Because PMI works exclusively with Pediatric practices from around the country, we have been a part of every imaginable practice valuation method being used. Based on our experience, we wanted to share our thoughts on how to best determine the value of your practice.
Most practices rely on their accountant to tell them the value of their practice. While helpful in some ways, this can be extremely dangerous. Most accountants primarily rely on the ""book value' (assets minus liabilities) along with the shareholder's total income and practice revenue stream to determine a figure. Such an approach is wrong on so many fronts. Adding to the confusion, I recently worked with a client that had 8 providers generating well over $4,000,000 in revenue each year and their lawyer said ""with all that money coming in, the practice is worth millions"". Guess what, he was wrong.
Gone are the old days where hospitals would hand over a blank check to acquire a practice.. Today ACO's are popping up but hampered by Stark regulations limiting what they can pay providers. In fact, there seems to be a growing trend across the country where hospitals are no longer employing Pediatricians since the revenue from such referrals does not justify the costs.The trick to a fair shareholder valuation formula is to keep it simple. Practice leaders need to be able to convey the framework in a simple manner when a physician is thinking about joining your practice. If the process takes more than a minute to explain, then it is more complicated than it needs to be.
The approach PMI takes to determine the value is to establish the added benefit of owning the practice instead of being employed. For example, if a shareholder makes $250,000 for a given year and an employed physician at the same practice makes $180,000, the added benefit for owning the practice is $70,000. Make sense?Much like the stock market, PMI's approach projects that value by a multiple of years. While Apple, Chevron and Microsoft stock prices may be based on the expected 10-15 years of earnings, PMI remains conservative with a multiple of 1-2.25 years projected earnings when valuing a medical practice. In the same example used above, the benefit of owning the practice is $70,000. Multiplying that times 1.5 years shows a value of $105,000. Seems pretty straight forward so far, right?
If the practice has more than one shareholder and one or more employed physicians, the process to determine the value is rather simple:
Determine the average of the shareholder earnings
Compare shareholder earnings with the average compensation for the employed physicians in your practice. If all physicians are shareholders, find regional or national averages for comparison. Then multiply the variance times the number of shareholders to determine the Valuation Basis.
Multiply the Valuation Basis times the number of years of projected earnings.
There are a variety of adjustments the formula that may need to be made including:
Taking average shareholder salary for previous 2 or 3 years.
Adjusting Average Shareholder Compensation for end of parity payments that expired December 31, 2014.
Adjusting Average Shareholder Compensation based on whether or not meaningful use monies have already been received.
Adjusting Average Shareholder Compensation based on whether or not the shareholders may have previously taken lower salaries to fund practice projects that are expected to generate additional earnings in the future.
Adjusting the Years of Projected Earnings or Average Shareholder Compensation to account for upcoming large capital expenditures.
Adjusting for a variety of nuances in the shareholder compensation formula.Other Shareholder Concerns
Be sure to check out our previously posted article about the Common Issues Overlooked In Shareholder Agreements. As with any process that involves money, there needs to be open dialogue on how to handle the six possible adjustments to the formula listed above.