By - Jeremiah Grant
Last Updated - October 5th, 2023 7:40 AM
Oct 05
Are you thinking about selling or buying a medical practice and want to understand its current fair market value?
Conducting a medical practice valuation is crucial in making well-informed decisions in such transactions. This process involves assessing and estimating the fair market value of your medical practice.
But how do you actually go about valuing a medical practice?
What methods and factors should you consider, and where can you find the right business valuation firms with useful tools and resources for assistance?
In this guide, we’ll provide answers to the question “How to value a medical practice,” giving you the essential information you need to accurately determine the value of your medical practice.
Medical practice valuation is the intricate process of determining the fair market value of a medical practice.
This value signifies the price at which a willing buyer and seller agree in an arm’s length transaction.
In simpler terms, it’s the amount of money someone would be willing to pay to acquire your practice or the sum you could expect to receive if you decide to sell it.
Like the valuation of any other business or practice, medical business valuation is more of an art than an exact science. It demands a combination of judgment, experience, and specialized knowledge.
To do that, multiple methods and factors come into play, and the choice often hinges on the purpose and perspective of the valuation.
For example, if you’re in the process of selling your practice, you may lean towards a method that maximizes its perceived value.
Conversely, if you’re a prospective buyer, you might opt for an approach that minimizes your acquisition cost.
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What are the Methods of Medical Practice Valuation?
To make things simpler, let us start with a metaphor.
Imagine you’re trying to figure out the worth of your family heirloom, like an old piece of jewelry.
You know it’s valuable, but how much exactly?
Well, valuing a medical practice is a bit like that – it’s about understanding how much your practice is worth in the healthcare world.
There are five most used methods:
The Asset Approach
The asset approach values your practice based on its tangible and intangible assets, such as equipment, furniture, inventory, goodwill, etc.
Continuing with our metaphor, this is like appraising your jewellery for the value of the gold, diamonds, and sentimental worth.
Similarly, the asset approach looks at the tangible (like equipment) and intangible (like patient loyalty) assets in your practice.
It’s useful when you’re thinking about selling everything or when the practice isn’t making much.
Example
Let us assume that you have a quite successful dental practice. To determine its worth using the asset approach, we first must consider all the tangible and intangible assets that your practice owns, like equipment, patient records, size of EHR, goodwill, etc.
Let’s say that the estimate of all your assets is $200,000; then, the value of your medical practice would be $200,000 as well.
This method values the practice based on its expected future earnings or cash flows, discounted to present value.
Let us shift to a different metaphor that explains this method a bit better.
Imagine you’re trying to predict if your favorite sports team will win next season.
The income approach is a bit like that. It looks at the future earnings your practice is expected to make, adjusted to today’s value.
This one’s great if you want to invest in a practice or if it’s been doing well consistently.
Example
Let us assume that your practice is projected to generate $60,000 annually for the next 5 years.
If we use a discount rate of 8% to account for the present value of these future earnings, then the present value of your practice would be $244,000.
The Market Approach
This approach values your practice based on the prices paid for comparable practices in recent transactions in the market.
Aligning with our last metaphor, think of your practice as a unique player in a competitive league.
The market approach sizes you up against similar practices in your area. It’s a way to see where you stand compared to others.
This one’s helpful for setting benchmarks and needs data from your market.
Example
Let’s say you want to sell your medical practice and want to know how much is it worth in the market.
To do that, you look at similar medical practices that were recently sold in the area. With your research, you found out that Practice A was sold for $300,000, and Practice B was sold for $350,000.
Then, you compare your practice to these two and evaluate all the pros and cons that we have over these two. After the comparison, you estimate the value of your practice at around $320,000.
The Rule of Thumb Method
The rule of thumb method values your practice based on a simple formula or ratio that is derived from industry norms or averages.
The rule of thumb method applies a quick formula to a financial number in your practice, like annual revenue.
For example, a common rule of thumb for medical practices is to multiply the annual gross revenue by a factor of 0.5 to 1.5.
Think of this as a ballpark estimate. It’s like hearing someone say, “Oh, that jewelry is probably worth about 10 times what you paid for it.”
But, it’s a simplified way and may not capture all the practice’s unique aspects.
Hybrid Approach
The hybrid approach is a sophisticated method to evaluate your medical practice by combining various elements of the valuation approaches that we discussed earlier.
How does it work?
Typically, we first use the income approach the gauge your practice’s worth as an operational entity.
Then, we use the asset approach to estimate the value of the assets that your practice owns.
Example
Let’s say that for the valuation of your medical practice, you decide to use both the income and the asset approach to get a more accurate estimate of your practice.
Income Approach: Assuming your practice is projected to generate $70,000 net income annually for the next five years, we use an 8% discount rate, and we get an estimate of $280,000.
Asset Approach: Now, we estimate the value of all the assets, tangible and intangible, that your practice owns, which, let’s say, comes to around $220,000.
Now, to get an accurate estimate of your practice, we combine the estimates from both these approaches, which gives you a valuation of $500,000 ($280,000 + $220,000).
What are the Financial Metrics and Multiples Used for Medical Practice Valuation?
The financial metrics and multiples used for medical business valuation play a crucial role during the valuation process and vary depending on the method and the type of practice.
However, some of the most common ones are:
Annual Revenue or Gross Income
This metric basically sums up all the money your medical practice brings in from the stuff you do and sell.
For regular docs, the usual range for how much your practice is worth compared to your yearly earnings is between 0.5 to 0.7 times.
Now, if you’re a specialist, things can get even better – you might score a higher multiple, depending on how hot your services are and how much of an expert you are in your particular niche.
For example, if your practice generates $500,000 in annual revenue, a valuation multiple of 0.6 would mean a valuation of $300,000 (0.6 x $500,000).
If you’re a specialist with high demand for your services, your multiple might be higher.
For instance, a sought-after dermatologist might receive a multiple of 0.8, leading to a valuation of $400,000 based on the same annual revenue.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
The EBITDA multiple medical practice, in plain terms, tells you how much money your practice is making from its day-to-day operations without sweating over things like non-cash expenses and financing costs.
Now, when it comes to figuring out how much your medical practice is worth, experts usually use multiples in the range of 3 to 5 times EBITDA.
But here’s the twist: the exact multiple you land on depends on things like how much your practice can grow and how risky it seems to potential buyers.
Let us say that your EBITDA multiple medical practice is $150,000. If we use a valuation multiple of 4, the worth of your practice would be $600,000 ($150,000 x 4).
Now let’s say that you are a very successful cardiologist. In that case, buyers might be willing to pay you a multiple of 5, valuing your practice at $750,000 ($150,000 x 5).
SDE is the cash you, as the practice owner, get to pocket once you’ve taken care of all the bills, factored in any one-off payments, and accounted for your personal spending.
Now, in the world of medical practices, people often throw around multiples in the ballpark of 1 to 3 times SDE when figuring out how much your practice is worth.
But here’s the catch: the exact multiple can swing this way or that, depending on how big and profitable your practice is.
Let’s say that your SDE is around $200,000, and you use a multiple of 2. In that, the worth of your practice would be $400,000 ($200,000 x 2).
Now, let’s imagine that you run a small medical practice with $80,000 SDE. However, you have an excellent patient retention rate and a strong presence in your community.
In this case, an expert might use a multiple of 2.5, which values your practice at $200,000 ($80,000 x 2,5).
Note: Remember, these numbers and ratios are like ballpark figures based on what’s typical in the industry and what’s happened in the past.
But when you’re trying to figure out how much your medical practice is really worth, you’ve got to think about the unique stuff too – like where you’re located, the people you’re treating, your reputation, and how much you can grow in the future.
So, it’s a good idea to get some expert advice. Talk to a financial expert who knows the healthcare industry inside out. They can help you pin down a more precise value for your practice that takes all these special factors into account.
9 Factors that Affect the Value of a Medical Practice
The value of your medical practice is influenced by many factors that can be classified into two categories: internal and external factors.
Internal factors are those that relate to the characteristics and performance of your practice, such as:
The type and specialty of your practice: It determines its market demand, competition, reimbursement rates, regulatory environment, and growth opportunities.
The location and demographics of your practice: It influences your patient base, referral network, accessibility, visibility, and reputation.
The quality and condition of your assets: Assets such as equipment, furniture, inventory, software, etc., affect your operational efficiency, maintenance costs, and depreciation rates.
The financial performance and stability of your practice: Revenue growth, profit margin, cash flow generation, debt level, working capital management, etc., indicate your earning capacity and risk exposure.
The goodwill and intangible assets of your practice: Brand name, customer loyalty, staff expertise, contracts, licenses, etc., enhance your competitive advantage and market value.
External factors are those that relate to the environment and conditions of the market and industry, such as:
Economic and social trends: Population growth, aging, income level, health awareness, etc., affect the demand and supply of medical services and products.
Technological and scientific developments: Innovation, research, discovery, etc., create new opportunities and challenges for medical practices.
The legal and regulatory changes: Laws, rules, standards, etc., impact the compliance and liability of medical practices.
Competitive and strategic factors: Mergers, acquisitions, alliances, etc., shape the structure and dynamics of the market and industry.
These factors can have positive or negative effects on the value of your practice, depending on how they align with your strengths and weaknesses. Therefore, it is essential to analyze them carefully and objectively.
Valuing a medical practice is like valuing a family heirloom. We know it’s valuable, but how much exactly?
As we discussed, there are 5 most used methods that you can use for medical practice valuation, namely:
Asset Approach
Income Approach
Market Approach
Rule of Thumb Method
Hybrid Approach
Now that you know that, how do you proceed from here?
Well, your best bet would be to consult with a professional who is an expert in evaluating businesses and knows the healthcare industry inside out. These experts can help you consider all the unique aspects of your practice and arrive at a more precise valuation.
But where can you find such an expert?
We at Arrowfish Consulting can help you with that. Our team of experts has 20+ qualifications and 200+ years of collective experience across various industries, the healthcare industry included. With these attributes combined, we have been trusted by our numerous clients to handle even the most complex financial cases. Contact us and use your free initial consultation with our expert business appraisers to get started.
Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.
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