05 Nov Buying or selling a medical practice – how do you calculate the value?
We are often asked to value medical practices, whether it be acting for the vendor or the potential purchaser. Buying a medical practice is often the best investment a doctor makes, providing the potential to generate higher income than what would otherwise be generated as a non-owner.
What is goodwill?
Goodwill represents an intangible asset of a business that includes the value of the practice’s brand/reputation, solid patient base, stable staffing, systems and procedures. Goodwill exists if the practice has a maintainable competitive advantage that generates above average profits that can be passed on to a new owner. That is, the practice profits exceed the amount that you can otherwise earn as a non-owner paying a management fee to a practice.
How do you value a practice?
Market value is the price a willing but not too anxious buyer, and a willing but not too anxious seller will agree on.
There is no commonality in practice valuations as every practice is different when calculating goodwill. Some practices have very little or no goodwill value and others have substantial value. It varies from practice to practice and is ultimately dependent on the different categories of income generated and who generates the income. Firstly, a lot of goodwill value is attributable to the owner of the practice who normally continues seeing patients and generates part of the gross income in the practice. The patients have a personal preference to seeing that doctor for their professional skills and expertise. Therefore, we see this as personally generated goodwill that will easily follow the doctor if they were to move to another practice nearby.
So, what creates goodwill value in a practice?
Engaging other medical or dental practitioners is the most profitable addition to a practice. But if this is not possible then consider other specialist and allied health professionals too. Make sure they pay an appropriate market management fee to be part of the practice’s patient eco-system.
Other forms of passive income include income generated in the form of government incentive payments and sub-leasing of practice premises to pathology or other specialist and allied health professionals.
The nicest profit is one made for you by someone else and this is what we call passive income. It is this which creates goodwill value in a practice.
How to enhance goodwill value
There is no complete list of the qualities that create goodwill, but it is likely to include the following:
- Stable and personable assistants and associates, who have their own lists of patients, and who are able to operate at a maximum capacity, with minimal supervision and control (and who do not intend to, or who are contractually prevented from, setting up an opposition practice in the same locality);
- Established relationships with allied health care professionals, such as physiotherapists, pathologists and chemists, ensuring the practice can provide a broad range of services. In dentistry this includes the services of hygienists.
- Increasingly, a market niche or practice specialty that attracts a particular type of patient, as well as the general practice. Examples of this include skin cancer, geriatrics, sports medicine, a language expertise, and women’s medicine. In dentistry it may include cosmetic or paediatric dentistry specialist areas;
- Efficient support staff that enjoy a friendly rapport with patients;
- Clean modern premises that are easily accessible, have adequate car parking space and, preferably, a play area for children, with some form of entertainment for adults, so patients find the ambient surroundings comfortable;
- Good location, both within a particular suburb and as to the choice of suburb or region itself, and the related issue of a practice’s physical presentation; and
- In some cases, specialist equipment, that has a high cost or market interest, creates a barrier to entry for a particular type of procedure or treatment, thus bringing patients to this particular practice.
How is goodwill value calculated for a potential buyer?
Let’s take a non-owner General Practitioner engaged as an Independent Associate paying a market management fee of 35% to the practice for the administrative services provided to them. The doctor will need to generate income from their own personal exertion and therefore, there’s a natural limit to the amount that can be generated depending on their style of practicing medicine. The doctor then receives 65% of the gross income after paying the management fees to the host practice.
When evaluating the potential purchase of a medical practice, the key calculation in this instance would be: how much would you receive over and above what you would otherwise receive as a non-owner paying a management fee to the practice?
How is goodwill value calculated for a potential seller?
In this instance you may have the complexity of multiple owners at different age groups and retirement plans. However, the goodwill calculation is somewhat similar in that an adjustment should be made to the income generated by the owners to reflect a true market return. Ultimately the same calculation is sort where it is determined how much an owner receives over and above what a non-owner would receive paying a market management fee to the practice.
A mark of a good practice is to demonstrate ability to produce an above average return for its owners. Prospective buyers will be prepared to pay a premium over the value of the practice’s tangible assets to receive that above average return.
To buy an existing medical practice or set up a new one?
There is no definite right or wrong: some people are better off starting their own practice, and some are better off buying an established one. More often than not, our advice tends to be “buy if at all possible”. Starting a new practice from scratch is a more daunting option. It takes time and creates stress and will incur higher risks than purchasing a perfectly good practice down the road. It can take months for a new practice to get up and running before you start seeing the monetary benefit. Those starting a new practice will still experience the teething issues relating to human resources as you would with historical legacy staffing issues in an existing practice.
Buying an existing practice has more certainty. It allows you to be confident that the patients will be there. This lowers risk and ensures there is income from day one. The ideal scenario for a purchaser is working in the practice before buying to become familiar with its strength and weaknesses. This is the best due diligence: real hands on experience in the practice. Know the patients, the other health professionals and the staff. You learn what makes it tick, and can be confident it will be there for you once you own it.
Is the price right?
Negotiations are dynamic, and backing intuition is usually the best thing to do. It is a good idea to get someone else to double check the reasoning. This helps to ensure decisions are not rushed and a true market value is obtained for the sale and, in the case of a purchaser, you avoid paying an above market price. At the end of the day, both parties must be satisfied on the matter of price and therefore, it makes sense engaging someone else to value and negotiate the transaction on your behalf. Emotional indifference can be a wonderful asset in a negotiation, and can throw an objective perspective over the whole proposal.
Once a price is agreed, it should then be set aside. Negotiations are difficult and, in most cases, it will never be known whether a better price could have been reached. Once the price is agreed it is time to begin making the practice work. Don’t look back. No regrets!
Need help with a medical practice valuation?
Given our extensive knowledge and experience in the medical, dental and allied health industry, we have been engaged in a number of sale and purchase transactions to value the goodwill to determine a fair and reasonable market value.
Whether you are considering buying or selling all or part of a practice we can assist you in reviewing the practice and preparing a formal Valuation Report to assist you in negotiating your way to a favourable outcome.
Please do not hesitate to contact us should you wish to discuss our services further.
General Advice Warning
This advice may not be suitable to you because it contains general advice which does not take into consideration any of your personal circumstances. All strategies and information provided on this website are general advice only. Please arrange an appointment to seek personal financial and taxation advice prior to acting on this information.