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| Benefits Comparison | ||||
|---|---|---|---|---|
| Owner | Employee 1 | Employee 2 | Employee 3 | |
| Health Insurance Disability Insurance Life Insurance 401k Other Retirement Profit Sharing Annual Bonus Auto Allowance Club memberships Other benefits | ||||
After deducting the benefits paid to the owner, the buyer needs to make an assessment as to whether benefits will be increased, decreased, or kept at the same level for other staff members and to account for the increase or reduction in expense that will result.
Payroll Taxes. Payroll taxes are the amounts the employer pays for Social Security, Medicare, federal unemployment insurance and state unemployment insurance. If the buyer plans to increase or decrease the compensation paid to employees, this expense area will also increase or decrease.
Advertising. This expense item should be scrutinized very carefully. The buyer should request a breakdown of all advertising expenditures. From this breakdown the buyer can determine what forms of advertising will be increased, maintained, reduced, or eliminated. If the seller does little or no advertising, the buyer should list the types of advertising that they intend to do such as yellow pages, direct mail, newspaper, radio or TV. If there is uncertainty about the cost of a particular type of advertising, the buyer should consult with the sales representative for that type of media.
It is not a good idea for a buyer merely to allocate a specified amount of money for advertising without knowing how much advertising that amount of money will buy. The cost of advertising includes more than the cost to place the ad. Ad production, postage costs, and the redemption cost of any coupons are all examples of factors that need to be considered along with the placement cost of the ad. Inaccurate assumptions about the expenses of a business are a major factor behind the failure of a business. It takes time and discipline to thoroughly consider the costs of advertising in different media. If advertising is a major part of a doctor's marketing strategy, understanding the total cost can help avoid a financial catastrophe.
Insurance. The buyer should list the types of insurance carried by the seller and amount of coverage for each policy. The buyer may be able to reduce the amount of coverage depending on the type of business they wish to develop relative to that of the current owner. For example, if the current owner services a managed care contract, they are probably required to have malpractice insurance with minimum policy amounts of $1,000,000/$3,000,000. If the managed care contract does not transfer to the buyer and the buyer does not wish to pursue other contracts, they may wish to purchase less malpractice insurance.
Employment Taxes. Social security, self-employment and Medicare are all examples of taxes that could be markedly different for the buyer at the time the business is sold. Each of these taxes is based on the earnings of the individuals employed by the business. If the buyer chooses to defer compensation or takes compensation in a different manner than the seller, it could affect both the type and the amount of the tax. Completing the grid on the following page will allow the buyer to determine how much difference there will be in these taxes.
Interest Expense. Three adjustments may have to be done in this expense category. The first is for any interest currently being paid by the seller. This amount would not apply to the buyer assuming that business debt is liquidated at closing. As previously discussed above, the second adjustment would be needed if there is real estate involved with the sale. The third adjustment is necessary if the purchase is to be financed. The buyer can expect that interest relating to financing the sale may be significant and could materially affect both the cash flow and profitability of the practice.
If real estate is to be purchased, a very thorough inspection of the roof, ceiling, HVAC, plumbing, walls and basement floors is essential to fully understand the condition of the building. Since most individuals are not likely to have the skills necessary to make an accurate assessment, an inspection service should be retained to provide the professional appraisal needed and to estimate the cost of any repairs.
The cost for required maintenance can be handled in one of two ways. The buyer and seller could agree on the amount of maintenance that must be performed and the cost can be deducted from the purchase price; or, the buyer can make an offer that reflects the costs of the needed maintenance.
The physical appearance of the practice can influence the success of the practice. A seller with a great reputation can afford to let the appearance of the practice deteriorate to some degree. Since a new doctor does not have that benefit, the cost presenting a highly professional image should be part of the negotiations for the practice.
Is it better to break out each segment of the transaction or to sell all of the items as a package?
There is a lot of emotion that goes into buying a practice. For the seller it means letting go of something that it very close to them. For the buyer, it is a confusion of emotions as they try to balance the tremendous excitement about owing their own practice with the fear of entering into the biggest financial transaction of their life.
A seller that puts a single price tag on the entire practice without breaking out each component of the sale will have a more difficult time selling the practice than an individual that fully justifies each asset that is being sold. Breaking the practice into components allows the buyer to make smaller purchasing decisions, each of which can be justified, that add up to the large transaction of the purchase. The component parts of the sale would be:
Separate questions in this section deal with the advisability of including real estate and/or accounts receivable in the purchase price. The more a buyer can justify the purchase of each component of the practice, the less likely they are to suffer buyer's remorse.
My practice receives a large portion of its revenue from managed care contracts. How might that impact the price of my practice if it is sold?
The answer to this question assumes that the managed care contracts are a financial benefit to the practice. There are instances where a doctor loses money on managed care agreements especially if the reimbursement is based on capitation. If the managed care agreements are not profitable, the seller should develop a price for the practice that does not include the revenue or expense from these agreements.
The transferability of managed care contracts can be a major benefit or hindrance to the sale of the practice. The benefits are obvious if the agreement provides reasonable reimbursement. However, many chiropractors do not think to negotiate for the right to transfer their contracts to a new owner at the time the agreement is signed. When the doctor decides to sell all the cards are in the hands of the managed care company. They can:
A buyer should insist on a letter from each managed care company that does business with the practice authorizing the transfer of their respective managed care agreement before the sale is finalized. To protect against the possibility of being accepted by the managed care company for the balance of the agreement and then terminated on the renewal date, the buyer may want to condition their offer on being successful in extending the term of the agreement. If this is not possible, the buyer may also wish to consider adding a term to the sales agreement that would provide for a reduced price if the managed care agreement(s) were not renewed at the end of their terms.
Where can I get an evaluation of the worth of my equipment?
Just as individuals tend to be disappointed when they learn the value of their used car, doctors are generally disappointed when they learn the market price of their used equipment. If you have a good working relationship with an equipment supplier, they should be able to give you an objective estimate of the value of your practice's equipment. Another source of information is the classified ads in The Wisconsin Chiropractor that often has used equipment for sale.
Should real estate be included as part of the sale or should I sell my building separately?
Whether or not the practice's real estate is included in the sale depends on two factors, the financial resources of the buyer and the degree to which relocation would affect the revenue of the practice.
Owning the real estate in which a chiropractic practice is based, is usually too much of a financial burden for the typical chiropractor entering practice. With large school loans and the other expenses of daily living, young doctors are lucky if they have enough money for the equity needed to purchase a practice, much less the additional capitol needed to finance a real estate transaction. Because a new chiropractor is seen by many in the lending business to be a credit risk, a buyer is likely to find it difficult to finance a real estate transaction. Seller financing is definitely an option; however, it adds to the risk of the transaction.
Complicating the situation is the feasibility of relocating the practice if the building is sold to an unrelated buyer. If there are a lot of other chiropractors in the area, relocating the practice may increase the risk to the buyer because some patients may decide to get their chiropractic care from a more convenienently located chiropractor in the immediate neighborhood. The loss of these patients will reduce the income of the practice and, consequently, the value of the practice.
If purchasing the building is not feasible and relocating would diminish the value of the practice, the seller might consider retaining ownership of the building and leasing the space to the buyer. Assuming the space occupied by the practice is appropriate for the number of patients seen; this option could be a win-win situation for both parties. Either party may wish to negotiate for the right to buy/sell the property at a specified price at a future date.
If the buyer has sufficient financial resources to purchase the real estate along with the practice, or the seller is willing to assume the risk of financing the purchase of the building, negotiating the price for the property should be based on at least one professional appraisal. The estimates prepared by commercial real estate appraisers consider a wide range of factors in developing a realistic estimate of the value of the property. The credibility of the appraiser and can help reassure the buyer that the price of the property has been fairly estimated.
Do I have the right to transfer the remaining years of my lease to the buyer?
The right to assume a lease is not something that should be taken for granted by the buyer or the seller. Each lease has specific language about its transferability and it is one of the most important considerations for a buyer. If the lease is not transferable without the written permission of the building owner, the seller should involve the building owner as soon as possible to avoid a delay in the sale of the practice.
Most building owners are likely to approve the request if they believe the buyer has the financial capacity to meet the terms of the lease. However, some building owners might balk at transferring a lease depending on how long the seller has occupied space in the building. If the seller has been a tenant for a long period of time with favorable lease terms, the building owner may want to take the opportunity to renegotiate the terms of the lease. If this occurs, it complicates the sale of the practice as each party has to calculate the impact of an increase in lease payments; or, if moving the practice is feasible, the loss of patients and the related impact on profitability.
In a situation where the seller has the right to assign the lease to a buyer, the buyer may want to extend the lease and/or negotiate new terms with the building owner as part of the negotiations to buy the practice. Extending the term of the lease assures the buyer that the location of the practice will be stable and allows for more accurate long term budgeting.
The lease for the practice I am buying is not transferable and I will have to relocate the practice. What factors should I reconsider when re-locating the practice?
The seller has a large inventory of x-ray chemicals, rehabilitation supplies, and nutritional supplements. He wants me to pay for all of these items as part of the sale. Is this a good idea?
The seller wants a buyer to purchase these items because he/she will have no use for them once the practice is sold. While it is possible these items could be sold on the secondary market to another chiropractor, it is not likely that the seller would want the headache of doing so. Since the buyer is the most likely customer, the seller has to focus on negotiating an acceptable price as part of the sale.
The buyer, on the other hand, may not be at all interested in the merchandise. For example, the sale of nutritional supplements may not be in their business plan, they may plan on replacing the x-ray equipment or, they may feel the supplies are obsolete. If the buyer does not perceive the need for an item as part of their practice, they will not want to include it in the sale. Before an offer is made, the buyershould complete the following checklist for each inventory correspond with them over errors. Any receivable over item: these limits is not likely to be collectible. While patients may be responsible for the debt, collecting from them
- Be sure the item has not passed its expiration date. This
after a long period of time may also be difficult. is especially true for a nutritional
supplement or chemical preparation. Items beyond their expiration Receivables
not collectible because of billing errors. It date should not be sold to the public
or used in any part is not unusual for a CA to postpone cleaning up claims of
the practice. with billing errors. Even those claims that are legitimate
- Be sure the chemicals you are buying are those that the
may be difficult to collect if the time period for manufacture recommends for
use in their equipment. submitting the claim has expired. While the patient is
- Some doctors permit their patients to use and return still
responsible for paying the balance, the longer the rehabilitation supplies. Do
not purchase used delay, the more difficult the collections process. rehabilitation
supplies.
- Be sure to check the rate of sale for any items sold to
Receivables based on claims that have been determined patients. If you are being
asked to purchase a three year to be not medically necessary. If the selling doctor
supply of an item based on its past rate of sale, the item has not been successfully
in defending his/her care, it may be obsolete by the time it is sold. is not likely
that the buying doctor will fare any better.
- Do not accept estimates of the amount of an inventory item.
Count each item to be sure you are purchasing Receivables based on personal injury
claims that have the correct quantity. The inventory should be done as yet to
settle. Depending on the age of the claims, partial close to the sale as possible
otherwise supply items that payments that may have been made by patients and the
the buyer has paid for may be consumed by the seller ethics of the attorney representing
the patient, these between the time of the inventory and the date of the receivables
may or may not be collectable. sale.
- Receivables based on worker's compensation claims If a buyer is uncertain about whether or not certain items in which the WC carrier has denied liability. Claims in will be sold or, if the inventory of supply items it which the WC carrier has denied liability are the unreasonably high, the buyer and/or seller can consider responsibility of the patient unless an administrative making a contingent sale. The contingency sale can be law judge decides in favor of the injured worker. If structured in one of two ways. Option one would have the there has been no collection activity on these claims, buyer make payment for the items as they are sold. Typically, they are not likely to be paid. an inventory would be conducted monthly with payment accompanying the inventory. The second option would have Receivables that are outstanding with group health the buyer making payment for the items at the time of sale carriers and/or patients that are older than 120 days. with the seller promising, in writing, to refund the money While payment on some of these claims is likely to be for any items remaining after a certain date. made, it will take a great deal of concentrated collection activity to be successful.
Should accounts receivable be included as part of the transaction? Payment options for receivables
If a seller does not wish to have any responsibilities once If receivables are to be included in the sale of the practice the practice is sold, it is to his/her advantage to include the here are the ways in which the transaction could be handled. accounts receivable as part of sales package. From the position of the buyer, paying for accounts receivable is like Straight sale of the receivables playing the Go Fish game at a carnival. You pay your money and you do not know what you will find in the The buyer and seller agree on a price that is paid in full at package of receivables you purchase. Here are some of the the time of closing. This is the method favored when the surprises that you could find: buyer does not make an independent determination about the collectibility of each individual receivable. Receivables
Receivables so old that the insurance company will no can be purchased at full value (100 cents on the dollar) or longer pay. Insurance companies have limits on the for a fraction of their value (example: 60 cents on the dollar). submission of claims and the time you have to Assuming an acceptable price can be negotiated, sellers like this approach because it allows them to turn over the practice without any lingering administrative responsibilities. It is impossible to understand the financial impact when this approach is chosen until six to twelve months after the sale has been completed. It is only then that the buyer will be able to determine if their guesstimates about the quality of the receivables was accurate.
Structured sale of the receivables
Using this approach, the buyer would look and each receivable and categorize it according to the buyer's belief about its collectibility. Generally speaking, this is normally done by assigning a percentage factor to each outstanding claim with 100% assigned to the claims that appear almost certain to be paid and 0% for the claims that appear to be worthless. In order to do this work accurately, the buyer needs to have knowledge of the payment patterns of particular insurers and be able to assess the quality of clinical documentation produced by the seller.
The following charts are an example of how this calculation is made.
Group health claims
| 100% | $13,456 | $13,456 |
| 75% | $ 3,288 | $ 2,466 |
| 50% | $ 750 | $ 375 |
| 25% | $ 433 | $ 108 |
| 0% | $ 1,985 | 0 |
| $16,405 |
* For simplicity only 5 probability levels were used. Depending on the analytical ability of the buyer or seller, these could be exponentially expanded.
Works' compensation claims
| 100% | $11,452 | $11,452 |
| 75% | $ 0 | $ 0 |
| 50% | $ 2,220 | $ 1,110 |
| 25% | $ 0 | $ 0 |
| 0% | $ 1,911 | $0 |
| $12,562 |
* For simplicity only 5 probability levels were used. Depending on the analytical ability of the buyer or seller, these could be exponentially expanded.
Personal injury claims
| 100% | $ 4,560 | $ 4,560 |
| 75% | $22,680 | $17,010 |
| 50% | $ 8,470 | $ 4,235 |
| 25% | $23,550 | $ 5,888 |
| 0% | $ 3,235 | 0 |
| $31,693 |
* For simplicity only 5 probability levels were used. Depending on the analytical ability of the buyer or seller, these could be exponentially expanded.
Medicare/Medical Assistance Claims
| 100% | $9,320 | $9,320 |
| 75% | $2,080 | $1,560 |
| 50% | $0 | $0 |
| 25% | $0 | $0 |
| 0% | $1,723 | $0 |
| $10,880 |
* For simplicity only 5 probability levels were used. Depending on the analytical ability of the buyer or seller, these could be exponentially expanded.
Cash Patients
| 100% | $12,976 | $12,976 |
| 75% | $0 | $0 |
| 50% | $4,030 | $2,015 |
| 25% | $0 | $0 |
| 0% | $6,437 | $0 |
| $14,991 |
* For simplicity only 5 probability levels were used. Depending on the analytical ability of the buyer or seller, these could be exponentially expanded.
Managed Care
| 100% | $35,200 | $35,200 |
| 75% | $0 | $0 |
| 50% | $2,682 | $1,341 |
| 25% | $0 | $0 |
| 0% | $0 | $0 |
| $36,541 |
* For simplicity only 5 probability levels were used. Depending on the analytical ability of the buyer or seller, these could be exponentially expanded.
Summary
Receivable Type | Calculated Value |
Group Health | $16,405 |
Worker's Compensation | $12,562 |
Personal Injury | $31,693 |
Medicare/Medical Assistance | $10,880 |
| Cash Patients | $14,991 |
| Managed Care | $36,541 |
| $123,072 | |
Acting as collection agent for the receivables
Using this approach, the buyer agrees that he/she will act as a collection agent for the seller. In exchange for a percentage amount from each dollar collect the buyer could:
- Bill for services that were not billed by the seller.
- Answer inquiries from insurers, attorneys and patients.
- Send clinical documentation when requested by insurers.
- Inform the seller when a report is necessary to supplement
the clinical documentation.
- Re-bill when necessary to correct previous billing errors.
- Follow-up with insurers, patients, and attorneys.
- Accept payments and apply them accurately to patient accounts.
Pay the seller the net amount due under the terms of the agreement.
This approach takes all of the guesswork out of estimating the value of the receivables. The seller will only have to be involved when additional information is needed beyond what is contained in the clinical records. The buyer does not have any financial risk and gets paid for the administrative work they are performing.
How do the buyer and seller evaluate the prices the current owner charges for services in relation to the price of the practice?
The amount that is currently being charged for services will impact the buyer and seller differently. Since the price of the practice is based on its profitability, the seller needs to evaluate the price of his/her services a year or more before the practice is sold. By adjusting prices the bottom line profitability can potentially be improved assuming the adjustments consider the impact on patients visits and UCR limitations. The price of the practice can be increased proportionate to the increase in profitability.
It is to the buyer's advantage to find a practice that is fairly priced and, in addition, also has current prices that are lower than the competition. If a buyer finds such a practice, he/ she can use this advantage in one of two ways. Prices can be kept low thereby securing a marketing advantage as the low cost provider of care. Or, prices could be increased thereby taking some of the financial pressure off of the buyer by improving the profitability of the practice. The degree to which this approach can be successful depends on the price elasticity for chiropractic services in the community in which the practice is located. If patients perceive that price increases are not justified, the doctor risks losing patients to the competition.
What kind of fundamental knowledge do I need to understand how a business is valued?
There are two major elements involved with the valuation of a business. Net asset value, the business liquidation value, is determined first. Then return on investment, or the value of a future income stream, is calculated.
Net Asset Value (NAV). This represents the equity of a business, or how much money would be received if everything was sold off or cashed in. It is determined by adding up cash on hand, accounts receivable, savings, and the market value of items like computers, adjusting tables, x-ray equipment, peripherals, desks, etc. Subtracted from this figure are accounts payable, long-term debt, lease obligations, and any other financial commitments. Net asset value is the foundation of a business valuation because the market value of a company can never be lower than this figure.
Return on Investment (ROI). This is sometimes referred to as the practices goodwill. ROI can be determined in several ways, but the only way that usually makes sense for closely-held small health care practices is looking at the amount of demonstrable, predictable profit that has been generated in the past several years.
After examining the basis for the profit of a practice, the individual performing the valuation arbitrarily assigns a number (multiple), which is used to determine the ROI component of the valuation. In the world of business outside of health care, multiples for small businesses having sales of less than $l million are typically from 3.0 to 4.0; larger businesses carry a multiple of 4.0 to 7.0. (The multiple is based on the experience of the valuator, and several standard accounting procedures.)
What does this mean? A multiple of 5.0, which assigns a higher value to the business, means that the valuator believes that a potential investor would be comfortable with only a 20% return on investment (ROI). A multiple of 4.0, which assigns a lower value to the business, means that the valuator believes that there is higher risk involved, and that an investor would demand a return of 25%. (Divide 100 by the multiple and you get the percentage return expected.)
What is goodwill?
Goodwill is the intangible asset arising from the positive reputation of a practice and its relations with patients. It can be a key component of the price that it paid for a chiropractic practice because of the nature of a chiropractor's business.
If establishing a chiropractic practice were easy, chiropractic graduates would quickly earn the same amount of money as their more established colleagues and there would be far less deviation in the range of chiropractic incomes as a whole. The primary reason this is not true (discounting the impact of closed managed care panels) is that chiropractors form a close and unique bond with their patients that results in a long term care and revenue relationship.
This relationship has value because a portion of the worth of a business is based on the certainty that revenue will continue to be earned in approximately the same amount as in previous years. The key to this occurring is the goodwill of the practice that can be expressed as both personal and business goodwill. Personal goodwill represents the intangible value of a particular individual to a business enterprise. In a chiropractic practice this individual primarily represents the owner of the practice but also include key associate members of the practice. The stronger the bond of this personal goodwill, the more likely that patients will leave the practice when it is sold. The extent to which patients leave the practice is a variable that must be factored into the purchase price.
Business goodwill, also referred to as institutional goodwill, represents the intangible value of a particular business enterprise which is substantially independent of any one individual. A chiropractic practice in a community without competitors is likely to have exceptional business goodwill because the patients have no alternative for their care if the practice is sold. A practice located in a community with competitors can also have substantial business goodwill if the patients in the practice do not perceive the value of chiropractic to be rooted in the skills of a particular doctor.
There is no universally accepted formula for quantifying the value of goodwill in a chiropractic practice. As a matter of fact, in competitive markets where a sole practitioner is selling his or her practice, patient loyalty is such an unknown factor that all assumptions used to calculate the value of goodwill should be treated skeptically. Tax ramifications in the allocation of goodwill between business and personal make it essential that a qualified accountant be involved in the transaction is a significant portion of the purchase price is allocated to item.
Every chiropractic practice has elements of personal goodwill and elements of business goodwill. The value of each of these elements is specific to each practice. Although there are no absolute methods to quantify the amount of personal to business goodwill applicable in a chiropractic practice, there are a number of attributes that can be identified, and ultimately, be used to reasonably allocate the overall value. These attributes include:
- General attributes
- The size of the practice
- The number of years the seller has been in business
- The degree to which referrals are an important source of
practice revenue
- If the practice has more than one chiropractor, the amount
of production attributable to the selling chiropractor.
- Current pricing of the practice & bull; The intentions of the seller
General attributes
There are many reasons why patients may seek care at a particular chiropractic office. The location of the practice will be important to some patients. In the absence of a referral or the requirements of a managed care plan, it is not unusual for a patient to select their doctor based strictly on their location. Even when a managed care plan has a limited panel from which a patient may choose their doctor, patients are likely to select the doctor that is most conveniently located to their home or office. A patient unhappy with their care may well seek a less conveniently located chiropractor but that does not occur very often because, by and large, almost all chiropractors are able to develop a good rapport with their patients.
The size of the practice
The smaller a chiropractor's practice, the greater the tendency for there to be more personal goodwill. Conversely, for larger practices there is a tendency towards more business goodwill. This is not always true, however, since many other factors may affect the success of a small practice. Large practices with several doctors can still be severely hurt by the loss of a single doctor if that person's reputation was particularly influential in the success of the practice.
The number of years the seller has been in business
Chiropractic practices that make it to second generation or that have successfully passed the ownership from the founder to a younger associate have a tendency to be more institutionalized. Some transfer of ownership has already taken place. It is reasonable to assume that there is business goodwill. However, even in very established practices that have gone through a number of transitions, other attributes of the doctors may show that most of the goodwill is personal to the practitioners.
The degree to which referrals are an important source of practice revenue
If a chiropractor is dependent on referrals for new business, the referral patterns must be analyzed. A chiropractor receives many referrals from medical doctors or attorneys based on their personal relationship with the individual making the referral. A referral pattern from one professional to another professional based upon their personal relationship usually indicates personal goodwill. Business goodwill would be indicated if the referrals, from other doctors or attorneys, were made to the practice and not a particular practitioner. When a patient schedules an appointment based on a referral, the basis for the referral needs to be evaluated. If the patient requests to see a particular doctor personal goodwill is indicated. If not, business goodwill must be assumed.
If the practice has more than one chiropractor, the amount of production attributable to the selling chiropractor.
Three things need to be determined with respect to how revenue is allocated within a practice.
- First, determine how the patient made contact with the
practice.
- Second, determine which doctor provided care to the patient.
- Third, determine if the patient has a continuing relationship
with the doctor that provided the initial care.
There is personal goodwill if it is determined that one doctor performs all of these functions on a consistent basis. When these functions are handled by two or more doctors, business goodwill may exist. You must determine if the patient has a continuing relationship with the doctor that provided the initial care to establish whether personal or business goodwill exists.
Sometimes personal goodwill is transferred from one doctor in the practice to another. Usually this happens when significant responsibility for patients is delegated and other doctors perform the work and provide the treatment for subsequent injuries. Business goodwill is created, however, when more than one doctor is equally responsible for the patient. While most practices are not set up in this manner, you might have instances where the practice styles of doctors in a practice are so similar in a group practice that the patient sees whatever chiropractor happens to be working on the day they are scheduled for treatment.
Current pricing of the practice
The buyer and the seller will have different perspectives when it comes to the prices charged by the practice at the time it is offered for sale. Since the price of the practice is determined in great part by its profitability, it is in the best interests of the seller to maximize the practice revenue in the year(s) before the sale.
A buyer, on the other hand, has more flexibility if the prices charged by the practice at the time of the sale are low relative to the competition. The buyer may reason that prices could be raised to offset some of the purchase price if the marketplace allows them this latitude.
The intentions of the seller
The seller's intentions can create business goodwill even when it is clear that the value of the practice is based on the doctor's personal goodwill. Assume that a practice's value is based solely on the personal goodwill developed by the seller. If the seller's intent is to sell the practice and assist in the transition, the personal goodwill can be transferred to the new owner. Whether or not business goodwill was created in the transfer, or personal goodwill was assumed by the new owner(s) may be at issue. The case could be made that if value was transferred, there was at least some business component to the goodwill.
Alternatively, if the sellers, in this same example, did not intend to transfer their personal goodwill, it would be difficult, if not impossible, for another doctor to maintain the value.
How is goodwill valued?
It is well-established in both the business world as well as the courts that the transfer of the goodwill of a professional practice generally requires an enforceable covenant not to compete in order to be fully effective.
| Profit if practice | Net profit | |
|---|---|---|
| is started from a | (after interest expense) | |
| Year | zero patient base | if practice is purchased |
| 1 | $ 20,000 | $ 100,000 |
| 2 | $ 25,000 | $ 100,000 |
| 3 | $ 35,000 | $ 100,000 |
| 4 | $ 45,000 | $ 100,000 |
| 5 | $ 55,000 | $ 100,000 |
| 6 | $ 80,000 | $ 100,000 |
| 7 | $ 100,000 | $ 100,000 |
Suppose you analyzed goodwill in the context of how long it would take you to get to the same level of profitability as the practice you want to buy?
As the table indicates a doctor could earn $340,000 over the seven years it would take for a doctor who started a practice from scratch to make the same amount of money as an established practice. This $340,000 represents all of the intangible factors discussed in the preceding question plus the value of the goodwill attributed to the practice. The question that the buyer and seller have answer is how much will the buyer pay for this goodwill?
There is no formula available that can possibly be applied because of the variability of each chiropractic practice as well as the assumptions made about the future profitability of a chiropractic practice. The best each side can do is to look carefully at the assumptions made by the other party and attempt to quantify the risk attached to each assumption. The process of negotiations involves arriving at a common set of assumptions and the values attached to them.
1 While for the purpose of this example it is assumed that this would take seven years, both buyers and sellers should view this number skeptically. Seven years has been chosen because, in past compensation surveys conducted by the WCA, seven years seem about the time that earnings stabilize. However, the number of other chiropractors in the area and other competitive factors could easily make this period longer or shorter. Buyers and sellers can apply the principles of the example to a time period either party believes is appropriate.
2 Net profit is the amount available after all of the expenses of the practice have been paid but before any compensation has been paid to the owner.
Difference
3 A buyer's decision on the price to pay $80,000 for a practice is greatly influenced by the $75,000 anticipated profits of the practice. Since the $65,000 buyer will have higher interest expense $55,000 than the seller (related to financing the $45,000 purchase), it would not be fair to use the $20,000 profit numbers of the seller without $0 adjusting for this expense.
4 To simplify the example, an assumption has
been made that the profitability of the practice stays level indicating that increased
costs have been offset by increases in revenues.
Are there tax consequences to the way in which goodwill is handled?
Goodwill is a tax issue, specifically Capital Gains Tax (CGT). If it can be shown that a business has an element of internally generated goodwill, then there are two major tax concessions:
1) If the business was started prior to September 20, 1985,there are strong grounds that the goodwill is a pre-CGT asset, and therefore any consideration received for the sale of that asset is free of tax to the seller. 2) If the business was started on or after the September 20, 1985, and if the goodwill is shown to be worth lessthan $2 million (indexed for inflation to current values), then 50% of the consideration paid for that goodwill will in most cases be free of tax to the seller.
This is a very brief overview of this question. Both buyers and sellers should consult with their accountant to get specific tax advice about the sale.
What subjective factors can influence the success of the practice once it is sold?
Each of the following factors can influence the success of the practice once it is sold.
Technique of the selling doctor. Patients get comfortable with the adjusting style of a particular doctor. If the patient feels uncomfortable with the new chiropractor's adjusting technique, they are likely to leave the practice. The buyer can alleviate this concern by discussing their adjusting technique with the patient during their first visit and following up after the adjustment to insure that they were satisfied with the technique and the result.
How long the selling doctor stays in the practice.A major part of the purchase price is for the goodwill of the practice. That goodwill is predicated on a consistent flow of revenue into the practice. The selling doctor is an expert in understanding the needs of the patients. Keeping that individual involved in the practice for as long as possible is to the advantage of the buyer as long as the seller does not interfere in the administrative changes that the seller may wish to bring into the practice.
This is especially true for patients that claim that they can only be successfully adjusted by the selling doctor. If the selling doctor were to leave, these patients are more likely to leave than the average patient. By retaining the services of the selling doctor, the buyer has the opportunity to get to know the patients on an individual basis, to observe the care that is rendered to them, to gradually provide the care on an occasionally basis and, finally, to assume the full time responsibility for care.
Style of the practice. Here are some of the factors that define the style of a practice:
Let's examine two of these factors: office hours and the techniques used to collect receivables. If the buying doctor decides to expand the office hours, it cannot possibly hurt the practice because he/she is offering the patient more options. If, however, they decide to reduce the hours or change the day off of the doctor, the changes negatively impact the practice.
The staff responsible for the collection of receivables can also impact the style of the practice. If they are aggressive and professional, the acquiring doctor can gain confidence that this part of the practice is under control. If this area has not been emphasized, the acquiring doctor knows that they will have to spend a good deal of management time to establish procedures that allow for the efficient running of the practice without jeopardizing good relationships with patient.
How can I mitigate the loss of patients to maximize the value of goodwill?
Any goodwill value is predicated on the fact that the buyer
will retain most of the patient's after the practice is sold. In a small town
with no competition this assumption is easily validated. As competition increases,
however, both the buyer and the seller must really work at the transition to assure
maximum patient retention.
If one assumes that patient loyalty is based on the confidence a patient has in the skill of the doctor, the buyer must do everything possible to demonstrate to the patient that their quality of care will equal that of the seller. How the buyer accomplishes this may complicate the transaction but may enhance the value of the transaction for both parties.
The first and most obvious opportunity is to make such that the adjusting techniques are comparable between the buyer and the seller. If the buyer exclusively uses the upper cervical technique and he/she wants to buy the practice of a Gonstead practitioner, he/she will find it hard to retain the patient base.
Assuming the techniques are compatible, the best scenario for minimizing the loss of patients would have the buyer joining the practice as an associate (no announcement would be made that the practice has been sold). After a couple of months the seller would begin to cut back his or her schedule by a day or two a week. This will still allow the seller to be active in the care of patient's but will introduce the patients to the care of the buyer. Naturally, all new patients would be assigned to the buyer.
After 2-3 months of this schedule, the sale would be announced. As part of the announcement, patients would be told that the seller intends to stay with the practice on a reduced schedule. The reduced schedule should be no less than 2 days per week, for at least 90 days, so that patients who are concerned still have access to their doctor. During this transition period, any patient that has not been exposed to the new doctor would have an introduction by the seller. To the degree possible, the buyer would see as much of the patient base as practicable with the seller being used primarily to care for patients that are not yet comfortable in transferring to the new doctor. If the practice is large enough and both are interested, this relationship can be maintained indefinitely. Otherwise, sometime after the 90 day transition period (the longer the better) the seller would officially retire from the practice.
One additional enhancement to this transition method is to focus on the way in which the new doctor is introduced to patients. Additional time should be allocated to each appointment so that there is no pressure on the buyer in getting to know the patient socially as well as clinically. This will add some work over the short term; however, the value of goodwill is predicated on maintaining the patient base. If a smooth transition is not achieved, patient erosion will occur on an accelerated basis.
I have recently put my practice up for sale and received a dozen inquiries. Should I work with everyone at the same time or a single buyer at a time?
Every doctor dreams of putting their practice up for sale and being deluged with interested buyers. While it will take an enormous amount of energy, you will maximize the amount you receive for the practice if you work with the entire group of buyers simultaneously. Working with a single buyer at a time would mean that those who were in line would likely lose interest by the time you got around to them.
To begin, you want to prepare an introductory packet of information about the practice. This would either be mailed to each potential buyer or be given to them as part of a short meeting. Ideally you would like a short meeting with each buyer to give them a feel for the practice, but this may not be feasible if the potential buyer lives a considerable distance from the practice.
As the seller, it is important for you to follow up with each potential buyer 3-5 days after they have received the information. You do not want to make assumptions about someone's intentions. This contact will allow you to discuss their impressions of the material and ask if they would like to set up a meeting to discuss the specifics of the practice (see other questions that deal with the specifics of the sales process). Naturally, you can expect some buyers to fall out at each step of the process.
The hardest step is if you have more than one interested buyer after all of the preliminary meetings. At this point you have two options. You can keep the buyers unaware of the interest of other chiropractors or, you can disclose that there is more than one interested party. The choice between the two options is somewhat dependent on your personality. If you like the idea of pitting one potential buyer against another, letting all buyers know of the other's intent would be to your advantage. If you are not fond of tension, or do not want to risk losing buyers who do not want to be part of a bidding contest, keeping everyone's interest confidential would be more to your advantage.
I have already done my preliminary screening and have a couple of potential buyers. What information should be given to a potential buyer during the first meeting?
The seller has three objectives for the initial meeting.
Objective One The buyer wants to meet you and understand why you have been a success. The buyer knows that a chiropractor's success is based on their relationships with showing them, in detail, how a claim is processed. This patients and your practice has developed its own unique should include: way of dealing with patients that has created a sense of loyalty. If the buyer feels comfortable that they can emulate your style, it will create a feeling of confidence.
A buyer also wants to get a feel for your honesty and integrity. Before long they will have to enter into negotiations with you. They want to have a sense of your character so they can begin to plan their negotiation strategy. It is a rare buyer that will buy a chiropractic practice if, at the first meeting, they truly do not like the selling chiropractor
Objective Two As the buyer looks at the practice; he or she wants to imagine coming to work in this practice everyday for years to come. The seller has little control over this imaginary process because every buyer has a unique self image. For example, if they perceive themselves as being a big city doctor, it will be virtually impossible to convince them to move to the country and vice versa.
Objective Three The buyer wants to get an overview of the financial condition of the practice and to begin the process of understanding the administrative side of the practice. It is not necessary to cram the buyers head with data. Most individuals would prefer to hear an overview and leave with information that they can study later. The most effective way for the seller to accomplish this objective is to leave the buyer with the sense that the practice is well run and that it will justify its price once someone has the opportunity to methodically review every area of its operation.
The seller should not attempt to close the sale during the first meeting. It is better to have a number of meetings where the buyer can gradually develop a comfort level with each area of the practice. Having a number of meetings also helps when the buyer discovers that everything about the practice is not perfect. Each meeting is another chance to understand that the positives of the practice outweigh the few problem areas.
The first meeting went well and the potential buyer has had sufficient time to study my financial records. What goals should I have for my next meeting?
Depending on your preference, the two following activities could occur over one or two meetings.
Administrative operations Give the potential buyer a detailed looked at your administrative operations by
- A complete tour of the building including along with a
written chart that explains the maintenance schedule (past and future) for all
of the major equipment.
- An explanation of the method you use to schedule patients.
- A tour of the waiting room including any special activities
for kids or adult education that is available.
- An explanation of the check in process including a review
of the forms a new patient completes prior to seeing the doctor and, any forms
used to explain the patient's financial obligations.
- An explanation of the price schedule used by the practice
and an overview of the managed care agreements currently served by the practice.
- A review of the doctor's current participating/nonparticipating
statutes with Medicare and Medical Assistance.
- An explanation of the referral relationships the doctor
has with other health care providers, employers and attorneys.
- A demonstration of the billing software including a review
of the hardware and software used in the practice.
- A review of the billing practices.
- A review of the procedures used to collect accounts receivable
from both patients and insurance companies.
- A review of the current accounts receivable balances.
- Clinical operations. Gives the potential buyer a detailed looked the clinical side of the practice by explaining your approach to clinical care. This should include:
- An overview of your chiropractic philosophy.
- A tour of your x-ray room including a detailed explanation
of the age and functionality of your x-ray equipment.
- A comprehensive discussion on your approach to the examination
of the patient including information of the role, if any, of properly trained
CA's in the history and/ or examination process.
- A discussion of the primary and secondary techniques used to adjust patients.
- A tour and detailed explanation of the physiological therapeutics
equipment used by the practice including the role, if any, of properly trained
CAs in the administrative of PT modalities.
- A tour and detailed explanation of the rehabilitation equipment used by the practice An explanation of the exercises and/or literature that is given to patients to assist them in their recovery and rehabilitation.
Negotiations. The seller will have more success in negotiations if he or she explains in detail how they arrived at the asking price for the business. This allows the buyer to discuss the assumptions used by the seller for each category of asset. At this point, the buyer has the option to make a formal written offer for the practice or can continue the informal discussions until they feel comfortable enough to make an offer.
I have found a practice for sale that looks very interesting. The seller included the asking price as part of the ad. What are my options in negotiating the price?
Sellers that include the asking price for their practice in an ad do so to keep unqualified buyers from requesting information. The fact that an asking price is listed should not dissuade a potential buyer from aggressive negotiations.
An asking price represents the seller's belief (or hope) about the value of their practice based on his or her underlying assumptions about how each component of the practice will be sold. If the underlying assumptions are incorrect or, the buyer can suggest alternative ways of purchasing a component, there could be a significant change in the asking price.
For example, the seller may have included the receivables as part of the package. If the buyer can convince the seller to retain ownership while the seller collects the receivables in exchange for a fee, the sales price can be reduced accordingly. If the seller had hoped to include the practice real estate as part of the sale and the buyer convinces him or her to retain ownership and lease them the space that also could have a major impact on the sale price.
The saying, it costs nothing to ask, should be a guide to potential buyers. If a practice for sale peaks your curiosity, make contact with the seller. Instead of jumping to conclusions, invest a little time to find out the details and then you will know whether or not this is a practice that you should pursue.
How can shadowing the seller help the buyer make up his/her mind?
Shadowing refers to the practice of accompanying a doctor for a number of days as they treat their patients and interact with their staff. For a doctor considering the purchase of a practice, shadowing can help the potential buyer develop the confidence they need to believe they are capable of maintaining the productive doctor/patient relationships that are in place. It also allows the buyer to observe how the staff performs their administrative functions and to absorb the atmosphere of the practice.
To comply with the HIPAA regulations, the permission of each patient should be obtained before the doctor is allowed to observe their care. The doctor should not be introduced as a potential buyer, but rather as a visiting colleague. The buyer should not offer any clinical comments without being specifically asked by the practice owner.
What are the sources of financing for this transaction and how can the buyer know if he/she got the best deal?
The typical sources of financing for a buyer would be:
Personal Financing. For a conservative individual, using personal funds can be the lowest cost method to purchase the practice. Sellers are particularly motivated to give self-financed buyers a lower price because it means that third parties, such as banks, which might be inclined to scrutinize the transaction more aggressively and will not have a part in the transaction. A transaction that is personally financed is also likely to close more rapidly.
Just because an individual has the financial resources to finance the purchase personally; it does not necessarily mean this is the most advantageous method of acquiring the practice. On of the ironies of business is that a buyer who has sufficient funds to finance a purchase is more attractive to banks. Depending on a person's resources, their investment strategies, and their tax situation, borrowing the money may be a better investment decision.
There is also no reason to preclude a buyer with financial resources from negotiating financing from the seller. While some sellers may prefer to have an immediate payout, there may be advantages to both parties in financing the deal on a long term basis.
Family Financing. It is a rare young doctor that has the financial means to purchase a practice without help from an outside source. In competitive markets where managed care is a major factor, banks are less inclined to offer financing for a new practitioner. Under these circumstances, family and friends are often a source of financing.
The major advantage of using family and friends for financing is that the lender is basing their decision on their trust and confidence in the individual that they know on a personal basis. They will assume that the buyer has reviewed the financial statements of the practice thoroughly and