Classified under the SIC code 8011, the primary care physician practices are part of a large professional health practitioners service industry. In fact, there are over 373,000 medical practices in the US alone.
The industry as a whole generates some $202B in annual revenues, and employs over 3,000,000 professional and office staff. However, a typical medical practice is small business: producing around $600,000 in annual sales with an average staff of 8.
Medical practices tend to generate highly stable earnings due to the repeat business that arises out of an established and loyal patient base. As a result, established practices are a frequent acquisition target. Selling prices of similar physician practices offer you an excellent way to estimate the market value of your own practice or one you are interested in acquiring.
Market based practice valuation using multiples
In order to estimate the value of a medical practice, you can use a number of valuation multiples. Derived from recent sales of similar practices, the multiples relate the actual selling prices to the practice financial performance measures. The typical valuation multiples used in appraisals are:
- Selling price to net annual sales
- Practice price to gross profit
- Price to net income
- Practice value to EBIT and EBITDA
- Price to total practice assets
- Price to owners’ equity
It is a good idea to use a number of such valuation multiples for accurate business valuation. Each estimate may differ depending on how well your specific practice does compared to its peers. The result is a range of values, or some weighted average of all the practice value estimates together.
Example: using valuation multiples to value a primary care medical practice
Let’s consider a typical private medical practice with the following financials:
- Annual net sales: $600,000
- Gross profit: $585,000
- Net income: $80,000
- EBIT: $82,500
- EBITDA: $84,000
- Total practice assets valued at: $250,000
- Book value of owners’ equity: $11,000
For this example, we pick a set of reasonable valuation multiples and apply them to the financials. The practice value results are as follows:
|Multiple||Multiple value||Business value|
|Price to net sales||0.85||$510,000|
|Practice value to gross profit||0.9||$526,500|
|Value to net income||3.25||$260,000|
|Practice value to EBIT||3||$247,500|
|Practice price to EBITDA||2.75||$231,000|
|Price to total assets||3.1||$775,000|
|Price to owners equity||10.0||$110,000|
|Average Practice Value||$380,000|
Why such considerable variation in the results? Because our example medical practice compares less favorably with its peers when it comes to the owners’ equity measure and profitability.
Other business valuation methods to consider
To be defensible a medical practice appraisal usually relies on a number of business valuation methods. Since physician practices tend to create considerable business goodwill, the Capitalized Excess Earnings valuation method is a common choice.
Practice goodwill valuation: a common requirement in divorce cases
This is especially so in cases of marital dissolution in those jurisdictions that treat professional practice goodwill as part of the marital estate. You may have to split the goodwill into the personal and institutional parts depending upon the way the court in your jurisdiction handles the distribution of goodwill assets.
Direct capitalization techniques such as the Multiple of Discretionary Earnings valuation method are another common choice for valuing owner-operator managed physician practices. The method provides a very consistent way of calculating the practice value based on its earnings and a set of financial and operational performance factors.