminology
If you are considering selling your practice, make sure you understand terms and appraisal definitions. If you ask an accountant to appraise your business, you may be surprised to find that the “book value” given by the accountant is far different than what is known as the fair market value (FMV) that you could actually receive at time of sale. Essentially, the book value of an asset is its original purchase cost, adjusted for any subsequent changes, such as for impairment or depreciation. FMV, on the other hand, is the price that could be obtained by selling an asset on a competitive, open market.
Realizing that there is no absolute sales price is the essence of FMV. When determining valuation, look for a price range with a reasonable floor and ceiling. Determining what is reasonable takes experience and thus, consultants and valuation companies often are able to provide what may be reasonable for your practice. An experienced 3-person team consisting of a consultant, an accountant, and an attorney can help you through the process as you contemplate selling your dermatology practice.
For starters, value is not an absolute number. A dermatology practice’s assets can be grouped into 2 broad categories: physical assets and nonphysical assets. Examples of physical assets include accounts receivable, leaseholds, medical equipment and furnishings, medical records, and real estate. Examples of nonphysical assets include buy/sell agreements, goodwill, managed care contracts, restrictive covenants, and staffing.
Estimates of value differ significantly, depending on the purpose of the appraisal, the acumen of the appraiser, and other factors. Astute appraisers will consider a host of questions and make a valuation that takes the answers to all those questions into account. Some considerations include: What is the value of the practice for purchase or sale? What is the value of a practice for merger? What is the value of practice assets for joint venture with a corporate partner? What is the value to establish buy-in or buy-out arrangements for partners? What is the value of practice assets for purchase or sale, apart from ongoing operations?
Formal Terms of Valuation
Practice appraisers use FMV as the standard to derive a reasonable value for a dermatology practice. FMV means an arm’s length transaction between an unpressured, informed buyer and an unpressured, informed seller. The following are components of valuation calculation.
The “business enterprise value” of a practice equals a combination of all assets (tangible and intangible), and the working capital, of a continuing business. The value of “owner’s equity” equals the combined values of all practice assets (tangible and intangible), less all practice liabilities (booked and contingent). The “working capital value” equals the excess of current assets (cash, accounts receivable, supplies, inventory, prepaid expenses) over current liabilities (accounts payable, accrued liabilities).
Informal Terms of Valuation
Outside the realm of formal negotiations, there are other factors that can occasionally impact the selling price. The “asking price” is often arbitrary and difficult to substantiate, and typically is reduced by a significant percent during negotiations. The “creative price” is derived by way of creative financing; for example, the practice may provide the down payment. The “emotional price” may involve either a motivated buyer or seller, who pays an underinflated or overinflated price for the practice. The “friendly price” is reserved for associates, partners, or other colleagues. The “realistic price” is one that both buyer and seller believe is fair.
What Is My Dermatology Practice Worth?
The ideal result when pricing a dermatology practice is that both the buyer and the seller feel they have received a fair deal. As mentioned earlier, there are many different considerations that go into a practice valuation; however, at its most basic, a practice can be grouped into its tangible and intangible assets, or physical and nonphysical assets.
For most practices, the value of the furniture, equipment and other assets is small and may not amount to very much (unless you recently purchased an expensive piece of equipment). On the other hand, supplies inventory may have significant value and is usually valued at the historic cost of each item. Other tangible assets include prepaid expenses such as malpractice insurance (which may be quite significant). Additionally, if the dermatologists own their office building, it will need to have a current (within 2 years) appraisal. Any mortgage balance will be subtracted from the building’s FMV in order to determine the equity interest of the physician owners.
Intangible assets are by far the most subjective elements of a dermatology practice valuation. What is the value of restrictive covenants? What is the value of the existing medical practice staff? Valuation considerations here should also take into account the payer mix, patient demographics, level of competition, and the geographical location of the practice. And as disheartening as this may be for practice owners to hear, goodwill may be zero in some instances. That is, it may have very little value depending on whom the practice is being sold to.
Accounts receivable is often one of the largest assets of any medical practice. Since physicians never collect 100% of what they are owed, an adjustment is taken into account when valuing practices. A common method to deal with this discrepancy is to use a historical collections rate and apply it to outstanding accounts receivable. This also becomes a point of negotiation because a buyer’s collections success may differ from the seller’s collections success.
Completing the Valuation
The purchase or sale of a practice will be one of the largest and most complex transactions a dermatologist will ever undertake, but understanding the terms and appraisal definitions, as well as the many ways value can be determined.
Mr Hernandez is the chief executive officer and founder of ABISA, LLC, a consultancy specializing in solo and small group practice management (www.abisallc.com).