April 1999 Bulletin

Selling a practice

'The way you value a practice is by asking how profitable is the business.'

Amenities, payer mix appraisals play a role in how much you can get

By Sandra Lee Breisch

Whenever the idea of retiring comes to mind, you will likely wonder about what you can expect to get from the sale of your practice.

"This really depends upon many factors such as your practice's location, productivity and payer mix, compared with others in the market," explains Mark Rust, a Chicago healthcare attorney.

It's true that a practice with a good physical layout, in good condition, with outpatient services, parking and accessibility via public transportation is an attractive lure. But having a good payer mix is key, notes Rust. "It tells a potential buyer a great deal about the stability of a practice's finances," he says. For example, does the practice have a financially stable balance of managed care contracts, indemnity insurance and Medicare and Medicaid contracts?

A negative might be if the market is moving out of the fee-for-service environment into the managed care arena. If so, the future income potential will change, says Rust.

Value also is placed on potential affiliations or merger partners and their market positions; how physician(s) are compensated, direct contracting and managed care strategies; practice style; and utilization review and quality assurance activities, notes Rust.

What are buyers looking for? Although your bundle of managed care contracts might look like a good way to ensure patient flow, buyers want to make sure the capitation rate is high enough to cover the volume of services they'll have to provide. "Buyers want to know, 'Am I going to get patients and get paid to take care of them?,' says Robert J. Cimasi, president of Health Capital Consultants, St. Louis, Mo. "Any fool can take an HMO contract and be responsible and do orthopaedic carve-outs for a large number of covered lives. But sometimes the more patients you get, the more money you lose."

Today, respect and reputation is "getting more difficult" to define for the selling orthopaedist since they rely on managed care providers and do not own or control referral sources, notes Cimasi. "So if you're a buyer, you're asking, 'Does the seller have any leverage in the marketplace?'" Cimasi says. "Will I have a choice to dictate or negotiate some terms on how I practice and what cases get referred to me?'"

Appraisals help you determine your practice's market value. But be aware that the market value of your practice is what the buyer wants to pay for it. Rust recommends getting appraisals by individuals certified by the American Society of Appraisers, the Institute of Certified Business or other organizations.

"If a potential buyer presents an appraisal, you still have a right to require an independent review of any appraisal a potential buyer makes and you should be able to choose your own appraiser," he explains.

The appraisal includes the furniture, fixtures and equipment. "They're easy to value and will be very close to book value," says Robert J. Krypel, a healthcare management consultant at The Abrix Group, L.P. However, he says that an expert may be required to value the practice's more sophisticated equipment such as a CT or MRI.

An appraisal will factor-in the stability of the market and the competitive environment. For instance "if the hospital in town has bought up every single primary care physician practice and is telling the physicians where to refer [orthopaedic cases]."

How do you put a price tag on the practice? Elizabeth Woodcock, a Medical Group Management Association (MGMA) consultant says, "Most practices are evaluated on a discounted cash flow basis, but it totally depends on who your seller is and if it's a young physician who wants to take over your practice."

"Discounted cash flow is a very specific methodology that uses discount factors to calculate the present value of future cash flows. It means if a physician is due to get $1,000 in year 2003 for a procedure, they'd be willing to take $850 to get it now. The discount is what you pay to gain that advantage." However, she says many physicians "won't go through the rigmarole" of having a discounted cash flow analysis done for them.

"The way you value a practice is by asking, 'How profitable is the business?' explains Rust. "The trick in physician practices is there's never a line that says 'profit' on the balance sheet. They don't have profits. They take everything out in compensation. And in a year that's really, really good, everything comes out in compensation. So, they have higher compensation, but they don't have higher profit."

Rust recommends coming up with a firm profit number and a mechanism of doing a rough calculation of what the value would be theoretically.

"It's called make believe," explains Hobie Collins, an MGMA consultant. "What you assume in looking at the calculations is that the orthopaedist would take a lower salary. Let's say a person generates $1 million a year. If that orthopaedist takes a salary of $500,000 and operating expenses are $500,000, the orthopaedist breaks even. If you did an analysis assuming that the orthopaedist had $1 million a year in income and fixed expenses were $500,000, and the orthopaedist took a salary of $450,000-there would be $50,000 profit. That $50,000 profit projected over five years gives you a revenue base for those discounted cash flow calculations."

In valuation, the size, reputation and whether the physicians who are not partners have restrictive covenants are all very important factors as well, notes Rust. "A relatively large orthopaedic practice that has a big reputation and a large number of surgeons who are already employed, but are not shareholders and have restrictive covenants is far more valuable than a solo practitioner who's living on his/her own reputation," he says. "The big question is, 'can that reputation transfer to someone who he/she sells the practice to?'"

Timetable for closing a practice

Because of the ethical and legal obligations to provide medical services to patients, physicians must take appropriate steps to inform their patients that they're retiring.

One year before closure you should contact your accountant and/or attorney, advises Elizabeth Woodcock, a Medical Group Management Association (MGMA) consultant, "Orthopaedists need to begin planning for retirement income, health benefits, disability insurance and life insurance policies, for themselves and their office staff," she says.

Six months before closure, contact your state medical society to obtain its rules regarding storage of medical records, notes Woodcock.

Three months before closure you should prepare the patient letter, advises Woodcock. Prepare a letter to your active patients, generally those seen within the last two years. It should include, at a minimum:

Add a statement in the letter regarding prompt payment of all outstanding bills, and be sure to include a forwarding address.

The patient letter is also the best means to thank your patient for having had the opportunity to serve them.

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