Thinking of selling or buying a practice?
Thinking of selling or buying a practice?
Study identifies criteria influencing purchase price
The amount of money a practice brings in the door rather than whether it specializes in broken bones or nose jobs is the greatest determinant of the practice’s valuation by a potential purchaser, according to a study by the Chicago-based Center for Healthcare Industry Performance Studies (CHIPS).
"The more revenue [practices] can generate, the more attractive they’re going to be to purchasers," says Patrick Knott, vice president of CHIPS and co-author of The 1997-98 Physician Practice Acquisition Resource Book.
How do you use the findings?
This finding is not surprising given the cries of decreased revenue Physician’s Managed Care Report hears from its readers, but what do you do about it? Although Knott says the study did not investigate how the higher-revenue practices were building their businesses, he points out that two specific factors the study investigated showed a tie to practice valuation:
• Payer mix the higher the amount of commercial insurance patients, as opposed to Medicaid patients, the better.
• Capitation practices with no capitated contracts showed an average practice profit before physician compensation of $156,983, compared with $133,151 for practices with capitated contracts.
"Because capitation is just so new to many practices . . . some of them are just figuring out how to keep their costs in line with a cap rate they’re receiving," Knott says.
Further exploration
Other elements the study explores include:
• Physician practices acquired by hospitals are expected to lose money.
The study attributes this trend to higher salaries paid to employed physicians compared with salaries paid by group practices, and a hospital’s belief that it can substantially increase revenue or decrease expenses once it acquires a practice.
"It tells us that the medical groups buying other medical groups and PPMCs . . . seem to know what they’re doing more than hospitals do. Hospitals are finding out that managing physician practices isn’t their business," Knott says. He points out that hospital acquisitions of physician practices are decreasing and that many hospitals are divesting their physician practice acquisitions for this very reason.
• Using a discounted cash flow method of valuation increases the valuation.
The CHIPS survey says this is true because a discounted cash flow method relies upon forecasts of projected cash flows for the practice after acquisition, whereas other methods rely strictly on historical data. "Proponents of a capital project will often unintentionally forecast higher revenues and lower expenses than may actually result because they are committed to the project. We believe that the same degree of bias is entering into the acquisition of physician practices," the report states.
• A sizable percentage of the total purchase price paid for physician practices is related to tangible assets.
The study found that on average, 48% of the purchase price was related to tangible assets, which typically include accounts receivable, property, plant, and equipment. Variances did occur depending on the practice’s specialty.
• Compensation levels for employed physicians in acquired practices appear to be market-based.
Because physician salaries of acquired practices are consistent with salaries reported in other studies, compensation is not being used to supplement low practice valuations or to reduce excessive valuations, the study found. Overall annual compensation averages for acquired physician practices were $152,217, although the majority of these employment contracts contained performance incentives.
• Very few purchasers included any price contingency related to future practice performance.
This may be attributed to legal or regulatory concerns, the study says.
• Cash is the predominant form of payment. This may be because physicians have strong incentives for immediate liquidity or because of the relatively small purchase price ($170,720) of practices studied in the survey’s sample.
• Payer mix is a critical factor in determining practice profitability.
The study found that on average, practice profitability before physician compensation was $134,755 for practices that receive less than 30% of their income from private insurers, vs. $189,562 for practices that receive 60% or more of their income from private insurers. "Practices with heavy percentages of Medicaid patients might not generate adequate profitability, even with potential operating efficiencies. In these circumstances, great care must be given to the salaries paid to physicians in the post-acquisition period," the study points out.
Beating the competition
Why has acquisition activity stepped up so much these days? It boils down to increasing competition that hospitals and physician practices are facing and the need to gain a competitive advantage when negotiating managed care practices, Knott says. "From the hospital side, everybody’s looking to develop an integrated delivery network to offer more services. Medical groups are doing it to have bargaining power with managed care contracts," he says. Finally, physician practice management companies are acquiring practices to increase their size, and, therefore, increase profits and/or the value of their stock.
[Editor’s note: To order a copy of The 1997-98 Physician Practice Acquisition Resource Book, contact CHIPS at (614) 457-1777.]
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