There are four main considerations unique to valuing a medical service practice. Each contributed to the goodwill (that is, the value unrelated to tangible assets) of the practice. The considerations are as follows:
For any practice, the patient base will make of a high percentage of a practice’s long-term recurring revenue. How many total patients does the practice have? How many visits per year do they make? In a transition from one owner of a practice to another, patients will likely stay with the new practitioner as a matter of convenience. A simple introduction to the new owner and transition period will ease ensure loyalty to the new owner.
A practice’s ability to generate high levels of revenue is influenced by the patients themselves – how old are they patients? Do they have spouses and children? A new practice starting out with a young patient base will have the ability to grow as the patients get older, marry and have children.
An established practice may have an older patient base. It’s important to examine patient characteristics to examine a practice’s ability to generate future revenue. The ages of its patient base will be a significant determinant.
Location of a practice is highly influential of a practice’s goodwill. Consider a practice located in the financial district in Toronto. The convenience of the practice for many professionals working downtown would likely be the sole reason for that individual to be a patient. If a patient required a referral to a specialist, it’s likely that those services would also be located nearby. On the other hand, the practice likely would not have a large base of child patients.
A young practitioner that is considering starting a new practice from scratch should carefully consider location. A new housing development with limited services for families could be a good choice. The leasing costs may be low, and there would be a lot of families looking for a convenient location.
As noted above, the convenience of specialized medical services for a patient base is an important factor influencing practice goodwill. This can include proximity to: hospitals, dermatologists and other specialists, chiropractors, and physical therapists. There is a growing trend of practices adopting a ‘one-stop shop’ method for most of the regular needs for their client base.
Absentee Practitioner Approach
A simple approach to calculating the goodwill of a practice is estimated by subtracting from pre-tax net earnings before the remuneration of a non-arm’s length practitioner, an amount reflecting the wage level that would need to be paid to hire an arm’s length practitioner to run the business.
In layman’s terms, the non-arm’s length practitioner generally is an owner-manager who frequently portrays the role of a practitioner and contributes the practice’s necessary administrative services, while other professionals are employed to provide most of the face-to-face client services.
The difference between the determined fair market value of the practice and the fair market value of the practice’s tangible assets constitutes the practice’s goodwill component of value.
The absentee practitioner approach illustrated below is based upon the following facts:
• The practice’s pre-tax earnings before the owner-manager’s remuneration is $300,000;
• An arm’s length individual could be hired for $150,000 to perform all the duties of the
• The appropriate pre-tax multiple is 4.0;
• The tangible asset backing is $250,000; and
• There are no redundant assets.
Example: Absentee Practitioner Approach
Pre-tax net earnings before remuneration to owner-manager $300,000
Deduct arm’s length practitioner’s salary 150,000
Adjusted pre-tax earners to be capitalized 150,000
Pre-tax multiple 4x
Practice value $600,000
Less: Tangible asset backing 250,000
Value of goodwill $350,000