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.
Mr. Fanburg said that 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.”
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, Tenn., office of Horne, a health care 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 said.
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.”
Also, the valuation can be well above a reasonable asking price, said Sean Tinsley. “The market dictates the price. 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, Mr. Fanburg said. “Relying on the buyer to tell you what you’re worth means you may sell your practice well below its true value.”
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 health care valuation firm based in Dallas.
Mr. Barbo said these documents include financial statements for the practice, usually going back 3-5 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.
Mr. Dietrich said 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. 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.
Mr. Barbo said 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.