Valuing a Medical Practice

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There’s a revolution going on in healthcare these days. No, I’m not talking about the mega mergers like CVS and Aetna, or the recently announced “Haven,” the joint venture between Amazon, J.P. Morgan, and Berkshire Hathaway. This headline probably won’t make it above the fold, but it’s a trend that is likely to rewrite the delivery of healthcare forever more.

The days of the independent doctor are rapidly coming to an end. Nearly half of all physicians recently surveyed say they’re now affiliated with a hospital or large medical group.

Record consolidation of physician practices (about 7.5% per year since 2016) is expected to continue as health systems, payors, private equity investors, and large medical groups gobble up small practitioners. 31% of all physician practices are now owned by a hospital.

Attorney Brad Mondschein has been involved in merger and acquisition negotiations for more than two decades and now serves as Chief Legal Counsel at, VertitechIT, baytechIT, and the parent company, GPMF Holdings. Within the next few months, GPMF is expected to announce formation of AKIRO, a new consultancy aimed at helping hospitals, physicians, and private equity investors, navigate the complex world of M&A.

Compare the M&A market for medical practice acquisition to that of hospitals.

Mondschein: “Physician to physician practice mergers by volume are much higher than hospital to hospital. Hospital to hospital mergers are larger in scope but there are fewer of them. Practice mergers are larger in volume and you’re also starting to see private equity groups enter the practice acquisition market.”

Why?

“Physician practices are seeing a need for significant capital investment due to government mandates around medical record keeping. As a result, they’re not seeing the traditional financial returns they’d seen in the past. That leaves an opening for private equity that can acquire say, a hundred practices and in theory, achieve the economies of scale inherent in a larger organization. Things like bulk purchasing, insurance, centralized billing and IT services, all make physician practices ideal targets for the right PE firm.”

Are most physician groups capable of putting a valuation on their business?

“I think physicians, like most business people, are incapable of valuing their practice. Some undervalue. Some have a much-inflated view. They need professional guidance to understand where the market would value their business.” 

How do you value a medical practice?

“It’s a similar valuation method to a commercial company. Fair Market Value means “the value in arm’s-length transactions, consistent with the general market value” on the date of acquisition of the asset or at the time of the agreement. We would also look at what is the potential increase in EBITDA (earnings before interest, taxes, depreciation, and amortization) if expenses were reduced post transaction. That can affect what a buyer is willing to pay. It’s important to have a document that sets forth how the valuation was done by the buyer and the seller.”

Let’s talk about efficiency. What makes a practice less efficient and thus, less attractive to a potential suitor?

“One of the first places we look is in their coding. Are they maximizing revenue by coding properly for each procedure they perform in their office? Are they overpaying their staff? Are they effectively using information technology to make them more efficient or do they look at IT as a necessary evil that only needs attention when something breaks?”

What about reducing costs?

“Most physicians don’t look at what a traditional business would call cost of goods. They see themselves as providing a service and look mostly at revenue, rather than expenses. Cost of goods is the cost of your staff, your supplies, your rent, your insurance…anything you need to look at before your take the profit out of a business.” 

And then there’s the subject of HIPAA and data security. Is that sometimes an unfortunate afterthought during the M&A process?

“There have been numerous fines levied against purchasers of practices and hospitals because of violations that occurred pre-closing. We’re talking fines that have been levied in the tens of millions of dollars. Looking at the way a practice protects patient information is every bit as important as looking at their balance sheet.”

The Harvard Business Review estimates that 9 out of 10 hospital to hospital mergers fail. Do the statistics hold true for physician practice M&A?

“In hospital M&A, we’re seeing that acquiring hospitals are not achieving the benefits of scale they predicted before the acquisition. On the physician side, you’re seeing it from both sides. The buyer isn’t seeing the realized efficiencies they anticipated because they failed to perform full due diligence. On the seller side, transactions are falling short because the seller may be forced to spend more post-closing. I’m talking about things like necessary IT upgrades to meet the buyer’s infrastructure requirements.” 

So what’s the advice for buyer and seller in today’s competitive M&A marketplace? 

“Maximize. We look for practices that pay attention to both sides of the ledger, maximizing profit and maximizing efficiency. Valuation is dependent on decreasing costs to maximize cash flow. Maximize cleanliness. An attractive practice is one that understands and embraces the reporting regulations that govern it… that makes sure they’re not over-coding or under-coding. And finally, physicians who want to sell their practice need to understand that in many cases, they’re in the driver’s seat. It’s a very competitive marketplace, especially among specialties with a high level of ancillary revenue like cardiology, radiology, orthopedics, gastroenterology, and primary care. They should market their practice and not necessarily take the first offer that comes along.”

Independent medical practices, for better or worse, may soon be a thing of the past. And while the big names in healthcare may still steal the headlines, you may want to keep your eyes on the smaller print.

Brad Mondschein is Chief Legal Counsel for GPMF Holdings, VertitechIT, and baytechIT and is a principal of AKIRO Consulting. He can be reached at bmondschein@gpmfholdings.com.


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