How much is your practice worth? -- Part I. (Nuts and Bolts of Business).

You are about to offer partnership to an employed physician. How much should the new partner pay to buy in to the practice?

The answer depends on how much your medical practice is worth. There is a great deal of misunderstanding in the medical community about the value of a medical practice.

Finding out its value requires looking at many individual factors related to a practice that may set it apart from others.

There are two important points to consider in any medical practice valuation.

1. Physicians must realize the value of their medical practice depends on how much revenue the practice produces, since revenue will usually outweigh any fixed assets the practice may own.

2. Physicians must also determine if the future revenue stream of the practice will mirror the current income, since the accuracy of valuations depends on how well the risk for future revenue production is assessed.

Valuation requires analysis of practice finances and subjective judgments on the part of the valuator, so the greater the amount of information you provide in the planning process, the more accurate and less costly the assessment will be.

Documentation

The first step in the valuation process is to gather the pertinent documentation required by the valuator.

The valuator will need to understand the business structure of the practice. You should provide copies of the articles of incorporation and by-laws if the practice is structured as a corporation, partnership agreements if structured as a partnership, or operating agreements for a limited liability company.

These documents provide insight into compensation as well as dissolution provisions. In addition, any previous buy-in documentation should be provided. This will allow the valuator to consider previous methodology and make comparisons to past market value of the practice.

Next, the valuator will need to assess the financial structure of the practice.

You must be prepared to submit five years of financial statements and tax returns. The financial statements allow the valuator to assess the financial architecture of the practice for debt structure, equity, income and cash flow.

A list of all fixed assets (equipment) should be prepared. Documentation should include information on the useful life of the equipment, whether any of it is obsolete or unusable, as well as plans to dispose of or purchase new equipment in the time frame in which the buy-in will take place.

An inventory of supplies and details on their rotation (typically 3-6 months for medical practices) should be prepared to allow an estimate of their value.

Any outstanding note agreements should be provided, since the end of an agreement may result in additional cash flow available to project in future years.

Copies of all lease agreements must be provided so that the valuator may decide whether to treat them as operating leases, which are expenses, or capital leases, which are treated similar to financing with debt.

Finally, an aged accounts payable listing should be provided to analyze the impact on current and future cash flow.

Charges, collections and contracts

Reports on charges, collections and contractual adjustments are also important.

The valuator will require a copy of your fee schedule to determine if it is market comparable. Your most commonly used CPT codes with fees should suffice. Unusually high fee schedules may devalue your accounts receivable balances.

In addition, you should provide as much detail as possible about your accounts receivable balances, including an aged accounts receivable report by payer class (for current, 30-60 days, 60-90 days, and greater than 90 days balances).

Copies of current managed care contracts also are important in determining contractual adjustments and any potential revenue issues, such as withholds.

Next, the details of physician compensation must be disclosed. This should include both base salaries and bonuses. As with the financial statements, five years of compensation data should be supplied to project compensation into the future. Methodology for the distribution of profits must be included.

Finally, the valuator will require information to place a value on non-tangible or goodwill assets of the practice. A listing of referring physicians, for specialty practices, hospitals for which the physicians have clinical privileges and information on size and location of your most significant competitors will help in determining this value.

Finding a valuator

You may be tempted to have your practice accountant perform the valuation (since he or she will be preparing many of the documents required), but unless that individual is an experienced medical practice valuator, you should seek outside consultation.

Most experienced medical practice valuators will be Certified Valuation Analysts. Your local or state medical society may be able to recommend an experienced medical practice valuator.

Valuation is not a simple process. It requires knowledge, experience and preparation. In the September/October issue of The Physician Executive, we'll take a look at the methodology used to place a price on your practice.

David P. Tarantino, MD, MBA, is the executive medical director of Shock Trauma Associates, P.A., a 50+ physician, multispecialty practice associated with the University of Maryland School of Medicine. In addition, he is the chief executive officer of The MD consulting Group, LLC, a health care management consulting firm in Baltimore, Md. Tarantino can be reached by phone at 410/328-3198 or by e-mail at [e-mail].