Traditional Reasons for a Medical Practice Financial Valuation

Some economic reasons for a medical practice valuation 

By Dr. David Edward Marcinko MBA CMP™

http://www.CertifiedMedicalPlanner.org

The decision to sell, buy or merge a medical practice, while often financially driven, and is inherently an emotional one for these impact investors who went into the profession largely because of a deep seated zeal to help others.

Still, beyond impact investing musings, there are other economic reasons for a practice valuation that include changes in ownership, determining insurance coverage for a practice buy-sell agreement or upon a physician-owner’s death, organic growth meter, establishing stock options, or bringing in a new partner; etc.

Practice appraisals are also used for legal reasons such as divorce, bankruptcy, breach of contract and minority shareholder complaints. In 2002, the Financial Accounting Standards Board (FASB) issued rules that required certain intangible assets to be valued, such as goodwill. This may be important for practices seeking start-up, service segmentation extensions, or operational funding. Some other reasons for a medical practice appraisal, and the considerations that go along with them, are discussed here.

https://www.crcpress.com/Risk-Management-Liability-Insurance-and-Asset-Protection-Strategies-for/Marcinko-Hetico/p/book/9781498725989

Estate Planning

Medical practice valuation may be required for estate planning purposes. For a decedent physician with a gross estate of more than current in-place tax limits, his or her assets must be reported at fair market value on an estate tax return. If lifetime gifts of a medial practice business interest are made, it is generally wise to obtain an appraisal and attach it to the gift tax return.

Note that when a “closely-held” level of value (in contrast to “freely traded,” “marketable,” or “publicly traded” level) is sought, the valuation consultant may need to make adjustments to the results. There are inherent risks relative to the liquidity of investments in closely held, non-public companies (e.g., medical group practice) that are not relevant to the investment in companies whose shares are publicly traded (freely-traded). Investors in closely-held companies do not have the ability to dispose of an invested interest quickly if the situation is called for, and this relative lack of liquidity of ownership in a closely held company is accompanied by risks and costs associated with the selling of an interest said company (i.e., locating a buyer, negotiation of terms, advisor/broker fees, risk of exposure to the market, etc.). Conversely, investors in the stock market are most often able to sell their interest in a publicly traded company within hours and receive cash proceeds in a few days. Accordingly, a discount may be applicable to the value of a closely held company due to the inherent illiquidity of the investment. Such a discount is commonly referred to as a “discount for lack of marketability.”

Discount for lack of marketability is typically discussed in three categories: (1) transactions involving restricted stock of publicly traded companies; (2) private transactions of companies prior to their initial public offering (IPO); and, (3) an analysis and comparison of the price to earnings (P/E) ratios of acquisitions of public and private companies respectively published in the “Mergerstat Review Study.”\

With a non-controlling interest, in which the holder cannot solely authorize and cannot solely prevent corporate actions (in contrast to a controlling interest), a “discount for lack of control,” (DLOC), may be appropriate. In contrast, a control premium may be applicable to a controlling interest. A control premium is an increase to the pro rata share of the value of the business that reflects the impact on value inherent in the management and financial power that can be exercised by the holders of a control interest of the business (usually the majority holders). Conversely, a discount for lack of control or minority discount is the reduction from the pro rata share of the value of the business as a whole that reflects the impact on value of the absence or diminution of control that can be exercised by the holders of a subject interest.\

Several empirical studies have been done to attempt to quantify DLOC from its antithesis, control premiums. The studies include the Mergerstat Review, an annual series study of the premium paid by investors for controlling interest in publicly traded stock, and the Control Premium Study, a quarterly series study that compiles control premiums of publicly traded stocks by attempting to eliminate the possible distortion caused by speculation of a deal.

Buy-Sell Agreements

The ideal situation is for physician partners to put in place a buy-sell agreement when practice relationships are amicable. This establishes the terms for departure before they are required, and is akin to a prenuptial agreement in the marriage contract. Disagreements most often occur when a doctor leaves the group, often acrimoniously. Business operations of the practice decline, employee and partner morale suffers, feuding factions develop spilling over into the office, and the practice begins to implode creating a downward valuation spiral. And so, valuations should be done every 2-3 years, or as the economic circumstances of the practice change. Independence and credibility are provided, and emotional overtones are purged from the transaction.

Physician Partnership Disputes

Medical practice appraisals are often used in partnership disputes, such as breach-of-contract or departure issues. Obvious revenue declinations are not difficult to quantify. But, revenues may not immediately fall since certain Current Procedural Terminology [CPT®] code reimbursements may actually increase. Upon verification however, lost business may be camouflaged as the number of procedures performed, or number of patients decrease after partner departure.

https://www.crcpress.com/Risk-Management-Liability-Insurance-and-Asset-Protection-Strategies-for/Marcinko-Hetico/p/book/9781498725989

Divorce

Physicians getting divorced should get a practice appraisal, and either side may hire the appraiser, although occasionally the court will order an expert to provide a neutral valuation. Such valuations should be done in light of both court discovery rules and IRS requirements for closely held businesses. Generally, this requires the consideration of eight elements:

• Practice specialty and operating history
• Economic and healthcare industry condition
• Estimates of practice risks and future returns
• Book value and financial condition of the practice
• Practice future earning capacity
• Physician bonuses, dividends and distributions
• Intangible assets
• Comparable practice sales

https://www.crcpress.com/Risk-Management-Liability-Insurance-and-Asset-Protection-Strategies-for/Marcinko-Hetico/p/book/9781498725989

Assessment

Sometimes, the non-physician spouse may even desire a lifestyle analysis to evaluate the potential for under reported income, by a forensic accountant, or appraiser. A family law judge is often the final arbiter of different valuations, and because of varying state laws there may be 50 different nuances of what the practice is really worth.

MORE: Valuation

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, urls and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

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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SURVEY: Tele-Health Weekly Visits

By MCOL

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% Providing Video Telehealth Visits to 5+ Patients Per Week

 •  Primary Care Physician: 74%
 •  Behavioral Health Provider: 88%
 •  Registered Nurse: 62%
 •  Medical Assistant: 80%

Source: RAND, “Experiences of Health Centers in Implementing Telehealth Visits for Underserved Patients During the COVID-19 Pandemic,” May 2022

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What Physician Investors STILL NEED TO KNOW about Monte Carlo Simulation in 2022

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Probability Forecasting and Investing

By Dr. David Edward Marcinko MBA CMP™

[Editor-in-Chief] www.CertifiedMedicalPlanner.org

dr-david-marcinko1Recently, I had a physician-client ask me about Monte Carlo simulation. You know the routine: what it is and how it works, etc.

From Monaco

Named after Monte Carlo, Monaco, which is famous for its games of chance, MCS is a technique that randomly changes a variable over numerous iterations in order to simulate an outcome and develop a probability forecast of successfully achieving an outcome.

In endowment management, MCS is used to demonstrate the probability of “success” as defined by achieving the endowment’s asset growth and payout goals.  In other words, MCS can provide the endowment manager with a comfort level that a given payout policy and asset allocation success will not deplete the real value of the endowment.

Quantitative Tools Problematic

The problem with many quantitative tools is the divorce of judgment from their use. Although useful, MCS has limitations that should not supplant the endowment manager’s, FA or physician-investor’s, experience.

MCS generates an efficient frontier by relying upon several inputs: expected return, expected volatility, and correlation coefficients. These variables are commonly input using historical measures as proxies for estimated future performance. This poses a variety of problems.

  • First, the MCS will generally assume that returns are normally distributed and that this distribution is stationary.  As such, asset classes with high historical returns are assumed to have high future returns.
  • Second, MCS is not generally time sensitive. In other words, the MCS optimizer may ignore current environmental conditions that would cause a secular shift in a given asset class returns.
  • Third, MCS may use a mean variance optimizer [MVO] that may be subject to selection bias for certain asset classes. For example, private equity firms that fail will no longer report results and will be eliminated from the index used to provide the optimizer’s historical data.

Healthcare Investment Risks

A Tabular Data Example

This table compares the returns, standard deviations for large and small cap stocks for the 20-year periods ended in 1979 and 2010.

Twenty Year Risk & Return Small Cap vs. Large Cap (Ibbotson Data)

[IA Micro-Cap Value 14.66 17.44 24.69 0.44]

1979

2010

Risk

Return

Correlation

Risk

Return

Correlation

Small   Cap Stocks 30.8% 17.4% 78.0% 18.1% 26.85% 59.0%
Large   Cap Stocks 16.5% 8.1% 13.1% 15.06%

[Reproduced from “Asset Allocation Math, Methods and Mistakes.” Wealthcare Capital Management White Paper, David B. Loeper, CIMA, CIMC (June 2, 2001)]

The Problems

Professor David Nawrocki identified a number of problems with typical MCS in that their mean variance optimizers assume “normal distributions and correlation coefficients of zero, neither of which are typical in the world of financial markets.”

Dr. Nawrocki subsequently described a number of other issues with MCS including nonstationary distributions and nonlinear correlations.

Finally, Dr. Nawrocki quoted financial advisor, Harold Evensky MS CFP™ who eloquently notes that “[t]he problem is the confusion of risk with uncertainty.” Risk assumes knowledge of the distribution of future outcomes (i.e., the input to the Monte Carlo simulation). Uncertainty or ambiguity describes a world (our world) in which the shape and location of the distribution is open to question.

Assessment

Contrary to academic orthodoxy, the distribution of U.S. stock market returns is “far from normal.”[1] Other critics have noted that many MCS simulators do not run enough iterations to provide a meaningful probability analysis.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

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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[1]   Nawrocki, D., Ph.D. “The Problems with Monte Carlo Simulation.” FPA Journal (November 2001).

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Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

The Long and Short of Portfolio Construction

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Long-Short Portfolio Construction vs. Long-Only

[By Dr. David Edward Marcinko MBA CMP™]

http://www.CertifiedMedicalPlanner.org

[Publisher-in-Chief]

Long-Short is an active portfolio construction discipline that balances long positions in high expected return securities and short positions in low expected return securities of approximately equal value and market sensitivity. This type of portfolio is “neutralized” or immunized against changes in value of the underlying market and, therefore, has zero systematic (beta) risk. If the selected securities perform as expected, the long-short positions will provide a positive return, whether the market rises or falls.

Misconceptions

While long-short portfolios are often perceived and portrayed as much costlier and much riskier than long-only, it is inherently neither. Much of the incremental cost and risk is either largely dependent on the amount of leverage employed or controllable via optimization. Those costs and risks that are not controllable—financial intermediation costs of borrowing shares to short, the trading costs incurred to meet long-short balancing, margin requirements, uptick rules, and the risks of unlimited losses on short positions—do not invalidate the viability of long-short strategies.

Long-Short Advantages

Compared with long-only portfolios, long-short portfolios offer enhanced flexibility not only in the control of risk and pursuit of return, but also in asset allocation. Basic market-neutral portfolios achieve a return consisting of three components: (1) interest on funds held as a liquidity buffer, (2) interest on the short sale proceeds maintained with the broker, and (3) the return spread between the aggregate long and aggregate short positions in the portfolios.

Disadvantages

Share borrow-ability and uptick rules make short-selling more difficult and costly than going long. Also, it may be legally or contractually restricted for some investors, such as mutual funds. Inefficiencies may be concentrated in overpriced stocks and, accordingly, short sales of the most overpriced stocks may offer higher positive returns than long purchases of underpriced stocks.

Assessment

Long-only portfolios are confined to altering the weighting of securities within an index in order to realize an excess return. Long-short portfolios are not constrained by index weights and, because they can short securities, they can “underweight” a security by as much as investment insights and risk considerations dictate. Long-short portfolios can be enhanced by “equitizing” them using stock index futures.

Note: “The Long and Short on Long-Short” by Bruce I. Jacobs and Kenneth N. Levy, The Journal of Investing, Spring 1997, pp. 73–86, Institutional Investor, Inc.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

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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PODCAST: IC-HRA [Individual Coverage – Health Reimbursement Arrangement] Explained

Health Insurance Job Options

By Eric Bricker MD

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DEFINITION: ICHRA (we pronounce it “ick-rah”) stands for “Individual Coverage Health Reimbursement Arrangement” (not the common misnomer of individual coverage health reimbursement accounts)  and is available for employers to start using as of January 2020. ICHRA is an evolution of another type of HRA, called a QSEHRA, that was created in 2017. Both allow employers to reimburse employees tax-free for individual health insurance, but ICHRA represents a “super-charged” version of QSEHRA with higher limits and greater design flexibility that will appeal.

More: https://www.takecommandhealth.com/ichra-guide

CITE: https://www.r2library.com/Resource/Title/082610254

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