How Much Is My Practice Worth?
This is a million dollar question for the seller – and a rough answer is usually surprisingly easy. However, when you google to find the answer, most of the time you find a long essay talking about various valuation models (e.g. Income Approach, Market Approach, Cost Approach, etc).
All of the above is true, but in practice a majority of buyers (and banks who fund them), follow a relatively simple method in valuing a profitable practice – which is either a multiple of EBITDA or a multiple of Discretionary Earnings (DE), also known as Seller’s Discretionary Cash Flow or Seller’s Discretionary Earnings (SDCF, or SDE). EBITDA is typically used for a business of reasonable size (say over $1 Million in revenue), whereas the DE is usually for smaller and typically owner-operator types of businesses where the owner of the practice is fully involved in the day to day operations. Medical practices often also sell by multiples of revenue.
EBITDA stands for Earnings before Interest, Taxes, Depreciation, and Amortization (yes, it is a mouthful). But essentially, you take the net earnings of the business, add back the interest expense, state and federal income taxes, depreciation and amortization and you get the value of EBITDA. In practice, we always use Adjusted EBITDA rather than ‘pure’ EBITDA, because in small businesses often there are “discretionary expenses” that are not business-related and also one-time expenses, such as certain amount of capital expenses which are typically not usual expenses but are expensed out in one year, instead of being on the balance sheet, for tax benefit. Examples of Discretionary Expenses include higher than market salary for the owner, personal car on the company expense, owner’s wife or son on the payroll even if they are not involved in the regular work. So these are called “add-backs” to EBITDA, because these are added back to the EBITDA to provide Adjusted EBITDA.
So once you have this magic Adjusted EBITDA number, you can approximately estimate the value of your practice by multiplying this EBITDA by a multiplier. This is where it gets a bit interesting. For example, for a small practice with revenues of say between $1-$5M and EBITDA under $1M, the multiplier is typically between 2.5-4 but usually between 3-4. Depending on the type of the practice, it could be higher or lower than this range or on the high end or low end of this range. Some of the factors that decide where it will fall, are discussed in the section for Sellers and determining your Value Builder score. Also in medical practices, the patient retention estimate is built into the practice. If a practice is too dependent on the reputation of a physician owner, then it is likely that many patients may leave once the owner leaves. In a larger practice with multiple physicians, if some physicians are staying on after the sale, this maybe less of an issue. The patient attrition becomes more of a concern in some specialty practices as opposed to practices of say Family Medicine / Internal Medicine. But the most important thing to remember is that a right value is what at a given time, a buyer is willing to offer, depending on how badly he or she needs it.
Also remember that as the size of the practice becomes larger, it also attracts higher multiples – EBITDA multiples could go up to 5-8 for practices that are much bigger in revenues and EBITDA. Remember the famous saying – value is in the eyes of a beholder. A strategic buyer who is not able to capture certain business because he or she lacks certain capabilities, or geographic presence, or some of the credentials, could easily pay a premium for a certain practice, and for that buyer, the price is justified.
What about smaller practices which are owner-operated and use DE or SDCF instead of EBITDA? DE or SDCF in simple terms is EBITDA plus owner’s compensation and the valuation multiple is typically for DE is in the 2-3 range.
Note that often physician practices are also often valued as multiples of revenue – around 40-80% of gross revenue. This is a large range, but it depends on the type of practice, its quality of earnings including how sticky the client base is, what is the client demographics including their payors, whether the equipment is new or old, etc.
The best approach is to plan a few years ahead of the sale and try and position your practice so that it is attractive to a buyer and which can fetch higher value as explained here.
EXCEPTIONS TO THE RULE
Of course there are several exceptions to this general valuation method. It is tricky for practices that have small, zero or negative EBITDA or are closed down.
For example, for a lab that has a very small, zero or negative EBITDA, obviously we cannot use the above method. We have to look at the value of the assets – assets could be hard assets such as equipment and inventory, could be employees and the turn-key nature of the practice, licenses that are hard and time-consuming to get, such as in-network contracts, etc. These intangible assets are often hard to value and it depends on how valuable these are to a buyer.