There are many variables to look at when valuing a practice and if you are looking to sell you need to start planning earlier than you think. This article discusses the important factors that are considered in a valuation as well as what you can do to improve it before you are ready to sell.
Do GP practices actually have a value in the market independent of a payment for the plant and equipment and the structural aspects of a practice?
There is room for a practice to have a value, however there is a threshold. Often we find a smaller practice may only be a worth a small amount of money if anything at all, while a larger, well-run practice can be worth a significant amount of money.
A very simple way to calculate the value of your practice is if you remove your owner Doctor billings from the Profit and Loss Statement, then consider your billing the same as you would a contractor (say 35% for the practice), would there be anything left? Effectively, are you subsidizing the practice, because if you took 65% as a contracting doctor, there would be nothing left? If that is the case, then it is a good indication that at the moment your practice isn’t really worth anything.
What should we keep in mind when valuing a practice?
The value of a practice is subjective; it’s important to keep in mind that the value is what someone in a free market is willing to pay for it, and what you’re willing to take for it. As the vendor, your value may be higher than the value of buyer. Essentially the value of your practice is somewhere in the middle.
Another thing to consider is if corporates become involved, that metric can change. A trap to be aware of is, if a corporate or large entity comes in, they will often offer big numbers, higher than most GPs would be expecting. However, the devil is in the detail of the contract, so it is important to understand it and talk to a specialist about it. For example, there may be big numbers offered up front, but restraints put on you as part of the contract. This could include requiring you to work in the practice for 5 years, at a contracting rate of 50% instead of 65%, meaning essentially they haven’t bought the business per se and have tied you up generating profit for them at the same time. While there may be some big money out there, it may not always be the best option and it is always best to talk to someone who can break it down for you, so you understand the long term effect.
What is a common approach to valuations?
There are a number of different valuation methods, but to keep it simple from a GP perspective, the business cap rate (also known as an EBIT multiple) is the most common. This method is where you work out the future maintainable earnings by looking at the adjusted profit for the last number of years, then apply this multiple by that number to work out what it’s worth. That is, how many years’ genuine profits or regular profits would you be willing to pay to take over the practice? Is that 1 years’ worth of Profit or 5 years’ worth of Profit?
Profitability: what are the principals involved in working out the adjusted profit of a practice?
I would recommend looking at your profit and loss over a number of years, say 3 as a benchmark. From that profit, add back any non-genuine wages you or your family have drawn and any expenses for you personally (eg motor vehicles, superannuation, etc). Likewise, take out any fringe benefits tax reimbursements you have contributed. Once you have this core business figure, apply the contracting rate for any owner Doctors (say 65%) to the owner Doctor billings, and this profit is the adjusted profit for the year.
When valuing a practice and if you are looking to sell you need to start planning earlier than you think.
In addition, you might also want to add back any abnormal expenditure over the 3 year period (eg large pieces of equipment or any other expenses you don’t consider “regular”). This will “annualise” a true profit of the business over the 3 years. You then also need to “weight” each of the years. This means that you will not look at the profit made each individual year, or the average of the profit over the 3 years, rather you would consider which years were more “regular” income years and give them a higher weighting than any years which were less “regular”. This gives you the weighted average EBIT.
How does a valuer work out what multiple to use in arriving at a valuation?
This is the harder bit; it’s not something you can just come up with or guess at. As a rough guide, a multiple of 1 to 5 years profit, however it depends on a number of factors. You should speak with someone who knows the medical industry and will also get to know your practice well. Once you have a rate, you will effectively multiply it by the weighted average profit figure.
There are a number of industry factors to consider in working out the multiple, for example:
Changes in Government policy will not only affect the industry, but your practice specifically;
Changes in healthcare, for example changes to the way public hospitals are run. If it were to become an option for patients to visit their public hospital as opposed to a GP clinic, that would affect your profit;
External environmental factors, for example practice location. Practices on busy roads are easily accessible, ample car parking and proximity to a train station will see a positive impact on the multiple. Practices which are difficult to access, don’t have street frontage or difficult car parking will see a negative effect on the multiple;
Demographics, for example areas with young families who are inclined to visit the doctor regularly versus areas with more elderly patients who may be bulk billed this will affect your practice performance;
Socioeconomic status, for example affluent areas where patients are happy to pay more to see their doctor, versus low socioeconomic areas which may be traditionally bulk billing areas.
It’s important the process is undertaken thoroughly to get an indication of what your business is worth.
Is that the final number?
This Cap rate approach will help determine the goodwill (or value) of the business, however don’t forget that the value of any plant and equipment should also then be added to this number if a sale does occur.This could be minimal value or it could be considerable if there was a recent fit out. The value of this equipment should always be considered at market value, not the price it was purchased for.
Is market competition important?
Most definitely. If you’re a small practice and a multi-clinic opens up a couple of streets away, that will affect your value. This may not be fully reflected in the numbers, which is why it’s important for the person making the assessment to understand the business.
What are some of the factors inside the practice that are relevant?
Growth is an important factor to consider; is there any room for growth within the practice? If you’re running a small practice with, for example, four rooms, and they’re at capacity, not much can really be done with the practice as there really isn’t a lot of room to grow.
If someone is coming in to buy that practice, they’re not going to want to pay a higher multiple for the profit of the practice if they can’t really grow
it or do much more with it. Whereas if a practice is not at full capacity, has space for more rooms or opening hours, there’s room to expand.
Fit out is also something to consider; is the practice fit out current and modern, or does it need to be updated, which could cost money in the future?
Is the staff and contracting team relevant?
The team is very relevant. A practice who has doctors on contracts who are happy working in the practice, who have regular patients who visit the practice to see them specifically, will be more appealing to someone coming in to buy the practice compared with a practice where the doctors aren’t on contracts and are not tied to the practice. For someone coming in to buy a practice where the doctors aren’t on contracts, they have to consider whether the patients will follow if the doctors leave.
Likewise, with nursing and admin staff; perhaps the practice has a great receptionist who knows all of the patients by name and the reason the patients visit that practice is because they feel at home there. These types of things will affect the value of the practice, and that isn’t something which can be seen in the financials.
Is there anything Prosperity Health can do to help our clients work out where they sit in that spectrum?
A good starting point for practices is to see how they compare to other practices. Prosperity Health run an annual GP Benchmark Report which is a useful tool for practices to gauge where they sit on the spectrum in terms of how they operate, whether their expenses are high and their income low.
The next step is to work out why you want to know what the practice is worth; whether it is for your own peace of mind, or because you want to sell the practice or for some other purpose. There are rules and guidelines that are followed when determining the value of the practice and how much detail goes into it will depend on the reason you want to know your practice’s worth. Valuing a practice is not something that should be done for the sake of it.
How long before wanting to sell your practice, should you start that conversation?
Practices should start the conversation several years out because once they get to the point where they want to sell and are trying to work out what their practice is worth, the first step is looking at the last 3 years. If the last 3 years aren’t great, the practice isn’t going to be worth much. If you start planning 5-7 years away from selling the practice, you have time to implement some changes and improve the practice, and ultimately its value. Again, our GP Benchmark Report is a good place to start to see what changes and improvements can be made.
The positive side of the multiple factor is that if the practice is making more money each year, the multiple will increase, meaning the practice will be worth exponentially more. If the worst case is practices are making more money each year by starting early, then that’s not a bad downside!