American College of Physicians: Internal Medicine — Doctors for Adults ®

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Selling your practice

Get the best deal by knowing what's behind the purchase price--and what's in the fine print

From the April 1996 ACP Observer, copyright © 1996 by the American College of Physicians.

By Deborah Gesensway

So you think you might want to sell your practice? But to whom? And for how much?

Internal medicine practices are being wooed by everyone from community hospitals and HMOs to the new for-profit physician practice management companies awash in Wall Street money. Prices, meanwhile, are ranging from zero to hundreds of thousands of dollars above what appraisers would consider fair market value.

"In some markets, like New Orleans, everybody is clamoring for primary care physicians and they are overpaying them [for their practices] and giving them large income guarantees. The market's hot," said Maryann Szostak-Ricardo, president of a Manhattan Beach, Calif., practice consulting firm, The Ricardo Group. "In other markets, all of a sudden all the [managed care] contracts are aligned and your practice isn't worth anything." In Orange County, Calif., for example, she said, she has watched physician clients recently simply give up trying to sell their practices because there is no value in them anymore. "It's all timing."

Managed care has thrown out the window all rules of thumb about physician practice sales. No longer are comparisons to practice values throughout the country valid. The concept of "good will" means less--or even nothing--if a physician doesn't "own" his patients, while the independent practice association (IPA) or HMO does. Physicians who sell are no longer doing so to retire, move or otherwise close up shop. They--and their buyers--expect them to stay on and continue to work in the practice they no longer own. Buyers are no longer just another friendly doctor. And specialists are having greater difficulty finding buyers for their assets.

These days, "one physician could have $300,000 in revenues and have a good practice and another physician down the block could also have $300,000 in revenues, but for valuation reasons, one practice could be worth zero and the other could be worth half a million dollars," said Adam Heavenrich, a principal in Heavenrich & Co., practice management consultants in Chicago.

In a national survey of hospitals and health care systems across the country conducted by the journal Healthcare Financial Management and Physician Services of America of Louisville, Ky., more than a third reported involvement in acquiring physician practices in the last five years. Of those, one-third purchased internal medicine practices or groups. (More than 80% bought family practices.) Those hospitals paid a median price of $125,000 per internist, but the price per physician ranged widely from as low as $7,000 to as high as $500,000.

Another recent study of hospital-based physician practice acquisitions found an ever-increasing range of prices paid for doctors, with practices in the Northeast consistently valued lower than those in other regions. The highest medical values paid per physician were for those in "medium managed care markets"--$134,000 per physician compared with $106,000 in high managed care markets and $95,000 in communities with low levels of managed care.

About 55% of the hospitals indicated that they plan to begin or continue to buy doctors' practices. Interestingly, the survey also found that in most markets, it was the doctors, not the hospitals, who were most likely to initiate discussion. A survey last fall by Heavenrich & Co. found, for example, that 34% of the internal medicine groups queried were "considering integrating or becoming part of a large organization"; 44% of those said they planned to do so within a year.

Consultants say physicians considering selling should be prepared for a time-consuming, expensive and emotionally trying process that typically lasts three to six months. It helps to hire a professional--a lawyer or consultant--to handle negotiations for you.

"This is a once-in-a-lifetime transaction for a doctor," said Joan Roediger, JD, LLM, a lawyer and health care consultant with The Health Care Group of Plymouth Meeting, Pa. "There are hospitals that will pressure you and steamroll you."

In addition to investing in advisers familiar with today's physician practice buying spree, experts offer internists the following recommendations:

  • Don't be blinded by the purchase price. Some hospitals and physician practice management companies appear to be offering an enormous price for a practice as a way to blind physicians to potential problems in the employment contract part of the sale, consultants said.

These purchase offers can mask problems such as huge cuts in salary that may be written into the small print of the contract. For example, Ms. Roediger says she is still trying to dissuade an ophthalmologist client from accepting a deal to sell his practice to a physician practice management company for the "massive" sum of $3 million. "They instantly would cut his salary in half. They assess a management fee. They are tying his salary to overhead. There were productivity targets," she said. "I told him to walk away from it. He wants me still to try to work something out."

Says Mr. Heavenrich, "If you are a 35-year-old physician, you should not necessarily be looking as much at the purchase price as you are at who best can help you service the needs of managed care. You need to think of it as a partnership, because your partner is going to be responsible for your revenues for the next 30 to 35 years. If they are successful, then you will be successful."

  • Have your practice assessed using several different valuation methods. This way, you might decide to make particular improvements in your practice before selling--think of the fix-ups you do before selling a house--or you might concoct your own strategy for marketing it.

Ms. Ricardo typically values a practice in three ways. First, she calculates its worth as an ongoing, operating business, looking at the value of future earnings adjusted against liabilities. The thinking behind this formula, she says, is that "you have furniture and equipment, accounts receivable, workers' comp patients, but I'm not going to split these things apart because that's not where the value is. The value is the fact that you are an ongoing business."

Second, she does an asset-based valuation, where she puts a price tag on every item from the doctor's refrigerator and his lease to his patients' demographics and his reputation. "Having both of these methodologies done will give you a value range to work in during negotiations," Ms. Ricardo said.

Third, she uses a market approach to value a practice, just as a house-buyer would, looking at prices paid for similar practices. But she says markets are so dissimilar these days that guidelines generally are no longer valid, particularly in highly penetrated managed care markets.

Whatever you do, make sure you understand the factors used to calculate your practice's value, and challenge them if you think they are wrong. For example, Ms. Ricardo said, appraisers typically adjust, or discount, their projections of your future earnings to account for how risky a buyer might find his investment in your practice. Knowing why an appraiser discounted the value of your future earnings by 25% and not 18%, for instance, can give you clues about how to raise the value before selling.

"I had one situation where one female physician had been spending time with her kids and didn't really spend the time working her practice," Ms. Ricardo said. "She thought she was worth a lot more than she was being offered because she had a lot of active patients and a lot of potential to grow. I told her that they have to value the projected future earnings based on historical performance. So don't sell today. Wait six months. Get a little bit of performance behind you, so you can trend it into the future."

  • Understand the employment agreement. Selling your practice today most likely means you will end up employed. In fact, if you are not planning to stay and work for the company you sell to, your practice is probably worth less, consultants said.

About 80% of the hospitals surveyed recently about practice acquisitions reported that they end up employing the doctors after they buy their practices, rather than contracting with the physicians for services.

The typical employment agreement, Ms. Roediger said, is for five years--she has seen as low as two and as high as 10--and will guarantee some level of compensation, probably a salary, plus a formula for incentive compensation.

When a physician reads this agreement, he should remember why he wanted to sell in the first place, she says. "If your reasons are you are tired of another managed care agreement every week, tired of never knowing what overhead is going to be, tired of chasing after collections, make sure selling fixes those [problems]." Employment agreements that tie income to fluctuations in overhead may not address those concerns.

It is also essential to think about what might happen when the employment agreement expires. Negotiate protections so the hospital cannot hire a resident to take over the practice after five years, she said. If real estate is part of the sale, she added, enter into a lease with its new owner for at least as long as your employment contract.

Ms. Roediger said she always tries to include a clause that states if the hospital breaches the agreement in any way, then the doctor can walk away and the non-compete clause will be void.

Non-compete clauses exist in 80% of practice acquisition agreements with hospitals, according to a January report from The Center for Healthcare Industry Performance Studies. A typical non-compete clause prohibits a physician from opening a new practice in a 25-mile area for a period of two years after the sale. If a physician is able to bargain the non-compete clause out of the agreement, the practice will generally sell for $66,000 less than it might have, the study showed.

  • Hire someone who knows the law. Many tricky legal issues can be associated with these deals, and they differ depending on whether the buyer is non-profit or for-profit, whether they are being transacted in a corporate-practice-of-medicine state or whether the physician is incorporated.

Issues range from anti-kickback statutes to implications for tax liability, depending on how the deal is structured. Consultants said physicians should also include their regular accountant throughout the process and may want to add the services of a practice management consultant who knows the local managed care market.

  • Shop around. Consider options that did not even exist a year or so ago. Mr. Heavenrich said physicians these days should be wary about simply jumping at the first offer from their local hospital.

"Doctors tend to think about only what has been historically available," he said. "But remember, there are 20 new physician practice management companies that have become available over the last two years, let alone other hospitals, HMOs, bigger groups. There is a world of new options."

For example, a 23-physician multi-specialty group in Florida chose to sell to PhyCor, one of the largest of the new physician practice management companies, because PhyCor has a "proven track record managing multi-specialty groups" while hospitals don't, the group's administrator explained at a recent meeting of medical group managers.

Some industry analysts are bullish on the practice management companies, the largest of which include Caremark International, MedPartners, Coastal Physician Group and Pacific Physician Services. Ms. Roediger said her experience to date has been that most of these companies are more interested in buying established large- and mid-sized groups than solo practitioners or doctor partnerships.

From a purely financial perspective, consultants say the jury is still out on the long-term viability of practice acquisition for both physicians and hospitals. The hospital acquisition survey by Physician Services of America found that only a third of the practices acquired were able to meet or exceed revenue and expense projections in the first two years following acquisition, and "only 17% of the acquired practices have generated a positive return on investment within that time frame."

Problems reported by hospitals after acquisitions, according to the survey, include "declining physician productivity, the inability and/or reluctance of physicians to relinquish control, problems with inadequate information systems, staffing issues and poor communication between the physicians and the hospital."

Doctors should keep in mind that they don't have to sell. There are other options, even in heavily saturated managed care markets where solo and small groups can no longer compete for patients very effectively, Ms. Ricardo said. They can join strong IPAs, merge with other physicians, join groups. "There are different ways to get big fast," she said.

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