Medical Practice Valuation: Within the Rules Established by the Uniform Standards of Appraisal Practice (USPAP)
The USPAP rules have been adopted to ensure minimum standards for appraisal reports. The valuation process described herein complies with the rules followed by the American Society of Appraisers (ASA) and the American Institute of Certified Public Accountants (AICPA).
Here are the four most important rules for appraisers:
- The appraiser has no present or prospective interest in the property.
- The appraiser has no bias with respect to the property or to the parties involved with the valuation assignment.
- The assignment is not contingent upon developing or reporting predetermined results.
- The compensation for completing the assignment is not contingent upon the amount of the value opinion.
The data collection process is both the most important and intimidating part of the valuation process. The data request will include:
- Practice tax returns for the previous three years
- Profit and loss statements for the previous three years
- Balance sheets for the end of each of the previous years
- Practice depreciation report
- Payroll report for the last year
- Practice production reports by provider
- List of discretionary items to account for quasi-business expenses that would not transfer to a new owner.
- Description of the practice (How many ops? How large is it? Do you own the building?)
- Patient counts (How many new patients per month? What is the active client base?)
It will take some time to gather all of the information, but the seller’s diligence during this part of the process will save time and money in the long run. Typically, appraisers won’t start working on a project until all of the data collection pieces are in place. After the data is collected it can take anywhere from a week to a few weeks to complete the valuation report.
When the data has been collected it needs to be cleaned up to remove discretionary items. For example, the practice’s automobile lease may need to be removed. That is, of course, unless the vehicle is actually used to make house calls. Another example of an adjustment that we may need to make would be to the owner doctor’s salary. Some owners will take a salary while some will not. The salary decision is generally determined by the way the business is set up. To put all of the practices that we see on a level playing field an adjustment to the owner salary may be necessary.
Methods Used in Medical Practice Valuation
This method values a practice’s equipment and leasehold improvements at today’s fair market value. Imagine this method as a fire sale method. It is generally not utilized when the company being valued is a service-oriented business.
This is a method is similar to the one used in real estate. In real estate, appraisers utilize comparable house sales (comps). A business valuation appraiser will use data from sources such as the Goodwill Registry, Pratt’s Stats, Bizcomps, and Midmarket Comps to compare to the subject business. Consequently, this method provides an appraiser with a good idea of the range of which the majority of similar business sold.
This approach examines the practice’s ability to generate profits above and beyond the owner doctor’s fair market salary.
The Capitalization of Excess Earnings (CEE) method looks at the extra profits of the practice and assumes that they will continue growing at a stable rate into perpetuity. Then, a measure of risk is applied, known as a capitalization rate, to the earnings to yield a value.
The Discounted Cash Flow (DCF) method relies on a forecast of the practice’s potential earnings. It then uses the capitalization rate plus growth, discount rate, to value the future stream of cash flows to an investor today. Most noteworthy, the two methods would yield the exact value if the DCF growth was the exact same. The DCF method would be preferred, if a company is likely to experience short term changes.
USPAP allows for two types of business valuation reports they are; an Appraisal Report and a Restricted Use Appraisal Report.
The Appraisal Report option will provide all of the details necessary for a person to make an informed decision about the business. I think of this report as the one that I want to use to help settle a partnership dispute or divorce. Since this report covers all of the details it is typically around 70 pages or so.
A Restricted Use Appraisal Report will omit certain sections of the full report. An appraiser will do all the necessary research for the assignment, but the report will be smaller, typically around 40 pages. I think of this report as one that has all the math, it just doesn’t tell the full story.
I also offer a non USPAP compliant calculation report for clients who want a ballpark estimate of their practice value, but don’t anticipate selling the business or settling a dispute.