Busting another Myth of Medical Practice Appraisal
[By Dr. David Edward Marcinko; MBA, CMP™]
For doctors, buying or selling a practice may be the biggest financial transaction of their lives.
Reasons for appraising practice worth include: succession, retirement and estate planning; partnership disputes and divorce; or as an important tool for organic growth and strategic planning.
However, the transaction is fraught with many pitfalls to avoid and no medical specialty seems immune.
For example, we recall the MD who asked her accountant for the “value” of her practice and was correctly given its lower “book value”, rather than its higher “fair-market-value” as a profitable ongoing-concern. The doctor lost tens-of-thousands-of-dollars in a subsequent attorney-driven sales transaction.
Although her CPA produced correct figures for exactly what was requested, the doctor and attorney did not differentiate between the two terms-of-art. Later legal mediation determined that neither was responsible for the linguistic error, as both parties acted in good-faith.
Of course, it was the doctor who paid dearly for her mistake in communication and business acumen.
“Rules-of-Thumb” [aka: benchmark formulas or calculations]
And so, in the stable distant past, physicians occasionally used “rules of thumb” formulas to value their medical practices.
“Rules” typically were expressed as benchmark calculations, formulas or multipliers (e.g. “one times revenues” or “five times cash flow”).
Today, because of the economic volatility in the healthcare industrial complex, “rules of thumb” should not be used to value any medical practice (other than as general internal managerial sanity checks).
Moreover, they are fraught with legal liability should the deal sour, and such benchmarks general hold little to no weight with the IRS.
Case example [the tale of two identical medical practices]
Economically, for example, consider two medical offices, each earning $1 million in gross revenues; both worth $1.5 million (according to a “rule of thumb” that a medical practice is worth 1½ times annual revenues). Yet, in reality Medical Office #1 is worth twice Medical Office #2.
How is this possible?
The answer is because Medical Office #1 is a newer practice in a hot neighborhood that did $500,000 last year, $1 million this year; and projects to do even more next year. Its property, instruments, HIT and medical equipment is new; aggressive young physician-executive management and medical training is excellent.
Medical Office #2 is an older practice located in a low-income area, revenues were $2 million a few years ago and have fallen to the current level; the practice has a leaky roof, old equipment and lots of deferred maintenance, etc. HMO patients abound, with declining reimbursement rates and an older practitioner.
So, although much more complicated than the above simple example, we can now see how “rule-of-thumbs” can mislead more often than inform.
Yet, we might also ask why they are still used by some misinformed doctors?
Simplicity and inertia is the answer, according to Hope Rachel Hetico; RN, MHA a valuation professional and Certified Medical Planner™ from the Institute of Medical Business Advisors Inc, in Atlanta GA www.MedicalBusinessAdvisors.com
And, the cost of a benchmark “rule-of-thumb” valuation is hard to beat; $0. Keep in mind that in most cases, you will want to ensure the value determination will stand up to IRS scrutiny, so the $0 rule-of-thumb is not really an option
The Case of Edgar versus Berg
Legalistically, a landmark legal case in business valuation was the Estate of Edgar A. Berg v. Commissioner (T. C. Memo 1991-279). The Court criticized the CPAs as not being qualified to perform valuations, failing to provide analysis of an appropriate discount rate, and making only general references to justify their “Opinion of Value.”
In rejecting these experts, the Court accepted the IRS’s expert because he possessed the background, education and training; and developed discounts, and demonstrating how reproducible evidence applied to the assets being examined.
The Berg decision marked the beginning of the Tax Court leaning toward the side with the most comprehensive appraisal. Previously, it had a tendency to “split the difference.”
Now, some feel the Berg case launched the business valuation profession.
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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com
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