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Valuing Private Practice
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Valuing Private Practice - January 9, 2001 6:31:00 AM
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Ron
Posts: 105
Joined: January 8, 2001
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Anyone have experience in valuing a well established private practice. Current owner wants to remain majority owner.
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Re: Valuing Private Practice - January 12, 2001 4:19:00 AM
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Andrew M. Ball, MS, PT
Posts: 500
Joined: October 8, 1999
From: Chapel Hill, NC, USA
Status: offline
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Determining "Value" of your practice is a HUGE task, and will very likely require the assistance of an outside consultant. Most will ask for the same kind of basic information, and if you know what's likely to be asked, you can have the information ready and save yourself some $$$ in consulting fees.
There are many consulting firms that can help you with this activity. All of them pretty much use the same 10 step process in determining value of a physician or therapy practice. The following is adapted from Progressive Healthcare, Inc. with some sprinklings of my own thoughts, esp. in terms of financial management.
1. Gathering of Practice Information/Data
The following information will be requested from the practice, in order to begin a detailed review of all aspects within the organization:
a. Therapist's Personal Information (e.g. curriculum vitae, years in practice, specialty education, other certifications
credentialing information, malpractice coverage and history of claims)
b. Practice Information (e.g. history and background listing of services provided,
organizational structure, description of practice facilities and locations, affiliations with local hospitals, physicians, employers, other groups)
c. Market Data (e.g. description of market service area population and median household income identification of ideal/target patient profile, market service area payor mix, managed care penetration, list of practice competitors
d. Practice Financial Data (e.g. audited financial statements for past 3 years, individual therapist financial statements,
tax returns)
e. Practice Budgets and Forecasts
f. Practice Productivity Reports (e.g. charges and collections by PT, CPT analysis by PT, accounts receivable by third party payor, total number of patient encounters by PT)
g. Practice Debt Structure (e.g. identification of long & short term debt
terms and current balances of debt
amortization schedules)
h. Practice Leases
i. List of all third party payor contracts
j. Employee Listing (name, title, salary, status, yrs. of service)
k. Information System Overview (hardware and software)
l. Copies of Last Coding and Compliance Review
m. Practice Contracts
n. Employment Agreements
2. At this point, the consultant should provide a detailed review and analysis of the data provided by the practice and begin to build the initial basis for measuring the operational value of the practice. During this analysis. Your practice will be compared to national and region standards to best practice standards and begin to identify growth and improvement opportunities.
3. Detailed On Site Assessment and Preliminary Analysis
a. patient flow
b. front office operations
c. back office operations
d. billing and collections
e. insurance tracking and follow up
f. PT and staff productivity
g. medical records processes
h. coding and documentation
i. human resources
j. practice marketing
k. practice purchasing and inventory
l. support staff
m. information systems
4. Staff and Patient Survey
a. practice strengths and weaknesses
b. perception of PT's
c. perception of practice staff
d. perception of patient satisfaction
e. practice image
f. what makes the practice different
g. overall practice working environment
h. practice satisfaction
i. practice goals and objectives
j. employee satisfaction
k. patient satisfaction
5. Focused Interviews of all PT's in practice (to validate and test results of surveys)
They will ask questions such as:
a. Can you describe the practice processes?
b. How is the practice performing financially?
c. What is your impression of the practice?
d. Can you identify any problems within the practice?
e. What is the overall practice morale?
f. What is the overall staff morale ?
g. How do you interact with your physicians?
h. How many patients are seen in this practice each day?
i. What are your individual goals?
j. What are your future plans?
k. What is your perception of the patient?
6. Patient Focus Groups
7. Market Study
Utilizing information obtained from the practice and other national databases, The consultant should perform an initial market analysis and study to identify potential market opportunities, product/service placement appropriateness and community need.
8. Analysis and Discovery
The preliminary information will be reviewed and any assumptions or findings that are not adequately validated will be reevaluated and confirmed.
9. Financial Review
Simultaneous to the review of operations, the consultant should prepare a detailed financial review, including a bottom up (or break-even) analysis of the practice.
Where X = volume of sales, P = Price, FC = Fixed costs, and VC = Variable costs per unit of service . . .
PX = FC + VC(X)
or
X= FC/(P-VC)
Though the consultant will likely also calculate liquity ratios (determine how well positioned your practice is to meet short term obligations) such as current ratio, acid test ratio, days cash on hand ratio, days in net accounts receivable ratio); as well as capital ratios (determine long-term financial structure of the practice) such as debt service ratio, long-term debt to fixed assest ratio, long term debt to equity ratio; and activity ratios such as operating margins and return on assets . . . it is the break-even analysis that is likely to have the greatest impact upon the CURRENT value of your practice. The other ratios may however predict future value, or financial stability of your practice.
Utilizing practice financial reports and industry benchmarks the consultant should provide a series of bench marking and placement reports that will show how the practice is performing against it's peer group.
The financial analysis serves as a key component in the determination of practice value and in quantifying potential practice growth opportunities.
10. Presentation and Final Report
Though I've not spoken directly with Progressive Healthcare, Inc., I find that their website pretty much describes the process I've outlined above point for point. I think that they focus mostly on MD practices, but the business administration principles are the same.
For further information regarding Progressive Healthcare, Inc. you may want to contact them at 615-371-9989. or e-mail them at info@progressivehealthcare.com
Andrew M. Ball, MS, MBA, PT
[This message has been edited by Andrew M. Ball, MS, PT (edited January 12, 2001).]
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Re: Valuing Private Practice - January 12, 2001 11:02:00 AM
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Ron
Posts: 105
Joined: January 8, 2001
Status: offline
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Thanks Andrew, very helpful
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Re: Valuing Private Practice - March 4, 2001 5:19:00 AM
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Andrew M. Ball, MS, PT
Posts: 500
Joined: October 8, 1999
From: Chapel Hill, NC, USA
Status: offline
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A Crash Course in Value of a practice and threats to it . . .
Financial Management is the, “acquisition, management, and financing of resources for firms by means of money, with due regard for prices in external economic markets.” 1 (p.6) Breaking this definition down into its component parts, we see that resource management is a key component of financial management. Resources are typically thought of as physical entities such as cash or equipment, but as we will note in subsequent discussion, the managers and employees working for the organization are resources too. Second, these resources are tracked in terms of money. Converting the value of all resources into a uniformly standardized unit (e.g. dollars) allows for comparison between departments and between organizations. Finally, financial management is not an entirely internal process. Though the primary concern of management is to the individual organization, performance is affected by a variety of external factors including tax rates, interest rates, and public policy, and political mood.1
Though some healthcare organizations and small practices operate as unincorporated sole proprietorships or partnerships, successful ones are usually converted into corporations. The reason for this is that corporations are legal entities given the rights to operate as an individual with limited liability. Limited liability means that if the corporation goes bankrupt, the owners stand to lose no more than they have invested. In a sole proprietorship or partnership, the personal assets of the owners can be used to offset the losses of the organization in the event of bankruptcy. In addition, corporations can raise funds by selling shares of common stock, by which the investor becomes a part owner in the corporation. Corporations are also able to raise capital (e.g. money) through the sale of bonds, which are long-term debts (e.g. IOU’s) that organizations use to obtain financing without diminishing the strength of their ownership. For these reasons, it can be argued that the single most important financial management decision that an organization can make in its early stages is to become a corporation rather than to remain a sole proprietorship or partnership.1
The fundamental purpose of any organization’s existence is to maximize its market value. The organization (e.g. firm, clinic, hospital etc.) is made up of its acquired resources, the management of those resources, and the financing of those resources. Its value, by contrast, is made up of what someone else may be willing to pay for a claim on those resources. This goal of value maximization can be expressed simply in the equation V = S + B. In other words, the value of the organization is equal to the claims of the stockholders and bondholders.1
The difference between a stockholder and a bondholder is that a stockholder’s claim upon the organization is a direct function of the total value of the firm, where the bondholder’s claim is limited to the amount invested. The shareholder enjoys a greater return on investment because as the value of the organization grows, so does the worth in his claim upon it. The investment is not without risk however. If the value of the organization decreases, the value of stock in the company will become less than the price at which it was bought. A bondholder, on the other hand, essentially lends the organization a fixed amount of money (e.g. $100) to be repaid at some future date. The benefit to the bondholder (relative to purchase of stock) is that risk is minimized. The organization will repay the bond, with interest, when the bond becomes due. A bond is a low-risk, low-return investment relative to purchasing stock.
In the event that the value of the organization is less than the amount of the bond, then the shareholders receive nothing and the bondholders take over the firm. If the value of the organization is more than the amount of the bond, then the bondholders are repaid and the stockholders claim the remaining value of the firm.
Maximizing market value is a function of enhancing the value of the organization in both the short and long-term. When conflicts arise between long-term viability and short-term gain, the organization should be most focused an concerned with the long-term.1
The value of a firm is a function of cash flow, timing of funds received, and the risks involved. The value of the organization, at any one point in time, is equal to the present value of expected cash flows. For this reason, although all cash flows are important, it is the changes in cash flow, or incremental cash flow, that are of primary concern to the administrator. It is important to note that earnings and cash flow are not the same thing. The earnings reports examine current revenue minus current expenses while the cash flow report examines projected revenue and expenses by making assumptions regarding the future amounts and timing of sales/services for cash, dividend payments, and debt repayments.1
It is important to remember, however, that there is a human element to virtually every aspect of financial management. In other words, individuals will act in their own self-interests. On some occasions, conflict can arise between an administrator’s self-interests and the organization of which he’s a part. Take, for example, the successful physical therapist that owns a private practice. He is offered the opportunity to buy out another practice that has talented clinical staff, mediocre equipment, a highly advanced (but grossly underutilized) computer network, and operations so inefficient that despite the highest volume of patients in the area sees the smallest profit margin. Purchase of the practice represents a tremendous business opportunity provided that the energy and work was put into making the purchased clinic financially viable. The therapist nevertheless decides not to purchase the clinic. He’s currently in the process of accompanying his son in college interview process and doesn’t want to spend the time necessary to turn the purchased clinic around. He prefers to know that despite the opportunity for greater financial rewards with the purchase of the clinic, that the risk of potential financial loss is just as great . . . and this is too great a risk to undertake with college tuition on the horizon. Because the physical therapist in question is both the owner (e.g. shareholder) and the manager of his practice, no conflict exists. The subsequent opportunity costs of that decision, are his to absorb, and his alone. If, on the other hand, he was the head of a large multi-national conglomerate, then his decision not to by the practice for these reasons negatively affects the potential value of the organization, and by extension, the value of the shareholders’ claim. In other words, “such a conflict in goals may cause the manager to bypass a risky but potentially beneficial new investment. They may prefer a safe project to a risky one that, if it fails, might cause the loss of their jobs.”1 (p. 12) It may be possible to both offset this effect, and encourage a greater level of productivity, by requiring administrators to make a substantial invest of stock in the company. Some companies, such as Eastman-Kodak require a commitment of stock equal to at least one year’s salary.1
Risk and return go and in hand. Simply put, rational people require increased rewards for exposing themselves to increased risk. In order to maximize financial rewards expected from an investment, we must increase exposure to risk. As the old saying goes, “there is no such thing as a free lunch!”1 (p19)
Finally, the financial manager must realize that options are valuable. An option is a right to invest in a venture, but to make a determination at a future date, as to whether or not to exercise that right. For example, if you were given the opportunity to invest in a new company in 30 days for today’s price of $10 per share, this would be considered an option. If the price of the share went up to $15, you would likely be more inclined to exercise that option and make an immediate $5, unless you believe the price to go below $10 by the time you were inclined to sell. If, on the other hand, the price of the share dropped to $2, you would not be obligated to exercise your option and immediately loose 80% of your investment. Options allow the investor to make a decision based upon performance of a company over a time period, and in so doing, reduce full risk of making a poor decision at any given instant in time.1
Andrew M. Ball, MS, MBA, PT
REFERENCES:
Pinches GE. Essentials of Financial Management. 9th ed. Oxford, England: Blackwell Scientific Publications; 1993.
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