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Complete Guide To Buying Or Selling Medical Practices

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Complete Guide To Buying Or Selling Medical Practices

Two Types Of Physician Practices For “Sale” In Today’s Marketplace: 

1. Solo Practices:  which are generally made available for sale upon the planned retirement of the physician.  For purposes of this discussion, solo practices are also defined to include practices of two to three physicians, provided that each of the doctors decide to retire during the same timeframe. 

2. Larger Physician Practices: are generally not subject to sale as they meet the definition of “going concerns,” whereby the business is perpetual in nature.  New physicians join and older physicians retire, typically pursuant to pre-established financial mechanisms, thereby eliminating a need for a sales transaction.

An appraisers guide to selling or buy a Physician Practice

The other type of practice currently subject to sale is the hospital-based specialty practice such as anesthesia, emergency medicine, and neonatology.  Fortunately for these specialty practice physicians, there are a number of active corporate buyers that may provide a very attractive “exit strategy” for such hospital-based groups.  While the marketplace for buying and selling solo physician practices is less efficient than it is for specialty practices, the process of locating a buyer and negotiating and closing a transaction can be lengthy and complicated for both types of practices.  This article highlights some of the major issues to be considered in connection with buying or selling a physician practice.

Positioning the Medical Practice For Sale

A) Tax Status. 

laptop and graphs with coworkers speaking in background

Apparently, many healthcare professionals received advice from their attorney and/or their accountant that their practice should be treated as a C-corporation for federal tax purposes.  The logic is that a C-corporation offers more liability protection to its owner(s), and since all of the profits can be distributed as earnings the double taxation that could occur at the corporate level and the individual level can be avoided.  Further, upon a future sale of the practice, the seller can achieve favorable tax treatment by selling stock thereby qualifying for capital gains treatment as opposed to income treatment.

However, this logic falls apart when attorneys for buyers routinely advise their clients against buying stock in a professional medical practice to avoid the assumption of possible unknown liabilities.  Once a stock transaction is ruled out by the buyer, the seller is left with potential gain from selling assets that is taxed at both the corporate and individual levels.  The effects of such double taxation can materially reduce the possible proceeds of a sale to the physician.

Accordingly, owners of C-corporations should give consideration to electing S-corporation status in contemplation of a future sale.  However, this action must be planned well in advance since the IRS requires a waiting period of 10 years before a sales transaction involving a former C-corporation can be treated as an S-corporation.

B) Develop Ancillary Income. 

One of the most attractive (and valuable) features that a medical practice can have in a sales transaction is the existence of ancillary income.  For a solo practitioner, the opportunities for such income sources are limited, largely due to the number of referring physicians oftentimes required to make certain ancillary services feasible and the Stark law and anti-kickback regulations that generally prohibit joint venture arrangements. However, there are a number of attractive ancillary income sources that are available to solo physician practices, largely depending upon the practice specialty.  These sources may include certain imaging modalities (e.g, ultrasound or DEXA), in-office surgical services, clinical trials, and physical therapy.  Similarly, a niche practice focus (e.g., a focus on weight management) may differentiate the practice and create additional value.

C) Maintain Good Accounting and Operational Data. 

The perspective of a possible buyer, (i.e., a physician who may be in the market for an existing physician practice) can simply be described as a “make vs. buy decision.”  Although the hurdles associated with establishing a de novo practice are not insurmountable, an existing practice carries less risk and a likely faster path to attractive profitability.  Therefore, a buyer weighs the cost of acquiring an existing practice against the costs and risks associated with establishing a new practice.

START EARLY AND ALLOW FOR A TRANSITION PERIOD.

Buyers of physician practices tend to be very diligent in their analysis.  To assist in the process, it is imperative that sellers be able to produce timely and accurate financial and operational information, preferably for several prior years.  As seemingly simple as it is to maintain such basic information, many physicians cannot readily produce such information.  While tax returns are a useful source of data, they usually do not provide accurate breakdowns of expenses by category.  In addition, tax returns are often not timely enough.  For example, for a physician considering the sale of a practice in the latter half of the year, the most recent tax return will already be six months to a year old.

At a minimum, the information that a selling physician should readily have available includes:
  • Tax returns for several prior years
  • Income statements that provide details of expenses by category for the past several years
  • Listing of tangible practice assets (g., office and clinical furniture and equipment)
  • Copies of managed care contracts
  • Cash collections by payer source (YTD and at least for the one prior year)
  • Procedure productivity report showing billings by CPT code (YTD and at least for one prior year)

Ideally, a “marketing package” containing the information above, plus narrative descriptions related to various practice attributes should be developed as the first step in the sales process.  Selling any business has a lot to do with “deal momentum,” and a lag time of several weeks to compile this information may result in the loss of a potential buyer.

D) Dress up the Practice to the Extent Possible.

Buyers of any type of business like to see increasing revenue and productivity trends.  It is helpful to have supplemental information available to help the buyer understand the true historical profits to the owner and to explain any factors that may appear to detract from value.  An independent expert can help position the practice as favorably as possible. 

For example, a practice may be unduly conservative in its coding of evaluation and management codes.  Recently, HealthCare Appraisers noted a practice that rarely billed for an evaluation and management service level high than a “level 2.”  By pointing this factor out to a potential buyer, along with analysis of the impact to revenue assuming a more normal distribution of E&M service levels, the potential earnings of the practice were substantially increased.

E) Start Early and Allow for a Transition Period.

One of the most difficult barriers to overcome in the sale of a physician practice is the lack of sufficient advance planning.  The unexpected death of a practicing solo physician most dramatically illustrates this issue, whereby such a practice trends to be worth little more than the value of the fixed assets.  Under such unfortunate circumstances, the most valuable aspect of the practice, i.e., the going concern value, is immediately compromised.

Too often, medical professionals take steps to sell their practices too close to their planned retirement date.  The process of finding a buyer and negotiating and closing a transaction can take many months, and failure to start far enough in advance can result in the appearance (or the reality) of a physician’s desperate need to sell the practice.  In addition, the selling physician’s ability to facilitate a transition period of six months or longer is often viewed as very beneficial by the buyer.

F) Market the Practice Regionally and/or Nationally. 

Since buyers are oftentimes younger physicians that may need to leave a restricted geographic area, it is important to broaden the marketing focus beyond the local community.  There are trade publications that accept classified advertisements applicable to all physician specialties.  Despite possible beliefs to the contrary, advertising in such publications can be fruitful, possibly identifying genuinely interested physicians from other states that otherwise would not be identified.

G) Keep Multiple Options Open.

  Ideally, two or more possible buyers will be identified.  Until a transaction is closed, the selling physician should attempt to actively negotiate with multiple parties.  Too often, a physician goes down a path with a single buyer that looks promising, only to find that months slip by without a successful transaction.  Whether purposely or not, some buyers may realize an economic advantage when the seller places undue reliance on a single prospective transaction.

Factors Pertinent to Medical Practice Buyers 

A) Avoid Buying Stock or Accounts Receivable

Attorneys will generally advise their clients not to buy stock or accounts receivable in physician practice transactions to avoid the assumption of potential liabilities.  On the other hand, it is frequently beneficial for the seller to assume ongoing collection efforts to maintain continuity and since the selling physician will no longer have resources at his disposal.  Arrangements can be made for the buyer’s staff to continue to collect pre-transaction receivables on behalf of the seller in exchange for a mutually agreeable collections fee.  The fee arrangement should also be structured to encourage the buyer to collect older receivables with the appropriate degree of effort.

B) Conduct Careful Due Diligence. 

There are many possible pitfalls in buying any business, and most of these can be avoided with the appropriate extent of pre-transaction due diligence, preferably conducted by qualified experts.  The due diligence process should consider each material aspect of the practice, including, as examples, financial operations; the condition of the equipment; the terms of the office lease(s); and managed care contracts.  Any adverse findings are generally resolved more favorably to the buyer if they are presented objectively and with appropriate supporting data and analysis.

C) Plan for Adequate Working Capital. 

It is imperative for buyers to be realistic regarding the cash flow needs of a new practice.  There may be significant disruptions in payments from Medicare and commercial payers while the incoming physician is being credentialed, and the existing working capital (i.e., the cash and accounts receivable) of the practice is typically retained by the seller.

D) Establishing the Value of the Practice

The value of a physician practice generally lies in its tangible assets (e.g., furniture and equipment), its accounts receivable and its goodwill.  While the notion of “goodwill” may seem elusive, it is fairly straightforward in the context of a physician practice.  Goodwill is simply a measure of the excess earnings capacity that a practice has as compared to its ability to provide average physician compensation as reported by salary survey data.  

"A physician practice that returns an “average” rate of compensation to its owner is worth much less than a practice that provides for above average returns. "

If a practice is expected to return to the buyer only the same level of earnings that could be achieved through employment (by another physician practice, for example), then a buyer would have little tolerance for assuming risk or paying any significant purchase price.  To the extent that practice has excess earnings capability, coupled with the expectation that the buying physician will be able to maintain the earnings capacity, such excess is generally valued at a multiple of perhaps 3 to 4 times!  Lower multiples are generally applicable if there are risk factors that suggest that historical levels may not be sustainable.

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As an example, if a gastroenterologist earns $400,000 from the practice, the “excess earnings” can be computed as $80,000, the difference between $400,000 and $320,000, the median gastroenterology physician compensation reported by a compensation survey source such as the Medical Group Management Association.  Therefore, the excess earnings value of the practice may range between $240,000 and $320,000 (i.e., 3 to 4 times).  This value, plus the value of fixed assets and accounts receivable, will determine the total value of the practice.  As expected, there are numerous factors specific to each practice and its marketplace that will establish a more exact valuation.

A final consideration regarding practice value relates to transactions costs.  Fees involved in selling a practice typically include broker fees and legal and accounting fees.  Such costs should be considered and offset from the expected value of the practice.  In certain instances, the transactions costs may make the sale of a practice financially unfeasible.

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