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Health care environment’s impact on practice values

By Vasilios J. Kalogredis, JD.

It was not that long ago that medical practice values in the region were going through the roof.

Many practices were very profitable. There were many potential buyers out there who were viewing the purchasing of strong medical practices as a viable way of benefiting from those entities’ cadre of patients from a financial standpoint.

Back in the early to mid 1990s, I often felt that I was a “doctor’s agent” as much as I was a health care attorney as many of our clients were being pursued by several “bigger” organizations, with checkbooks in hand.

The pursuit of these practitioners by institutions such as Penn, Allegheny, local hospital systems, and the like as well as by Management Service Organizations (MSO) and Physician Practice Management Companies (PPMC) resulted in many of our clients experiencing a very interesting and remunerative “bidding war” to purchase their practices and employ them post-sale. It was not uncommon for some practices to be sold for a value equal to more than their annual gross collections. Some institutions were so committed to having their own, large, network of physicians that they did what was necessary to accomplish that goal. Those who implemented that strategy believed that bigger was better. Doctors who were doing well in their private practices were not willing to be employed by a large entity unless they were offered a deal that was too solid to turn down.

Well, much has changed in the past decade or so.

Many of those practice acquisitions did not work out as well for the buyers as they had anticipated when they developed their strategy to buy those practices. Furthermore, reimbursement levels for medical services have stagnated, if not gone down, in many circumstances. The cost of operating a practice has skyrocketed, as well. In the forefront of that has been the dramatic increase in malpractice insurance premiums in this area.

All of this has resulted in some of those physicians ending up with their practices back and returning to a “private, independent” practice situation. Others have continued to be employed by institutions or other larger employers. Most of them are now compensated on a more “risk oriented” basis.

Obviously, the lack of “big buyers willing to pay big purchase prices,” has been one large factor in medical practice values (on average) being much less than they were a few short years ago.

Another factor has been the difficulty in recruiting certain types of physicians into this medical marketplace. In some specialties (surgery, neurosurgery, ob/gyn, for example) it has been very difficult to recruit a doctor into this area. Many of the potential recruits have found that due to reimbursement being higher, malpractice insurance premiums being lower, and there being less competition, that they may go to certain other parts of the country and make more money for the same amount of work. That has resulted in some of our clients in some of the specialties having to guarantee a higher starting compensation package to attract a young doctor. It has also caused some to have to shorten the “engagement period” before an employed doctor is offered Partnership. That has reduced the time frame during which the senior physicians could benefit from the excess cash flow hopefully arising from the employed doctor’s work. It has also caused many to have to greatly reduce the buy-in and buy-out values, in order to attract and retain doctors in a good group practice. In evaluating a practice opportunity, new physicians are looking at what the buy-in obligation is expected to be if and when partnership is offered. They are also looking to see what the anticipated buy-out obligations will be upon the retirement or other departure of the senior doctor or doctors.

Obviously, it is not realistic to generalize and state that every practice situation is the same. However, it is safe to say that many practices now have lower values as a “going concern” than they did ten years ago.

As a general rule, the valuation techniques used for equipment, furniture, and other hard assets have not changed dramatically. In most medical practices, that is not the largest portion of the price anyway. The same is true for the valuation of accounts receivable (although most practices are collecting a lower percentage of their gross billings than they did in the past due to many experiencing more managed care and third party reimbursement restrictions on what they may collect).

The biggest thing that has changed in the valuation of medical practices world has been the intangible/goodwill element of practices. A simplistic (but real) definition of intangible value/goodwill is what a ready, willing and able seller is willing to accept and a ready, willing and able buyer is willing to pay over and above the “hard assets,” accounts receivable, and other things one may touch and see because the buyer believes that by paying this additional “intangible value” he/she/it would do better off financially than if he or she did not so acquire the practice at that value. I am staying away from specific numbers and formulas here, since each situation is so different. It is not a “one size fits all world.” When I assist a doctor as he determines whether or not a buy-in price makes sense in a “Partnership” or outright purchase of a practice situation, I run the numbers through to see what the anticipated bottom line impact on the doctor may be anticipated to be. The proof is in the pudding.

For example, I recently evaluated a Partnership opportunity for a “shining star” young doctor who was very productive and skilled. When we ran the numbers through, it was clear that he would be earning less money in the first few years of Partnership than he was as any employee of the practice. After looking at things critically, we agreed he would be best served by walking away from the deal. In another recent case, we represented the seller. The entire practice was being sold. We valued the practice and structured an arrangement that ended up being a “win-win” for both parties. The senior doctor got a reasonable retirement package. The Buyer got a great practice for a fair price, with the realistic ability to make substantially more money. That is the “real world” in action.

We often get called in by practices wanting us to look at their current inter-doctor agreements to determine whether or not they are realistic in today’s real world. We encourage practices to look at their documents on a regular (in some cases annually, but at least every three years) basis to assure that unintended consequences do not result. We have seen difficulties in some practice settings where the currently effective documents are so unrealistic in their buy-out obligations that it actually encourages a doctor to leave and might result in the practice itself failing to survive due to the heavy financial burden of an unrealistic buy-out arrangement.

We recently got called in by a new client practice which was burdened with a huge buyout to an already departed doctor. The remaining doctors were worried about the continued viability of the practice and sought my guidance as to what to do going forward to avoid further difficulties. After several hours of meetings, and attempting to balance the interests of the practice, the “younger partners,” and the partners nearing retirement (who started by saying if departed Dr. D got $X, why should not I?), we were able to come to a reasonable compromise solution (higher than the zero goodwill some of the younger doctors wanted and lower than what the existing documents were calling for).

In closing, it is fair to say that in most medical practices in the area, as a percentage of gross income, their values are down in comparison to where they would have been ten or so years ago. If a group has not looked at its buy-out arrangements lately, it would behoove them to do so to avoid unnecessary problems down the road.

Vasilios J. Kalogredis, J.D., CHBC, CFP is founder and a shareholder of Kalogredis, Sansweet, Dearden and Burke, Ltd. in Wayne, Pa.

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