How To Value An Ophthalmology Practice And Its Goodwill

4/19/2017How to Value anOphthalmology Practiceand Its GoodwillMark E. Kropiewnicki, Esq., LLMDaniel M. Bernick, Esquire, MBA*The Health Care Group Plymouth Meeting, PAwww.healthcaregroup.com* Financial Interest Copyright 2017 The Health Care Group, Inc. All Rights ReservedMark E. Kropiewnicki, Esq., LLM Copyright 2017 The Health Care Group, Inc. All Rights ReservedFinancial Disclosure We Have the Following Financial Interestsor Relationships to Disclose:Shareholders of and Consultants with TheHealth Care Group, Inc. and Health CareConsulting, Inc.Shareholders of and Attorneys with HealthCare Law Associates, P.C. Copyright 2017 The Health Care Group, Inc. All Rights Reserved1

4/19/2017Who We Are Business and legal advisors to physiciansPublishers of the Goodwill Registry, usedin valuation of ophthalmology and othermedical practicesHandle and advise re: practice buy-ins,buy-outs, sales, mergers and valuations Copyright 2017 The Health Care Group, Inc. All Rights ReservedGeneral Objectives Give you the tools to talk knowledgeablywith your appraiser/consultantGive you basic framework to think aboutyour own practice – before the moment oftruth Copyright 2017 The Health Care Group, Inc. All Rights ReservedFocus of Presentation Is on doctor-to-doctor sales and buy-ins“Private equity” is a different animal Not yet available to most practices Copyright 2017 The Health Care Group, Inc. All Rights Reserved2

4/19/2017Why Are You Doing ThisAppraisal? Complete sale of practice entityPartner buy-inPartner buy-outYou need a valuation method that willwork for all of these transactions Copyright 2017 The Health Care Group, Inc. All Rights ReservedCore Assets for Valuation “Hard Assets”: Equipment, improvements, inventory,supplies, softwareGoodwill/intangibles:Charts, phone numbers, patient base/flow,workforce, all systems ready to goAll of these must be replicated if not purchased:“Buy” vs. “make” Copyright 2017 The Health Care Group, Inc. All Rights ReservedWorking Capital Assets Accounts receivableCash, net of payablesGenerally excluded from an “asset sale”But generally included in a buy-in/stocksale Copyright 2017 The Health Care Group, Inc. All Rights Reserved3

4/19/2017Goodwill Flashpoint Hard assets and accounts receivable:relatively non-controversialGoodwill: more difficult to value, and thereforeoften controversial Copyright 2017 The Health Care Group, Inc. All Rights ReservedHard Asset Valuation Ophthalmic equipment, businessequipment, office buildoutsBook Value? Nearly always too lowThink about all the items that you “expensed” Section 179: These assets have an immediatebook value of zeroThe rest have a book value of zero in 5-7 yrs Copyright 2017 The Health Care Group, Inc. All Rights ReservedSpecialized Appraisal May be feasible for high end items withactive resale market (e.g., slit lamps)But not generally available/reliable forbusiness equipmentLeaves you with a partial appraisal Copyright 2017 The Health Care Group, Inc. All Rights Reserved4

4/19/2017Modified Book Value Approach Eliminate assets no longer in useRecompute depreciation 8-12 year life (overall)Straight-line depreciationFloor value: 20% of original costGenerally reasonable for most items Copyright 2017 The Health Care Group, Inc. All Rights ReservedSupplies/Inventory Optical framesContact lensesPremium IOLsEye medications/dropsBotox , facial fillersRetina injectibles (e.g., Eylea , Lucentis ) Copyright 2017 The Health Care Group, Inc. All Rights ReservedValuing Supplies Physical inventory, at cost: Count number of units on handMultiply by acquisition costSomewhat laborious, but most accuratemethod Copyright 2017 The Health Care Group, Inc. All Rights Reserved5

4/19/2017Another Approach Estimate supplies value based on annualusageExample: Tax return shows “medical supplies”deduction for 120,000Monthly cost is 10,000Practice manager estimates typical inventoryat 2 months’ worth of supplyValuation is 2 X 10,000 20,000 Copyright 2017 The Health Care Group, Inc. All Rights ReservedValuing Optical Frames Do a physical inventoryBut be sure to exclude frames that are nolonger current Copyright 2017 The Health Care Group, Inc. All Rights ReservedAccounts Receivable Not relevant for asset sales (retained byseller)But definitely relevant for buy-ins and buyouts, which are stock sales Copyright 2017 The Health Care Group, Inc. All Rights Reserved6

4/19/2017AR in Buy-Ins New partner shares in AR on the books asof buy-in dateNeed to value AR. New partner “pays for”AR via income shifts to senior doctor, overtime. Copyright 2017 The Health Care Group, Inc. All Rights ReservedAR in Buy-Ins Alternative: “Redlining”Excludes AR from buy-inDo not need to value ARAll proceeds of AR go to senior doctorIs your system capable of doing thistracking? Copyright 2017 The Health Care Group, Inc. All Rights ReservedValuing Receivables Face value Excluding “deadwood” over 180 daysAnd amounts in collectionTimes historical collection ratioSometimes reduced further by collectionfee (e.g. 6%) Copyright 2017 The Health Care Group, Inc. All Rights Reserved7

4/19/2017AR Example Example: Face value of AR is 120,000. 20,000 of this is over 180 daysNet face value is 100,000Historical collection ratio payments/charges 60%.Final collectible value is 60,000 Copyright 2017 The Health Care Group, Inc. All Rights Reserved“I shouldn’t have to buy into myown receivables” Associate may feel that he has an ownershipstake in his AR, because he generated themBut typically the associate was paid aguaranteed salary to generate those AR Copyright 2017 The Health Care Group, Inc. All Rights Reserved“I am buying a 50% stock interest,but I shouldn’t have to buy 50% ofthe AR. (I am the low producer.)” This is a valid concern, if the income divisionformula is production basedInstead of buying into 50% of the whole,associate buys into 100% of his/her ownpersonal production Copyright 2017 The Health Care Group, Inc. All Rights Reserved8

4/19/2017Cash Excluded from asset purchasesIncluded in buy-ins Unless it will be bonused out to currentowners as compensation Copyright 2017 The Health Care Group, Inc. All Rights ReservedOther Miscellaneous Assets Prepaid items e.g. malpractice insurance Autos, artwork and other “personal” items: Include as an asset in buy-in and buy-outExclude as personal to doctor Copyright 2017 The Health Care Group, Inc. All Rights ReservedLiabilities Bank debt, accrued retirement, vendorpayables (esp. retina drugs)Generally excluded from asset sales Buyer does not assume liabilities Copyright 2017 The Health Care Group, Inc. All Rights Reserved9

4/19/2017Buy-Ins and Buy-Outs Liabilities are included in calculation of stockprice They reduce the stock priceIf corporate assets are 100, and liabilities are 40, net stock value is 60 Copyright 2017 The Health Care Group, Inc. All Rights ReservedWhat is Goodwill? The sum total of all intangible assets Charts and patient listsPhone numbersCorporate nameInstitutional reputation/past advertisingFamiliar location Copyright 2017 The Health Care Group, Inc. All Rights ReservedGoodwill Also includes “going concern” values/items Trained workforce in place;Leasehold/location secured;Policies and procedures developed;All systems in place and ready to operate Copyright 2017 The Health Care Group, Inc. All Rights Reserved10

4/19/2017Practical Application Sales: Goodwill is part of purchase price,add to equipment and supplies to arrive attotal purchase priceBuy-In: Goodwill is “purchased" via pre-taxincome shift Copyright 2017 The Health Care Group, Inc. All Rights ReservedGoodwill Valuation Three basic methods: Income ApproachMarket ApproachAsset Approach Copyright 2017 The Health Care Group, Inc. All Rights ReservedIncome Approach Examples: Discounted Future Cash Flow,Capitalized EarningsFuture revenues and expenses areprojected to yield estimated future earningsEarnings are discounted to present valueusing a rate that reflects riskiness of thesefuture cash flows, like a bond. Copyright 2017 The Health Care Group, Inc. All Rights Reserved11

4/19/2017Income Approach: Concerns Difficult to predict future revenues andexpenses - - esp. with ownership changeHard to determine the true “earnings” of adoctor PC. Most PCs “zero out” any earnings by payingbonuses, at years’ end, to avoid taxes“Required rate of return” is subjective Copyright 2017 The Health Care Group, Inc. All Rights ReservedCap Earnings Example 1 400kAvailable for owner- 300k“Reasonable Salary”100k“Profit” 20%Required Rate of Return( 5 x “multiple”) 500kValuation Copyright 2017 The Health Care Group, Inc. All Rights ReservedCap Earnings Example 2 400kAvailable for owner- 350k“Reasonable Salary”50k“Profit” 20%Required Rate of Return( 5 x “multiple”) 250kValuation Copyright 2017 The Health Care Group, Inc. All Rights Reserved12

4/19/2017In Example: 16.6% differential in “reasonable salary”assumption ( 300 vs. 350) yields50% differential in valuation ( 500 vs. 250) Copyright 2017 The Health Care Group, Inc. All Rights ReservedCap Earnings Example 1 400kAvailable for owner- 300k“Reasonable Salary”100k“Profit” 20%Required Rate of Return( 5 x “multiple”) 500kValuation Copyright 2017 The Health Care Group, Inc. All Rights ReservedCap Earnings Example 3 400kAvailable for owner- 300k“Reasonable Salary”100k“Profit” 25%Required Rate of Return( 4 x “multiple”) 400kValuation Copyright 2017 The Health Care Group, Inc. All Rights Reserved13

4/19/2017Asset Approach Value of business is the cost to replicate itscomponents (equipment, goodwill), less anallowance for depreciationVery difficult to determine the cost ofreplicating goodwill or other intangiblesRarely used for medical practices Copyright 2017 The Health Care Group, Inc. All Rights ReservedMarket Approach Aka “Comparable Sales”Same idea as pricing a houseComparables provide a benchmarkAdjust for individual features Copyright 2017 The Health Care Group, Inc. All Rights ReservedMarket Approach Does not eliminate subjectivityBut subjective elements are acknowledgedBenefit of this method is its link to “realworld” prices paid by others. Fair market value is what a buyer will actuallypay and a seller will actually take Copyright 2017 The Health Care Group, Inc. All Rights Reserved14

4/19/2017Review of HCG GoodwillRegistry Data Copyright 2017 The Health Care Group, Inc. All Rights Reserved Copyright 2017 The Health Care Group, Inc. All Rights Reserved Copyright 2017 The Health Care Group, Inc. All Rights Reserved15

4/19/2017 Copyright 2017 The Health Care Group, Inc. All Rights Reserved Copyright 2017 The Health Care Group, Inc. All Rights ReservedAdjustments: Location Is this a desirable place for physicians tolive? More potential physician buyers means more“demand” for the intangible assets of existingpracticesMajor metro areas versus ruralCoasts versus heartland Copyright 2017 The Health Care Group, Inc. All Rights Reserved16

4/19/2017Adjustments: Competition If there is no competition, it will be easy to starta practice Then why should buyer pay big for yourgoodwill?Reduced or zero goodwill value in rural areas Copyright 2017 The Health Care Group, Inc. All Rights ReservedAdjustments: Competition If there is cutthroat competition, buyers may bedeterred This also reduces goodwill Copyright 2017 The Health Care Group, Inc. All Rights ReservedAdjustments: Competition Moderate to strong competition is favorable forgoodwillHard to start a practice from scratchBetter to buy an existing practice Copyright 2017 The Health Care Group, Inc. All Rights Reserved17