[Editor's Note: Do you want to change somebody’s financial life? Would you like to help keep the future of medicine healthy? Then, consider donating to the WCI Medical School Scholarship, where we’re giving away tens of thousands of dollars to those professional students who will shape the next few decades of medicine. WCI is donating $25,000, but we’d love for you to help as well. Every year, the scholarship recipients tell us how much winning has positively impacted their educational journey. Your donation, no matter the size, would do the same! Make sure to check out the info for the WCI Medical School Scholarship today.]
By Fiona Smith, Guest Writer
Owning a medical practice is likely the largest financial investment of your life. Not only do you pour your heart and soul into your business, but most often, you also pour your money into it. With that said, it’s essential to know how to value your medical practice so you can make a sizeable profit once you decide to sell.
Let’s dive into some of the key elements you should know before you value your business.
#1 Understand the Meaning of a Business Valuation
If you’re planning to sell your business at a profit, the very first thing you need to know is the meaning of valuing your business.
While there is no perfect formula to value any medical practice, there are several factors that go into valuing a business, which includes:
- Your liabilities
- Your insurance mix
- Your practice’s reputation
- Your current income stream
- The seasonality of your clients
- The specialization of your practice
- The quality and quantity of your referrals
While there are several other factors that can play a role in determining the value of your business, the single most important factor likely will be your practice’s cash flow. In fact, in many other industries, the valuation of a company is often heavily based on the cash flow (which, in turn, is then multiplied by a set number of years to determine the sale price of the company).
Over the past two decades, it has been a common procedure for medical practices to evaluate the sale price of their practice by multiplying the annual gross revenue by a factor of 1 to 1.25.
To pin down the actual number of your revenue multiplier, you’ll probably have to drill into several additional details, including (but not limited to):
- How long your organization has been around
- The number (and level) of competitors in your area
- Your industry focus (the multiplier is different, depending on the industry in which you specialize)
In other words, if you own a company specializing in durable goods, you may expect a different factor than if you owned a private medical practice. To determine the appropriate factor for your business and industry specialization, you should consult a business valuation expert.
In recent years, however, the annual revenue multiplier may have decreased, so it’s even more important to understand the factors determining the value of your practice. In fact, some general practices may even sell between 0.5 to just under 1x their annual revenue.
As an example, if your medical practice earns a gross annual revenue of $1 million and your business valuation expert determines that your medical practice valuation multiple is 0.9, then you could expect to sell your medical practice at around $900,000.
While it might not seem logical to sell a practice for less than what you earn annually, recent trends indicate that it has become more common to sell medical practices for an amount that’s less than what they earn per year.
Just keep in mind that the hypothetical $900,000 is merely a starting point when determining an appropriate value for your business. Your business valuation expert may justify a higher sales price if you have medical equipment worth several hundred thousand dollars, a strong company brand, etc.
Another driving factor in valuing your business really comes down to whether you stay with your old practice. Sometimes, business transfers may require or highly encourage the former owners to stay with the business for one or even multiple years before they can officially leave. One reason why some contracts ask that you stay with your medical practice a few years after you’ve officially sold is to help with the transition. It’s likely that your old clients will feel more comfortable with the transition knowing that you’re still a part of the practice, and the new owners can also learn more from you, as it relates to operating your practice.
More information here:
Tips for Buying and Selling a Practice
#2 The Importance of Business Valuations
Of course, before you sell your business, it’s important to understand why you should consider valuing your business in the first place. Even if you’re not looking to sell the business right away, it’s still important to know.
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.
There are several other key motivations why business valuations can be so beneficial for business owners—even if the goal is not to sell in the near future.
Below are four additional reasons why business valuations are useful:
- Litigation purposes
- Tax reporting purposes
- Transactional purposes
- Financial reporting purposes
As it relates to litigation purposes, business valuations can be used in the case of divorce, possible shareholder disputes, or even economic damages (COVID and the recent PPP loans are prime examples of this). On the other hand, business valuations can also be very useful when it comes to tax reporting. For example, if you plan to gift your medical practice, your accountant or CPA will have to better understand the gift tax and/or estate tax implications of gifting your business to another party.
In fact, if you’ve worked on your medical practice for a large portion of your life, you may have a significant amount of your net worth tied up in your business. A heavy concentration of your net worth in one area could cause future estate planning complications, which may result in you overpaying in federal, estate, and/or gift taxes.
If you are charitably inclined and plan to donate a portion of your cash flow and/or equipment to charity (as an example), business valuations could also come in handy.
From a transactional standpoint, business valuations could help you plan your exit strategy, your partner buy-sell agreements, your equity financing tactics, and so on. If your business offers employee stock option plans (ESOPs), business valuations could also be of use in this scenario.
Finally, business valuations can offer much insight into financial reports. This could include anything from valuing your overall net worth to determining purchase price allocations when undergoing an acquisition.
#3 How to Determine Your Practice’s Value
If you plan to move ahead and value your practice, there are typically three common business valuation approaches used in assessing your company’s worth.
The three methods include:
- Asset approach
- Market approach
- Income approach
In most cases, the business valuation method that is most useful to you and your medical practice typically is determined by several variables, which include the reason behind your business valuation (e.g., estate planning, divorce, buy-sell agreement, etc.) and the specialization of the company that’s being valued.
The Asset Approach
The asset approach (sometimes referred to as the cost approach) determines the value of your business by combining the fair market value of the net value of your practice’s assets (in other words, assets – liabilities).
The asset approach technique is commonly used to value underperforming companies, so this is probably not a business valuation method that you would employ for your medical practice.
The Market Approach
The market approach mainly focuses on comparing your medical practice to other medical practices in your similar niche, industry, location, etc.
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.
The Income Approach
Lastly, the income approach is a business valuation method that is often implemented when public information about competitors is not readily found.
This valuation approach typically weighs the expected benefits from investing in a company against the required rate of return, taking risk into account. The income approach translates future cash flow figures into present value numbers. Typically speaking, the income approach works best for more established businesses with a profitable and reliable income stream.
While there are many additional factors that are used to determine a business’s value, the descriptions here provide a basic understanding of the three main business valuation methods.
More information here:
Selling Your Medical Practice for an Early Retirement
#4 The Information You Need to Conduct a Sound Business Valuation
If you’re just about ready to start your business valuation process, you’ll have some work on your part as well—not just the business valuation specialist. To help ensure that the process goes as smoothly as possible, it would be helpful for you to collect a list of items before your practice is valued.
Some of the most important items are listed below:
- Intellectual assets
- Income statements
- Business projections
- Financial statements
- Your most recent tax return
- Photos of your medical practice facility
While all documents are important to gather, one of the most important items you can find for your business valuation is your balance sheet. Most business valuation specialists actually require financial statements lasting from the last 3-5 years in addition to your current year’s financial statements.
Financial statements can include documents such as:
- Balance sheets
- Income statements
- Cash flow statements
Especially if you’re just venturing into starting your own medical practice, make sure you take impeccable care of your records, financial statements, etc.
#5 The Cost of a Business Valuation
One of the most important items to understand before you pursue hiring a business valuation specialist is the actual cost of the business valuation itself. Unfortunately, the answer to this question is: It depends on the situation.
However, the range of the typical cost of a business valuation is generally between $3,000-$20,000+. How much you actually pay depends on the scope of the work. For example, if you hire a specialist to focus on only creating what is known as a Summary Valuation Report, then you’ll likely be charged on the lower end of the spectrum. But if you’re looking to hire someone to conduct a Detailed Valuation Report, then you’ll probably start looking at the higher fees. Detailed Valuation Reports typically require the specialist to use a more in-depth approach when calculating the value of your business.
Most business valuation fees will be charged in one of two ways: Either you’ll pay a flat fee or an hourly fee. If you’re considering hiring someone to conduct an in-depth review of your medical practice, then it could make sense to consider the flat fee structure (if this even is an option).
Before you actually engage with the specialist, it would be helpful to hop on an introductory call (or even meet in person) to discuss your thoughts and the scope of the engagement for which you’re planning to hire the specialist.
Typically, the specialist could then draft a free quote for you to better estimate how much this process could cost you.
Bonus Element: Hiring the Right People
If you don’t know anyone personally who is a business valuation specialist, then your first stop may be asking your accountant for a referral. If your accountant is not familiar with someone in the area, you may want to chat with your wealth advisor or even your attorney. Otherwise, you can simply do a quick online search for business valuation specialists.
Now, before you commit yourself financially to a business valuation specialist, there may be a few things that you should keep an eye on. First and foremost, you’ll probably want to consider hiring an accredited business appraiser to do the job. Accredited business appraisers come with the specialized hours of training and expertise needed to conduct a solid and tenable business valuation report. Second, you may want to consider reviewing the business appraiser’s additional certifications.
Some of the most common certifications include:
- Certified Valuation Analyst (CVA)
- Accredited Senior Appraiser (ASA)
- Certified Business Appraiser (CBA)
- Accredited in Business Valuation of the AICPA (ABV)
While there are no formal undergraduate or graduate degrees and there are no formal licensing requirements set forth in the business valuation industry, it would be prudent for you to consider hiring someone with experience and certifications. For example, the ASA (Accredited Senior Appraiser) and the CBA (Certified Business Appraiser) certifications both imply that the specialist has been active in the business valuation field for a minimum of five years, has good ethical standing, and has completed continuing education courses.
The ASA certificate holders also demonstrate they have proficiently passed four levels of coursework in addition to written and oral exams.
In addition to analyzing a business valuation expert’s designations, experience, and credentials, you may also want to ask whether they approach your business valuation from an individual or a team perspective. From my experience, those who approach a project with a team typically perform better. Two brains are often better than one.
More information here:
First-Year Review of Our Medical Practice Startup
Closing Thoughts
If you’re starting to venture into opening a medical practice or if you’ve already established your own practice, chances are this business will be the largest financial transaction of your life. Since you’ll be spending such a large part of your life working on your business, it’s never a bad idea to be proactive and consider your exit options.
One of the best tips my mentor (who sold his business, albeit not in the medical industry, for 75x the original value) once told me is to impeccably track your finances. Keep track of your financial statements, gross and net revenue, expenses, etc., and you will thank yourself later.
Have you ever undergone a business valuation of your practice? What did you learn? Was your practice worth more or less than you originally believed? What other tips and tricks do you have for selling your practice? Comment below!
[Editor's Note: Fiona Smith is the founder of The Millennial Money Woman. She holds her Master of Science Degree in Personal Financial Planning, and she has co-founded a local nonprofit community teaching financial literacy. This article reflects her own views, ideas, and opinions. She is not an investment advisor, and she always recommends you communicate with your accountant and financial advisor before investing. This article was submitted and approved according to our Guest Post Policy. We have no financial relationship.]
The post Valuing Your Medical Practice: 5 Most Important Elements appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.