Originally posted on https://greatlakesadvisory.com/what-is-the-value-of-your-medical-practice/
After several grueling years of medical school, residency, and maybe a fellowship, you’ve managed to build your own practice. That is something to be proud of it is not easy to build any business from the ground up, medical practices included. You deserve to be compensated appropriately.
What if you could pay yourself that same salary or more, free up your time, and secure a comfortable or even lavish retirement? All of those are possible if you can increase the value of your medical practice.
Chances are, however, that you have not put too much thought into what your medical practice is worth or how to increase its dollar value.
You will not work forever; eventually, you will want to retire. Hopefully, you have been prudently saving a portion of your annual salary each year for when that day comes. However, you may not have considered how your medical practice fits into your retirement puzzle.
To illustrate the value a company may represent in a founder’s retirement, let’s look at an example with Jeff Bezos, the CEO of Amazon. Jeff Bezos founded Amazon in 1994 out of his garage in Bellevue, WA. In 2018, Jeff Bezos paid himself a modest salary of approximately $80,000 plus an additional $1.6 million in Amazon stock. For simplicity, (and because data is not available on Amazon before the company went public in 1997) let’s assume that Jeff Bezos paid himself an annual salary of $80,000 from 1994 to 2018 and he was able to set aside 15% (or $12,000) of his salary each year for retirement. Assuming he invested his savings each year and earned a modest return of 5%, his retirement account would have a balance of approximately $575,000 at the end of 2018. Although $575,000 may not provide for sufficient assets to live a comfortable lifestyle in retirement, Jeff Bezos is the actually the richest person in the world with a net worth of approximately $113 billion (as of the date of this writing).
Due to the strategic vision implemented under Jeff Bezos’s leadership since the company’s founding, the market value of Amazon has grown a staggering 1,060% since the company went public. As a result, his net worth grew at a similar rate, despite only owning 12% of Amazon today.
Since you will likely leave the working world behind at some point, your medical practice can be a viable source of value to contribute to your retirement in addition to your current investable assets. For some physician-owners, this source of funds may actually represent the majority of their assets in retirement.
But what kind of lifestyle do you want in retirement? Are your current retirement savings alone sufficient to get you there? Or is the value of your practice required to cover that shortfall? Knowing the value of your medical practice can help you answer these questions.
Business valuations are generally performed by one of two types of firms: either a Certified Public Accountant (preferably one with an Accredited Business Valuation certification) or a dedicated valuation services firm.
These firms typically use one of three methods to determine the value of your practice:
In the discounted cash flow method, the valuation is determined by forecasting future cash flows then discounting the cash flows back in present value terms to account for inflation and the risk associated with the cash flows. Publicly traded companies typically use the Weighted Average Cost of Capital (WACC) for their discount rate. The WACC is a calculation of a firm’s cost of capital. All sources of capital, including common stock, preferred stock, bonds, and any other long-term debt, are included in a WACC. Since the majority of medical practices are not publicly traded, the discount rate would be determined using the same methodology for WACC but then a liquidity risk premium is added to account for the lack of liquidity in a private practice. The calculation and factors that go into determining the appropriate discount rate were omitted from this article for simplicity’s sake; however, it is important to note that the higher the discount rate, the lower the value of firm, all else being equal. For example, firm one has a discount rate of 5% and year one cash flow of $100. The value of firm one’s cash flow is $100 / 1.05 = $95.24. Firm two has a discount rate of 7% and year one cash flow of $100. The value of firm two’s cash flow is $100 / 1.07 = $93.46.
The asset value method is much more intuitive. Your medical practice’s value is calculated by subtracting its liabilities from its assets. Subtracting liabilities from assets leaves you with the owner’s equity, which in this case is your equity. It is similar to purchasing a house; the house is the asset, your mortgage is the liability, and the difference between the value of the house and the remaining mortgage you owe is your equity in the home. If you sold the home, you would receive the full value of the house but would then have to pay off your mortgage, leaving you with the equity amount as the payout.
Lastly, there is the comparable multiples method. In this method, the valuation firm uses an industry multiplier. These multipliers are ratios of a financial metric, such as enterprise value (equity plus debt minus cash), to another, such as EBITDA (earnings before interest, taxes, depreciation, and amortization); the exact financial metric varies by industry. The main assumption here is that similar businesses can be compared using certain metrics.
Some valuation firms may also use a hybrid of two or more of these approaches to increase the accuracy of its valuation.
In many cases, your practice may not be worth enough to provide you with the retirement lifestyle you desire. To retire comfortably, you will have to find ways to increase the value of your practice.
Successful entrepreneurs are not afraid to spend money to make money. They work ON their business (i.e. looking for ways to increase revenue, cut costs, and make their business more efficient) rather than work IN their business (i.e. working as an employee in your practice). Don’t forget that you are one of these entrepreneurs. If you hope to grow your practice, you will have to take on this mindset as well.
As a physician-owner, you are the practice’s greatest asset and likely the primary revenue driver of the practice. You should continue to manage your time effectively by caring for patients. However, your remaining working hours should be spent on opportunities to grow the practice’s value, not just accomplishing the day-to-day things within the practice. Your time is too valuable to be spent on tasks that can be delegated to your staff.
Software is one way to increase your practice’s value. For example, the right scheduling software can make it easier for patients to schedule appointments and cut down on no-shows, which lead to increases in revenue. It will also cut labor costs and free up time for your staff to work on other tasks.
Outsourcing responsibilities not within your core skillset will also lead to a more efficient use of your valuable time. It may be difficult to cope with the reduction of control you have over all functions of the practice, but most successful entrepreneurs will tell you that one key to success is to focus on the work you do best and delegate everything else. For example, outsourcing your accounting/financial management to a CFO service will free up time and brainpower from several time-intensive accounting/finance tasks. This extra time and brainpower capacity can then be directed towards patient care and practice growth. On top of that, you will receive expert financial advice from an outside perspective, which can prove extremely valuable in increasing your practice’s valuation.
With more time freed up, you can concentrate on building marketing campaigns to bring in more patients and thus more revenue, increasing the value of your practice.
To reiterate, you won’t be able to grow your medical practice an appreciable amount solely by working IN it. Stepping back and working on growing your practice will increase revenue and cut costs while freeing you from a lot of day-to-day work, allowing you to pay yourself the same salary or even more while growing your practice further.
However, every practice is different. What works for one practice may not work for another, even in the same specialty. Not to mention that there are endless products/services to invest in, making it difficult to decide on what will benefit your practice the most.
Great Lakes Advisory can help you navigate the sea of options in front of you to find the best ways to grow your practice. After getting to know your practice inside and out, we look at the difference between your retirement savings and your current savings, then implement strategies tailored to your practice that will fulfill your lifestyle needs when retirement day comes.
So, if you’re looking to secure yourself a relaxing, enjoyable retirement, schedule an appointment with us today.
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