EyeNet Magazine


 
Practice Perfect

Know Your Practice’s Worth:
Put a Value on Goodwill

By Chris McDonagh, Associate Editor
 
 

Whether you have invested a lifetime building up a practice or are looking to buy into one, how do you determine what it is worth? For a full valuation, you must go beyond the practice’s bank balances and physical assets and consider its goodwill value.

Putting a price tag on a quality as elusive as goodwill is a challenge, but Mark D. Abruzzo, JD, Dana L. Holtz, JD, and Mark E. Kropiewnicki, JD, have done exactly that in hundreds of practice valuations (see “Meet the Experts”). They offer this advice.

Pills, Bills and Intangibles
Appraisers have developed several ways to estimate total practice value (see “Valuation Methods”). The asset accumulation approach defines practice value as the sum of a practice’s assets minus the sum of its liabilities. Those assets fall into three principal categories: hard assets (such as medical supplies, equipment and furniture), receivables and goodwill.

“Although most hard assets are no longer worth what they cost when purchased, their ‘book’ depreciation is generally more rapid than actual wear and tear. Hence, it is usual to redepreciate assets on a straight-line basis over economically useful lives (perhaps three to five years for computers and seven to 12 years for other assets) with a ‘salvage’ (or floor) value of 15 to 20 percent of original cost. But certain medical equipment, for which there is a secondary market, is often valued by appraisal rather than by formula,” said Mr. Abruzzo.

Accounts receivable should be valued carefully, said Ms. Holtz. “Balances determined uncollectible should be written right off; many appraisers draw the line at one year. With the remaining balances, group them by age and apply the probability of collecting them. For example, accounts aged up to 30 days might be assigned a collection probability of 96 percent; 30 to 60 days: 89 percent; 60 to 90 days: 75 percent; 90 to 120 days: 60 percent; 120 to 180 days: 50 percent; 180 to 365 days: 20 percent. As a rule of thumb, a practice’s AR balance is typically around 13 percent of annual gross receipts. So a practice that has grossed receipts of $1 million during the last year likely has an AR value of $130,000. In other words, if it shut its doors, it could expect actual collection of that amount,” she said.

“When it comes to practice appraisal, there are relatively few disputes over the value of hard assets and AR. Most debate focuses on the value of goodwill,” said Mr. Abruzzo. Goodwill embodies all the intangible factors—such as patient loyalty and the continued reliability of referral sources—that keep revenue flowing into the practice.

What Price Goodwill?
Suppose you are told that the good-will value of your practice is $300,000; how do you know whether that is a fair price?

By looking to past transactions that involved similar practices, you can see what value the parties to those deals placed on goodwill. This will provide you with a ballpark estimate of what your practice’s goodwill might be worth. It was with this in mind that The Health Care Group established the Goodwill Registry (see “Goodwill Hunting”). In this database, all of a practice’s intangibles are grouped together under the notion of goodwill and their value is standardized to a percentage of gross annual income. “If the gross income of a practice is $1 million, and the goodwill value is $300,000, then we standardize it to be 30 percent,” explained Mr. Kropiewnicki.

In recent years, the average goodwill value has been about one-third of gross practice income. Reported values have ranged from zero to more than the entire gross income, but the majority of goodwill values fall within one- to two-fifths of gross income, said Mr. Kropiewnicki. The goodwill value of your practice is likely to lie somewhere within that range, but whether it lies at the low or the high end will depend on the circumstances of your practice: Competitive environment. When expressed as a percentage of gross receipts, the more competitive the market, the greater the goodwill, said Mr. Abruzzo. “Practices in rural areas typically gross more revenue than those in urban areas due to higher reimbursement and lack of competition. The more competitive the market, the less the probability that outside forces such as increased competition will impact a practice. The less competitive the market, the greater the risk that increased competition will have an adverse impact on the practice.”

Competitive environment. When expressed as a percentage of gross receipts, the more competitive the market, the greater the goodwill, said Mr. Abruzzo. “Practices in rural areas typically gross more revenue than those in urban areas due to higher reimbursement and lack of competition. The more competitive the market, the less the probability that outside forces such as increased competition will impact a practice. The less competitive the market, the greater the risk that increased competition will have an adverse impact on the practice.”

Degree of specialization. “In a primary care practice, provided the buyer does a good transitioning job, the patients will transfer pretty readily,” said Mr. Kropiewnicki. Existing patients will continue to return for annual checkups and recommend you to others. “The less specialized the nature of the practice, the greater the goodwill factor,” concurred Mr. Abruzzo. But in a more specialized practice—for instance, a retina practice—there is less continuity of care. Patients are referred to you by other physicians and prospective purchasers have no assurance that they will continue to get those referrals.

Noncompete agreements. If doctors are allowed to leave a practice and compete against it, that will reduce the goodwill value.

Overhead. If a practice’s overhead is unusually high or low, then you should adjust the goodwill percentage accordingly. “It’s not quite lockstep, but we do see some correlation,” said Mr. Kropiewnicki.

Patient demographics. You should consider how demographic trends will impact future revenues, said Ms. Holtz. “Is it a growing community or are patients leaving? If you do a lot of LASIK, what’s happening to the community’s median income? Are a lot of young professionals moving to the area?”

Payer mix. Prospective buyers will want to know whether you have a Medicare- or Medicaid-based practice. Having a steady income stream—provided you don’t have to work excessively hard for it—will increase the goodwill value of your practice, said Mr. Kropiewnicki.

Reimbursement trends for your subspecialty. The fall in reimbursement rates is one reason why ophthalmic goodwill values have fallen over the last 10 years, said Mr. Kropiewnicki.


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Meet the Experts

Mark D. Abruzzo, JD,
and Dana L. Holtz, JD, are partners at Wade, Goldstein, Landau & Abruzzo, a health care law firm in Berwyn, Pa. They presented “What’s Your Practice Worth?” at the Academy’s 2003 Annual Meeting.

Mark E. Kropiewnicki, JD, is president of Health Care Law Associates and vice president of The Health Care Group in Plymouth Meeting, Pa. He presented “Ophthalmology Goodwill Value Benchmarks” at the Academy’s 2003 Annual Meeting.

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To buy audiotapes of their courses, visit www.nav-nnn.com. To contact them, visit www.aao.org/aaoe, select “Consultant Directory” and search by “Agency name.”


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Valuation Methods

Practice valuation is an inexact science, with the various appraisal methods relying on different sets of assumptions. To safeguard against wrongful assumptions, appraisers often use more than one method and then compare the results.

Asset accumulation method: This involves identifying and putting a value on all the practice’s assets and liabilities.

Comparable sales method: This is a market-based approach that bases practice value on the prices paid for similar practices.

Discounted cash flow method: This looks at what cash is expected to flow into the practice over the next five or so years. That sum is then “discounted” to reflect the risk that those future earnings might not materialize and the time value of money. This approach—also known as capitalization of income—bases the practice value on what somebody is willing to pay today in order to receive the practice’s anticipated cash flows.

Excess earnings method: This compares the physicians’ net earnings to a reasonable salary for the work that is being done (which might be based on the median salary for that subspecialty). If there are excess earnings, these are used to calculate the practice value.

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Goodwill Hunting

The Health Care Group’s Goodwill Registry was established in 1981 as a database of goodwill values used in buy-ins, payouts, mergers, outright sales and divorce settlements.

For each deal, the goodwill value is standardized as a percentage of the practice’s gross income. The registry uses gross income rather than net income, because practices are more consistent in how they quantify gross. Accountants, attorneys and practice consultants submit data to the registry in return for free access to the database.

“Generally speaking, goodwill values have come down a little bit. There’s a malpractice crisis in this country and reimbursements have come down—we have seen better times,” said Mr. Abruzzo.

According to the registry, the average goodwill factor for ophthalmology practices have been as follows:
  • 1981 to 2002: 37.48 percent
  • 1993 to 2002: 35.55 percent
  • 1999 to 2002: 32.65 percent
  • 2000 to 2002: 32.26 percent
  • 2001 to 2002: 31.76 percent

These averages don’t include practices where there was no goodwill value. The 2004 Goodwill Registry, which includes data for 2003, will be published next month.

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