Understanding Medical Practice Valuation: A Guide For Selling a Medical Practice

25 Jul 2023

Valuing a medical practice can be complex and daunting, especially for business owners not well-versed in valuation methodology. If you plan to sell your practice, using a professional broker or accountant is a sensible way to get an accurate valuation.

Remember, when buying and selling businesses, there are no ‘fixed’ formulae – your practice with have a different value to each buyer, and its value is ultimately determined by what they are prepared to pay for it.

This article will examine the most common valuation methods used in the healthcare and medical sectors, giving you a better understanding of your practice’s value.

1. Multiple of Net Profit

The first method we will look at is the ‘multiple of net profit’ method. The multiple of net profit method is popular for valuing businesses and often used for medical practice valuations. With this method, a multiplier is applied to the annual net profit of the medical practice. In the medical sector, the multiplier is typically between 2 and 5. The multiplier can depend on various factors, including the practice’s reputation, stability, location, and service demand. For example, a medical practice with a low turnover, limited time remaining on its lease, and revenue reliant on the owner may only command a multiple of 2. Conversely, someone would likely value a medical practice with a significant turnover, diverse team, and long-term contracts in situ closer to 5 times net profit.

The downside of using the multiple of net profit method is that it can undervalue a practice that has reinvested heavily in growth or overvalue a practice where profit has been artificially inflated by the owner undertaking a large proportion of the work below market value pay. The downside of this method can be mitigated by calculating and applying sensible adjustments to normalise business operations.

Need help understanding your practice financials – read our insight on: What financial information do I need to sell my business?

2. Multiple of Turnover

The multiple of turnover method is similar to the multiple of net profit method, but the multiplier is typically smaller and applied to the practice’s total annual revenue. Multiples within the medical and healthcare sector commonly range from 0.5 to 1.5, depending on the practice’s size, niche, and profitability. This approach is beneficial for practices with high revenues but relatively low profitability, particularly if profits have been reinvested into the business to facilitate growth.

Several trade associations within the healthcare sector appear to advocate this method for owner-operator practices. While it can be a valid method, one should take caution when applying it to practices that operate an associate model as it can over or undervalue a practice depending on the business model used. For example, Practice A takes 100% of treatment fees and pays 50% back to its associates, whereas Practice B requires associates to take payment from clients direct and pay 50% of their fees to the practice as rental income. Besides how the practice takes its payments, Practice A and B could be identical but would receive very different valuations where this methodology to be applied.

3. Market Approach

The market approach to medical practice valuation compares recent practice sales in a given geography or medical specialty. However, this method relies heavily on the availability and relevance of transaction data, which can take time to come by in niche sectors.

This method is usually very accurate. Specialist brokers like Verilo often use this approach to benchmark practice valuations or sense check offers based on other methodologies.

4. Discounted Cash Flow (DCF)

DCF is a more complex method for larger practices or those with fluctuating cash flow. It estimates the value of a practice by forecasting future cash flow and then discounting them back to the current value using a required rate of return. This method considers current profitability and growth potential, offering a more comprehensive view of a practice’s value. This method is common among larger financial institutions and private equity firms.

5. Net Assets

The net assets method values a practice based on the value of its net assets – in other words, its total assets minus its liabilities. This approach is most commonly used for businesses with significant tangible assets, such as property, high inventory levels, or specialist equipment. It is rarely used for medical practices, which tend to be asset poor. The exception to this might be medical diagnostic businesses. The other use case for this method is for practices experiencing financial difficulties, as it reflects the minimum value of a practice and its liquidation value.

6. Earn-Out

The earn-out method is another popular option for medical practices where goodwill is often linked to the business owner. It can be applied when there is uncertainty about the future performance of the medical practice or when the buyer and seller have differing opinions on the value of the practice. An earn-out involves the buyer paying a proportion of the purchase price upfront, with the remainder paid out over time and linked to its future performance. Earn-outs are often complex and should be carefully constructed to protect the interests of both parties.

Final Thoughts

In conclusion, understanding and selecting a suitable method for your medical practice valuation is vital in determining its worth. The chosen approach depends on your practice’s specific characteristics, objectives, and market conditions. You may look at multiple methods to determine fair value. Consulting with a healthcare broker or accountant experienced in medical practice valuation can help guide this process and maximize the value you obtain when deciding to sell a medical practice. You can also give our practice valuation calculator a try to get a high level estimate for your business.

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