In the employment model, discussed in the FMV Compensation Perspective, a hospital might be in a position to purchase a physician or group practice as part of its integration strategy. The process of determining future physician compensation, coupled with what price to pay for an existing medical practice, is a tricky one.
Future physician compensation is often based largely on the historical performance of the individual physicians. Since historical compensation for physicians in a private practice is essentially collections from the delivery of professional services less the expenses of running the practice, profits after physician compensation are negligible. As a result, traditional going concern value, where an investor expects to earn a return over and above the costs to operate the business, does not exist. Under these specific circumstances, the value of a physician medical practice boils down to the cost of reproducing the assets necessary to run the practice. In valuation parlance, this entails the application of the cost, or asset-based approach to value.
While identification of the items a physician practice needs to operate is the first step, placing value on each component is the second phase that requires due diligence. Involving the physician or physicians from the early stages, communicating frequently throughout the process and keeping the process transparent will make for a smooth valuation process.
Ask the question, “What is required to reproduce the medical practice from scratch?” The first meeting will involve identifying all tangible and identifiable intangible assets of the practice. Tangible assets generally include medical equipment and instrumentation, furniture and fixtures, such as exam tables and waiting room furniture, office equipment, and computer equipment such as hardware and software, etc. In addition, the practice may also own the real estate in which it operates, or if it leases the space, may have made investments in leasehold improvements that are of value to both buyer and seller for future operations. Other tangible assets include inventories of medical supplies and drugs. Accounts receivable are another tangible asset owned by a medical practice; however, they are not typically included as part of the transaction and the physicians are responsible for the collection of the receivables outstanding prior to the deal’s closing.
The most challenging aspect can be identifying intangible assets that can be included as part of the deal. Below is a list of intangible assets commonly considered when valuing physician practices:
• Medical records
• Insurance contacts, if reimbursement is at favorable rates
• Trained & assembled work force of non-physician providers and office staff
• Trained & assembled work force of employed physicians
• Trade name or trademarks
• Non-competition agreements
As part of the valuation process, it is advisable to include the physicians or practice administrator in the process early on to set expectations for how the practice will be valued, timing of major milestones such as meetings, and delivery of the valuation results. Hopefully the above tips have assisted in gaining perspective in terms of proper identification during business valuations.