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True value: Buying or selling a practice

There are ways to ensure that the transaction comes at the right price for both parties.

BUY: Be clinical
SELL: Don't be emotional

By Mike Norbut, amednews staff. April 7, 2003.

BUY: Be clinical when it comes to negotiating terms

There are no termites to worry about when you're buying a medical practice. Probably no leaky roofs or 25-year-old furnaces, either. But there still are plenty of pitfalls and costly traps that can snare the unsuspecting physician.

The evidence-based approach that doctors take when it comes to their clinical work should be applied to business dealings as well, whether they're buying a full practice or a small percentage, consultants said.

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Instead of taking the selling physician's offer at face value, the buyer would be wise to commission an independent appraisal or have the seller's offer analyzed by a trusted financial adviser, consultants said.

"It's much more debatable and variable than selling a house," said Keith Borglum, vice president of Professional Management and Marketing, a consulting firm based in Santa Rosa, Calif.

The inexact buy-in

With a medical practice, the value is directly proportional to the amount of business the doctors generated the year before. But some practices assign an arbitrary buy-in amount for new partners that may not coincide with the practice's true value, consultants said.

For example, a new doctor with an opportunity to buy into a practice may be told that he or she would need to pay $150,000 after three years of employment, or that buy-in could be deferred in the form of a lower salary over those three years. While the system may seem fair, the amount may not be correct, consultants said.

Instead, a physician may be wise to ask the practice to establish a formula to determine the buy-in amount, but not to establish the dollar amount until an appraisal is conducted near the time of the buy-in, experts said.

"My pitch to [the new physician] is you would be better off going with fair market value," said Rick Holdren, owner of AMG, a Houston-based consulting and appraisal firm. "An inexact figure like that tends to be more."

Not all physician groups use this type of formula, though. Pradip Morbia, MD, an interventional cardiologist in Port Arthur, Texas, said his practice does not ask new partners to take a salary reduction, nor does it require a buy-in. After three years of employment, the physician becomes a full partner, and there are incentive benchmarks along the way to encourage hard work, he said.

"The bottom line is, there has to be an incentive to work hard," Dr. Morbia said. "The reason I structure things the way I do is I want them to be happy from day one to doomsday."

Other avenues

If you can't find the right partnership match, there are other avenues to pursue to gain ownership in a practice. You could look to buy from another physician, or you may be in a situation where the practice management company or hospital that employs you is looking to divest itself of its practices.

Melvin J. Butler, MD, an internist in St. Louis, decided just more than two years ago to buy his practice from BJC HealthCare, a nonprofit organization of hospitals, nursing facilities, and retirement centers. He said he had to pay only about $50,000 for the equipment and medical charts, a small sum compared with what practices are usually worth.

"You would think you'll learn about this in medical school, but you don't," Dr. Butler said. "When you rotate through the clinical side of it, you're taught by clinicians who don't have a clue" about the business side.

Details to double-check

One of the first things doctors learn after they buy a practice is that they won't see any money for several months because of delays in insurance reimbursements. Physicians shouldn't just assume their agreement to buy a practice will mean they will have access to every patient, either.

Before you sign an agreement, consultants advise you to get written guarantees from insurers that not only will you be invited to join the network, but also the patients will be transferable within the plan.

In St. Louis, for example, some of the larger insurers take the opportunity to reassess the market any time there's a change in the physician network, said Jerrie Weith, president of Healthcare Management Alternatives Inc., a consulting firm in Belleville, Ill., near St. Louis.

"If they have enough primary care physicians, they're not always going to take you," Weith said.

Added up, these issues can scare many physicians away from buying a practice, but that shouldn't be the case, consultants said. A doctor can find good value among established practices, even though a practice doesn't provide income security the way an employed or group partner position can.

"What drives the practice is the doctor," Weith said. "They're going off their gut feeling they can make it alone. I had one doctor tell me he would rather go bankrupt on his own than to work for someone else."

SELL: Don't let emotions get in the way of the sale

Selling your practice? Take yourself out of the picture. That's what most consultants suggest, anyway.

While it may seem like letting your neighbor take your electric train collection on PBS' "Antiques Roadshow," consultants say an objective third party is the best option to handle an appraisal and negotiations.

Unlike real estate, which deals mostly with tangible assets, there are many items left up to interpretation when it comes to appraising and selling a practice. With so many different details to consider, it's not a time to let emotions or uninformed opinions get in the way, consultants said.

The appraisal "is the critical element of the whole thing," said Arthur S. Shorr, a health care consultant in Woodland Hills, Calif., and president of Arthur S. Shorr & Associates Inc. "If that buyer ultimately cuts a deal with the seller, that document becomes the basis of their agreement."

Larry Colman, MD, a family physician in Palos Verdes Estates, Calif., said he was surprised with what he was able to earn for his practice after he decided to retire about two years ago. He frankly thought he wouldn't find a buyer, and if he did, that person wouldn't be willing to pay more than what he paid nearly 25 years ago. He quickly learned that his estimate was wrong.

"Everybody told me nobody was buying practices," Dr. Colman said. "But I knew my practice was unique."

Indeed, there is a market for established practices, but the ability to sell one depends a lot on issues such as payer mix, referral patterns and the number of practicing physicians in the area.

More common than the sale of an entire practice is the sale of shares, which accommodates either a growing practice or a retiring partner.

Selling shares generally is a far easier endeavor because groups either have buy-in/buyout clauses established or have an attorney draw them up, consultants said. A retiring doctor may already have a potential partner in the fold as an employee, and the sale is simply a matter of knowing what the value of each partner's portion is, consultants said.

The key, Shorr said, is planning ahead.

For example, a five-partner group should know how Doctor No. 6 will take over for retiring Doctor No. 1, and when you want to bring in Doctor No. 7 to be groomed to buy out Doctor No. 2's shares, he said.

"The most successful projects are the ones when doctors give enough time to visit the issues," he said. "The buy-in/buyout mechanism is set up at the time of incorporation. That way, every deal is identical, even if it happens in a disjointed way."

Determining value

Appraisers generally determine a practice's value by using a formula based on its annual gross income. They also try to measure future growth and value with income projections.

Consultants differ on their opinions about goodwill, or the opportunity to assume care of the seller's patients. While some think it's fair to assign a value that's comparable to recently sold practices of similar size around the country, others say regional issues and market saturation, not to mention the age of a practice and the loyalty of the patients, play an important role in determining value.

Goodwill also is a topic that can tie a physician up emotionally. If you try to sell the practice yourself, you may naturally feel it's worth more because of the years you spent building it, consultants said. Emotional detachment is essential to sell the practice yourself, experts said.

Mike Hamed, MD, an obstetrician-gynecologist in Los Angeles, is starting to trim back his work schedule as he looks toward retirement in a few years, and he hopes to do it by selling one office of his overall practice. He's doing it himself, using a formula he learned from an appraiser the last time he sold a practice.

He's asking about $380,000 for it, which he says is equal to half the gross income for one year -- $600,000 -- plus equipment.

"If this is your first time, maybe you need professionals to do the appraisal," he said.

Many times, it's the buyer who determines the goodwill of a practice simply by accepting an appraisal at face value. For example, if there are enough patients to support a physician hanging a shingle and starting a new practice, an established practice does not carry as much value as its balance sheet may indicate, consultants said.

"In a normal situation, the buyer and seller have had good counsel, and the appraisal is within reasonable range," said Keith Borglum, vice president of Professional Management and Marketing, a consulting firm based in Santa Rosa, Calif. "Then it's not so much about price as it is other issues."

Some of those issues include the willingness of the seller to stay for a period of time to help the new doctor through the transition and the feeling that the new physician is going to uphold the reputation the previous physician spent years developing.

"Sometimes it can be really irritating from our standpoint," said Rick Holdren, owner of AMG, a Houston-based consulting and appraisal firm. "Their practice is their baby. The money's important, but not as important as making sure the name goes on in perpetuity."

Dr. Colman said he knew he found the right physician to buy his practice when, after their second meeting, he hugged the new doctor and the new doctor hugged him back. Dr. Colman's wife, who used to work for him, is still an employee in the new office, he said.

"When I was looking for a buyer, it wasn't just somebody who had that clinical ability," Dr. Colman said. "I wanted somebody who was a caring person."