Practice valuations

This post is for those of you who want to go solo by purchasing a existing practice. It might also be useful for someone who is looking to buy in or out of a group. Keep in mind that these are general guidelines; the free market dictates the price. Just like Zillow’s estimate doesn’t determine what your house will sell for.

Some folks think the practice isn’t worth more than the eBay price of the equipment,  but if someone had picked a good location, equipped it, credentialed me, and had hired well trained staff, I wouldn’t have had to sit around for a few months opening my practice, and in the first few months I would’ve seen more than four patients per day.

But sometimes you overpay for what you get, or the practice may need lots of changes.  Here’s a post about the pros and cons of starting from scratch vs buying a practice. The good thing about starting from scratch is when I was seeing four patients per day, I learned every last detail about how to run my practice, which has paid multiples now that my practice is busier. It runs on autopilot now.

When I posted this article on our google groups, I was surprised at some of the responses I got.  Some people thought my post was spot on, while others noted they overpaid for their practices but were nevertheless happy with the way things turned out. I have heard of one person underpaying for their practice.

A quick ballpark for practice value is 60-80% of last years collections.

By the way, the consultants charge several thousand for a rough valuation and up to $10-15k for full valuation and negotiation.

If there are five people in a group and the sixth is buying in, the entire practice is valued and divided by six. This number will be the buy in for the new partner.

Basically, the value of the practice is accounts receivable plus equipment plus goodwill. Let’s break down each of the following:

Accounts receivable is the amount the practice is owed by patients and insurance companies. It can be dated by age. Obviously debts that are 0-30 days have a higher chance of collection vs debts over 120 days. So you can value a percent for each bucket depending on the age of it, or perhaps just value AR as debts under 90 days, rendering debts over 90 days as uncollectible.  Personally, I’d be reluctant to purchase AR over 60 days.

A quick estimate of this for a practice with sound collections policies is two weeks’ collections, take the annual collections and divide by 26.

Equipment can be ball parked as declining 10 percent every year starting from the year of purchase, with a 20 percent floor, as long as the equipment is in use. So say I spent $200,000 on my equipment in 2013. At the end of 2014 it would be valued at $180,000, and at the end of 2017, $120,000. In 2020 and onward it would be valued at $40,000.

Now, obviously your phoropter, chair, gonioscopy lens would hold value over time, while your computers aren’t going to be worth anything after about four years, and I doubt people would pay much for a EHR or PM system over seven years old, unless it’s been updated. But when you average everything out, this is a quick and simple way to figure out a number.

Obviously, over the years you will be buying and updating to newer equipment and testing machines.

For equipment leases with $1 buyout, use the same formula declining 10% every year but subtract the amount owed on the lease; you could be upside down on the equipment if you owe more than what it’s worth.

The other way to do this is to hire an appraiser and value the equipment, and then find some way to value your computers, EHR, etc.

You then add the assets in the practice (office supplies, frames if you have an optical, etc; even the value of prepaid malpractice and business insurance), and then subtract any accounts payable such as payroll and future liabilities the practice may have (often retirement plan matches for employees that are paid once a year as a common liability).

Goodwill is the final component. Despite what people think, goodwill is very much a part of ophthalmology practice sales; not so much in internal med and peds. Basically it is compensation for the effort and sweat and lost wages for someone to start their own practice. According to consultants over 80-85 percent of practice sales have goodwill as a component.

According to practice brokers, the average goodwill for ophthalmology practices is 27-28% of what the practice has collected in the last year. So if your practice collected $800,000 last year the goodwill is approximately $215,000.

There can be tremendous variation in goodwill. If you are in a rural area and the only ophthalmologist in the county, why should someone buy your practice when they can open up right next door and capture a lot of your business? Conversely if you are a cash only practice on the Upper East Side of New York, that is not easy to establish, and you can bet that there will be higher goodwill. Even if you’re in a saturated area, if your practice is predominantly glaucoma and there is a shortage of glaucoma specialists, it will lower your goodwill. The more competition and the harder it would be to establish a practice, the higher the goodwill.

If the practice is contracted with plans that are difficult to get on to, such as medicare advantage programs, and it can passed on to whoever buys the practice, this will increase goodwill. The negotiated rates with plans is another factor, the better they are the higher the goodwill.

Other factors include: overhead (no one wants to inherit a practice saddled with high expenses), revenues, patient demographics (growing or saturated area, even practice name and internet site (Santa Clara Ophthalmology and http://www.sceyes.com are more transferable then the Choi Eye Institute and corresponding internet site.) For groups with physician employees, restrictive covenants have value. In CA and MA where they are not enforceable, group practices have less goodwill.

Analyze what procedures the senior partner (or existing doctors in a bigger group) perform. If they have a 50% conversion rate to premium lenses and do a lot of Botox and fillers, while you practice more conservatively, you might be overpaying for goodwill as you won’t be generating as much revenue.

Finally, in the case of a solo practitioner bringing on a partner, they recommend selling 50 percent so both partners are equal, to avoid resentment. But there will be a clause saying for X number of years (usually 5) if there are disagreements and the partnership is broken, he senior partner buys back and the junior partner leaves.

Usually in the instance of a junior partner buy-in goodwill is calculated as a percent of receivables (55/45 for instance).

A common question from someone looking to buy in is: “I’m the one that built the practice and now to buy in I have to pay a percent of what I made to become an owner?”  Generally speaking, that’s the price you pay for not having to start a practice.

So as a summary, the average solo ophthalmology practice collects $800,000 a year, meaning goodwill is about $215,000.  Equipment for a solo doc might run $200-350,000, so after five years let’s assume a price of $140,000.  And finally, for a efficient well run practice accounts receivable might run two weeks’ worth of collections, or about $30,000.  Adding these components gives you a ballpark of $390,000 to 400,000, so if your senior partner tries to tell you your buy in is $800,000 when your current salary is $250,000, start asking hard questions, or start reading my post on the steps to start a solo practice!

Just a note- if you offered me $800,000 for my practice I would probably decline because I’m happy with my situation and don’t want to start up elsewhere, which would take my time and energy as well as result in less patients and a lower salary for the next few years. So these are not hard and fast rules and it depends on how motivated the seller and the buyer are.

I am curious to hear what those of you that have actually purchased a practice have experienced, so please feel free to share with us.