The COVID-19 pandemic has decimated the bottom lines of many private practices, prompting physician-owners to seriously contemplate selling.
Physician-owners have had to sell at lower prices, reflecting lower cash flow under COVID-19. But sales prices may rebound following news on November 9 that a COVID-19 vaccine candidate produced by Pfizer and its German partner, BioNTech, may be ready for initial distribution before the end of the year.
"There are a lot of if's still, but if things go according to expectations, we may see an increase in the value of practices," says Mark O. Dietrich, a CPA in Framingham, Massachusetts, who deals mostly with valuations of physician practices.
"Practice valuations have been lower because many patients have kept away and cash flow has been reduced," Dietrich says. "But once patients feel safe, that barrier would be removed, and cash flow, which sales prices are generally based on, could rise. However, this may take a while. One major hurdle would be getting people to take the vaccine."
Many Doctors Have Been Contemplating Closing
The nation is currently undergoing a significant spike in COVID-19 hospitalizations, which could prompt another COVID-19–related downturn in practice volume, as occurred earlier in the year. That downturn forced many private practitioners to contemplate selling their practices.
In a survey released this summer by McKinsey & Company, 53% of independent physicians reported that they were worried about their practices surviving. Although many physicians have now reopened their offices, patient volume is reduced, and physicians are earning far less than before.
"In many cases, physicians who had been considering retirement in the next few years have moved their planning up and want to sell as soon as possible," says John D. Fanburg, an attorney at Brach Eichler, a law firm in Roseland, New Jersey, who specializes in medical practice sales and mergers.
"For physicians over age 65, it's not just worries about finances; it's also worries about the health risks of staying open," Fanburg adds.
Mid-career physicians are also selling their practices. Many of them become employees of the hospital, large practice, or private equity firm that bought the practice ― receiving a level of compensation set by the sales agreement.
Will Your Practice Be Hard to Sell?
With so many physicians ready to sell, are there enough potential buyers to acquire them all? Probably not, says Dietrich.
"Many hospitals may not need new practices right now," he says. "In the depths of the pandemic, they furloughed many of their existing doctors and may not have brought all of them back yet."
In fact, because of the pandemic, some buyers have delayed sales that were already in progress, says Monica H. Kaden, director of business valuations at Sobel Valuations, based in Livingston, New Jersey.
"Buyers are not only worried about their own cash flow but also about the possibility of lower revenues of the selling practices due to COVID-19," she says. She cited a very large multispecialty group that has put its purchase of a another large multispecialty group on hold.
Practice Values Have (Temporarily) Fallen
Many potential buyers are still looking, though. One thing that drives them is the possibility of discounted sales due to COVID-19. "The sense I get is that a lot of hospitals see this as an opportunity to pick up practices on the cheap," Dietrich says.
COVID-19 has been reducing practice values somewhat, says Reed Tinsley, a CPA in Houston, Texas, who performs medical practice valuations and runs a practice brokerage firm. "Practice revenues and net income are lower under COVID-19, so prices are lower," he says.
Kadan advises physicians to hold off selling if they can afford to wait. "It's always best to sell when the practice volume looks the best, because then the practice is worth more," she says. "But there are doctors who can't wait because revenues are really falling and they are running out of money. They may have no choice but to sell."
Even in the best of times, not all practices can be sold, says Sean Tinsley, a broker and licensed financial advisor at Tinsley Medical Practice Brokers, in Austin, Texas, which he runs with his father, Reed Tinsley.
"We turn down about as many deals to sell practices as we accept," he says. "Brokers have to be very selective because we don't get paid until the practice gets sold. Generally, we won't take practices in rural areas or practices that still only have a fraction of their pre-COVID-19 volume."
How Long Will It Take to Sell Your Practice?
Some practices find a buyer within weeks, but in other cases, it can take as long as a year, he says. Once the buyer is located, preparing the paperwork for the sale can take 45 to 60 days, he says.
Doctors can sell their practices on their own, but a broker can help them find potential buyers and select the right price. Business brokers generally receive a greater percentage of the sales price than residential brokers. They have greater command of business and finance, and the sale is more complex than a residential sale.
The broker may also help with selling the building where the practice is located, which is usually a separate sale, says Bruce E. Wood, an attorney at CCB Law in Syracuse, New York, who deals with practice sales. "A hospital buying your practice may not want to buy the building, so it has to be sold separately," he says. "You can always sell the space to a different buyer."
What's the Right Price for Your Practice?
For small practices, brokers often set a price by establishing a multiple, such as two times net earnings, Sean Tinsley says. In many cases, practices haven't retained net earnings, so the broker uses gross annual revenue and sets the price at 50% to 55% of that figure, he adds.
An alternative that is widely used in the business world and for many large practices is to base the price on earnings before interest, taxes, depreciation, and amortization (EBITDA). To determine a price, the EBITDA is then multiplied by a particular multiple, which depends on the perceived value of the practice.
Higher multiples go to practices that have a qualified management team, have documented financial policies and procedures, or have had significant past growth. Generally, the multiple of EBITDA at smaller practices is 1 or 2; larger practices have a multiple of 5 to 7 times EBITDA, Sean Tinsley says.
COVID-19 has had the effect of reducing the multiple somewhat. "As market forces shift from a seller's market to a buyer's market, multiples will likely remain below pre-COVID-19 levels for the remainder of 2020 and the first half of 2021," one report states.
Certified valuators like Reed Tinsley have more complex ways to establish the value of a practice, but as a broker, Sean Tinsley tends to use the multiples approach. He asserts that the prices derived from this method are on the mark. "Almost all the time we sell at the asking price," he says.
Using Valuations to Set the Price
A more complex and expensive way to set a price for a practice is to order a valuation of the practice. The valuator issues a report that runs dozens of pages and costs thousands of dollars.
Fanburg, the attorney, says very few physicians selling practices order valuation reports, owing to the cost and complexity. As a result, "they don't have a clear idea what their practices are worth," Fanburg says.
A comprehensive report is called a conclusion of value. The amount it finds ― expressed as a range ― is called "fair market value." The report can be used in the courts for legal disputes as well as for deriving a sales price.
Practices that don't want to pay for a conclusion of value can ask a valuator to assemble a less extensive report, called an opinion of calculated value. Also known as a calculation engagement or engagement letter, it still costs several thousand dollars.
This report has limited validity and can't be used in the courts, according to Jarrod Barraza, a certified valuator in the Nashville, Tennessee, office of Horne, a healthcare business valuator. "When I issue an engagement letter, I am not talking as an appraiser but as a valuation consultant, and I don't call the result fair market value; it's only estimating," he says.
For all of the precision of formal reports, however, valuations of a practice can vary widely, according to Reed Tinsley. "Two valuations using the same methodology can differ by $300,000," he says. Also, the valuation can be well above a reasonable asking price, says Sean Tinsley. "The market dictates the price," he says. "A traditional valuation almost invariably quotes a higher return than the market is willing to pay."
Buyers' Valuations
Physicians who decide not to get a valuation still have to deal with valuations ordered by buyers. Hospitals and large practices often order valuations of the practices they want to buy, and private equity firms use methods much like a valuation for the practices they are interested in.
Buyers rarely share the valuation report with the seller, so the seller has to accept the buyer's price without being able to review the thought process behind it, Fanburg says. "Relying on the buyer to tell you what you're worth means you may sell your practice well below its true value," he says.
When the buyer orders a valuation, the valuator interviews managers of the practice and asks for a great deal of information, says G. Don Barbo, managing director at VMG Health, a healthcare valuation firm based in Dallas, Texas.
Barbo says these documents include financial statements for the practice, usually going back 3 to 5 years; productivity reports for doctors and other providers; accounts receivables; reports of fixed assets; a roster of employees; employment agreements and management services agreements; reports on payer mix; facility leases and equipment lease agreements; budgets and projections; and tax returns.
Dietrich says valuators hone in on the practice's current procedural terminology codes. "If the practice is coding too high, this would artificially increase the profit and purported value of the practice," he says. "For example, coding at 99214 rather than 99213 for an established patient means that the practice is being paid 45% more for each visit." The valuator then reduces the value of the practice on the basis of the extent of the improper up-coding.
Barbo says some sellers don't want all the scrutiny of the buyer's valuation and just sell the practice's tangible assets ― furnishings, fixtures, and equipment ― which do not require a great deal of documentation but yield a much lower price.
A Primer on Valuations
As a valuator, "my job is to project into the future," Barraza says. "I am trying to see how the practice will fare going forward." Dietrich agrees, with one caveat: "As Yogi Berra said, 'It's difficult to make predictions, especially about the future.' "
The formal valuation assesses the practice in three ways: measuring income, assets, and what other practices sell for, called the market approach.
With the income approach, the most used measurement for practices, one tries to determine future income, which is what buyers are most interested in, Dietrich says. The income equals revenue (total collections) minus operating expenses and overhead.
"You are then left with all the money the physician is paid," he says. "The issue is, how much is attributed to the physician's own labor and how much to his or her ownership of the practice? This second category helps determine the value of the practice."
The market approach is often used as a way to double-check the accuracy of the income approach. The appraiser looks for the prices of similar practices that have already been sold and then adjusts the price on the basis of differences with the practice up for sale.
The asset approach may be used when the practice has no positive cash flow. It establishes a price for tangible assets, which are often much lower in value than the values that the other approaches come up with. The asset approach can be a lower-priced alternative for practices that can't be measured under the income or market approach.
"Equipment appraisers can do an inventory of your equipment," Wood says. "Generally, equipment that is more than 3 years old, such as computers, is not that valuable, but an ultrasound machine probably has some resale value."
Will the Buyer Pay for Goodwill?
Many practice owners hope they can get money for the "goodwill" of their practice when they sell. Goodwill basically represents the reputation of the practice, which is difficult to pinpoint, and Wood says buyers often don't want to pay for it.
"The goodwill is a wild card," Wood says. "It can range from zero to crazy numbers. There is a Goodwill Registry ― a list of the goodwill in other practice sales ― that you can consult."
One simple way to calculate the goodwill, he says, is to take the value of the practice based on examining income and remove the value of tangible assets. What is left is considered the goodwill.
Another form of intangible asset that is sometimes lumped together with goodwill is the value of the practice's trained staff. "Some buyers agree to pay for the staff in place, because they plan to use that staff," Kadan says. In one large deal she was involved with, the buyer agreed to pay something for the selling practice's staff of 180 people, she says.
Another item that buyers also do not typically pay for is the practice's accounts receivable. They may also not pay for any liabilities the practice holds, such as the facility lease, equipment lease, and maintenance contracts, Barbo says. "The buyer then often stipulates that all liabilities are left to the practice, or stipulates any specific liabilities that it may assume," he says.
Selling to Other Doctors
Doctors can sell practices or shares in practices to other doctors. A retiring physician, for example, can sell his or her share to the other partners. A valuator may be brought in to establish the value of the doctor's equity interest in the practice.
"Generally, practice buyouts aren't lucrative for selling physician," Wood says. "There are exceptions, of course, such as specialty practices in some cases."
A practice can also be sold to a new doctor or to a previously employed physician who wants to be an owner. These physicians usually need to get a bank loan to buy the practice.
The bank assesses the finances of the selling practice to determine whether the buying physician will earn enough money to pay back the loan. "Banks don't want lend more than the gross annual revenue of the practice, and some banks will only lend at 65% of gross annual revenue," Sean Tinsley says.
COVID-19 has seriously affected banks' lending decisions. Banks stopped lending to practice buyers at the beginning of the pandemic, and when they started lending again, they were more cautious, Sean Tinsley says. "Generally, banks want to see the practice at 85% to 90% of pre-COVID-19 numbers before they make a loan," he says.
He adds that if a buyer can't get a bank loan, the selling doctor may decide to finance the sale. The buyer agrees to a payment schedule to pay off the full price over several years.
Selling to or Merging With Other Practices
The usual buyer is another practice, Reed Tinsley says. "You can sell to a group, but prices are low because, with COVID-19, buyers don't want to incur a lot of money up front," he says. "Or you can merge with the practice, which means the selling doctor usually doesn't get any money, but he does get a share in the larger practice. In that case, the partnership is the object of value, and it can be cashed out when the physician leaves the practice."
Mergers can get very complicated. Fanburg says he has been working with seven groups that are merging into one. "The merger was scheduled to go live last January, but it was slowed down over negotiations about new managed care contracts and putting together a management structure, plus the groups were a little wary of each other," he says. "Now the deal is scheduled to go live next January."
One advantage to selling to a larger entity, such as a big group practice or a hospital, is that the selling physician benefits from the higher reimbursement rates that large providers usually command. "If the buyer has more favorable reimbursement rates with insurers, it could pay the selling doctor much more than he is making now," Barraza says.
Hospitals as Buyers
Because of COVID-19, currently many hospitals don't have money to buy more practices. However, this is most likely a temporary situation.
Hospitals typically offer less money than other buyers, according to Sean Tinsley. "We have never sold to a hospital, because hospitals generally don't pay for goodwill," he says. "They pay for the practice assets and offer a dollar amount for each chart."
Hospitals have to be careful not to pay physicians more than the usual amount for their practices, because the extra amount could be seen as a kickback for referrals, which would violate the federal Stark law and Anti-Kickback Statute. Not-for-profit hospitals also have to comply with regulations for not-for-profits at the Internal Revenue Service.
Hospitals usually require that the selling physician continue to work in the practice after it is sold. The selling physician's presence helps ensure that the practice's output will not decline after sale. Although the sales price may be low, the hospital may make up for it by paying a higher compensation, Sean Tinsley says.
Selling to Private Equity Firms
Private equity purchases are financed by investors who essentially want to "flip" practices ― that is, they want to make them more profitable and then sell them to someone else. The private equity firm starts by buying a "platform" practice, which forms the core of the venture. It then buys smaller practices that will be managed by the platform practice.
The number of private equity deals increased continually through 2019, then plummeted in March because of COVID-19, but by the summer, activity began to rise again.
Physicians are very intrigued about selling to private equity firms because they are known to pay the most for practices. But private equity buyers focus on a fairly narrow group of specialties.
Generally, Sean Tinsley says, private equity firms only look for pain, dermatology, and ophthalmology practices, but they have been starting to branch out to specialties such as gastroenterology. In 2018, there were only two private equity deals for gastroenterology practices, but in 2019, there were 16, according to one assessment.
Private equity firms buy very few of the practices they initially review, according to Fanburg. "Private equity negotiates with dozens or even hundreds of physician practices at a time, with only 1% to 5% of those practices actually being acquired," he says.
The private equity firm's upfront payment to selling physicians is quite high, but then the physicians become employees of the new group and earn much less in compensation than they earned on this own.
"In order for the venture to get any value out of the acquisition, the doctors have to make less going forward than they did historically," Dietrich says. That freed-up money boosts the value of the venture.
When the platform practice is sold ― usually after 5 years or so ― "chances are the management team will be replaced," Fanburg says. "There could be new policies and objectives, which could mean a bumpy ride for physicians."
Do You Really Want to Sell?
"When a group of physicians comes to me asking for help selling their practice, my first question is, Why are you doing this?" Fanburg says. "You need a better reason for selling than just the money.
"Once you make the leap, there is a certain amount of autonomy you lose," he continues. "The sale gives you an economic boost, but it may not be enough for the long haul. If you stay on with the buyer, your compensation is often lower. That makes sense if you're retiring, but not if you're a younger physician with many years of practice in the years ahead.
"When physicians say they see no other way out except to sell," Fanburg says, "I tell them that their buyer will see a path to future growth for your practice. If you think reimbursements are getting worse, why are the buyers pressing ahead?"
Leigh Page is a freelance healthcare writer based in Chicago, Illinois.
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