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Valuing a Medical or Dental Practice

March 30, 2015

Valuing a medical or dental practice is not an exact science. There is not one correct answer to the value of a practice, but that does not mean the value is arbitrary. There are methods to employ to determine a reasonable and defendable opinion of the value. Credible valuations contain background information and clear documentation to support how and why a value is achieved.

There are several methods used to value a medical or dental practice including the asset approach, the income approach and the excess earnings approach.  There are also other factors to consider such as risk and compensation structure.  With some time and effort an acceptable value can be determined and the sale of the practice will be successful.

Asset Approach
Medical and dental practices consist of assets. Assets are those items that can be used by the purchaser in order to generate a return on investment.  There are tangible assets such as equipment and inventory, and there are intangible assets such as a trained workforce and professional goodwill.  Professional goodwill includes a favorable location, patient lists or a trade name, depending upon the market’s perception of the name.

The asset approach is most applicable to practices with a large amount of tangible assets. The basis of this method is to examine the fair market value of the practice’s tangible assets against its liabilities. This approach does not consider any intangible assets, therefore it provides a floor value of the practice.  If intangible assets exist they must be added in to determine the whole value of the practice.  This approach is especially useful in the event of a liquidation, when no goodwill value is present.

Income Approach
If the practice is profitable, the income approach is the best method to employ.  The valuation is based on an analysis of the practice’s historical income and expected future income.  A potential buyer would consider the return on investment available from the purchase of the practice above what they could earn through simple employment. For example, if a physician can find employment with compensation equaling $150,000 a year, a practice that earns only $100,000 would have no value to him or her. 

A practice that earns $250,000 per year would have value to the physician, as it shows potential to increase the physician’s yearly compensation.  The income approach captures all tangible and intangible assets of the practice, but does not distinguish between the two.  Value is determined only by the return available.

Excess Earnings Approach
The excess earnings approach is a combination of the asset approach and the income approach.  This approach considers both the net tangible assets of the practice and the return on investment to determine a value.

Risk Assessment
Industry risk and the individual practice’s risk are considered during the valuation process.  These are important when determining cash flows and the ability to sustain those cash flows into the future. Some factors to consider are the practice’s specialty, recurring patient base, payer mix and quality of contracts and number of active patients.

Benchmarking the practice against other practices in the same specialty can help determine risk levels. Specific benchmarks can be acquired from sources like the Medical Group Management Associates (MGMA), the American Dental Association (ADA) and other medical societies.

Compensation Structure
Another important factor to consider when valuing a medical or dental practice is the compensation structure.  Physicians and dentists in private practices are used to receiving all earnings left over after expenses have been paid, however, a new owner of the practice will require some return on their investment. These two conflicting requirements will result in a reduced level of compensation for one of the parties.

A solution to this problem is a pre-compensation earnings (PCE) split.  An example of this would be a 90/10 split, which pays the physician or dentist 90% of the PCE and gives the owner a 10% return on investment.

There are many reasons to get a medical or dental practice valuation, including the sale of the practice, merging with another practice, buy-in or pay-out of a new or retiring partner or the divorce of current owners.  No matter the situation, it is important to realize there is not one correct value, but there are methods to apply to determine an acceptable range.

An accurate valuation considers factors like risk and compensation structure, and can be supported by documentation and facts.  Valuing a medical or dental practice is complex.  Working with a trusted advisor like the Commercial Lenders at Peoples Bank helps to ensure a smooth and successful transaction.