From working with medical practitioners over the years and also personal experience in looking at opportunities on behalf of my wife (a GP), one question that I get asked from time to time is “Should I buy into the practice?” and of course, following from that, “What is a reasonable price to pay for a share?” 

Occasionally the same questions arise when a specialist group is raising capital to invest in a private hospital, surgical facility or other shared infrastructure. The general principles for these investments are the same from a financial perspective, although the non financial considerations will likely be different.

Before getting into valuation though, I think it is worth stepping back and asking a more fundamental question: 

What are you buying?

Regardless of whether the practice is a small GP clinic or a large specialist group, the principle is broadly the same. Usually a practice will have little in the way of physical assets, as it is common to lease premises (perhaps some building fitout which will vary from brand new to ready for a refresh).

Really what a doctor is paying for when buying a shareholding is a future stream of profits over and above market rate pay for the work that they are performing in the practice.

Financial considerations are only part of the picture 

Keep in mind though that non-financial factors should be at least as important as financial considerations when making a commitment to buy in to a practice, factors like:

• Who are the other owners, can you see yourself working with them for years into the future?
• Is there a clear vision for the future and have the other owners considered the likely effects of demographic, political and technological change?
• Where is the practice and how does this fit with your intended lifestyle?
• Does the patient base align with the type of medicine you want to practise? 

How much is a practice worth?

In many industries there are traditional rules of thumb that are used to value businesses. For General Practice you will sometimes hear people talking about a percentage of gross fees or a value per enrolled patient. 

These approaches have their limitations however, as they do not take into account differences in profitability or the strengths and weaknesses of a particular practice. Two practices with similar revenue may have very different economics due to factors such as staffing costs, scale, location and operational efficiency. 

For this reason we recommend considering an “earnings multiple” approach to valuation.

To calculate a value on an “earnings multiple” or “Future Maintainable Earnings” basis the accounts should first be adjusted to remove non recurring items and to adjust any payments to shareholders to market based remuneration. 

Once those adjustments have been made, you can arrive at a normalised earnings figure.

It is then common to apply an earnings multiple to that figure. In smaller privately-owned medical practices, multiples of around four to five times maintainable earnings are sometimes seen, although the appropriate multiple will depend heavily on the circumstances of the practice. 

Viewed another way, this is equivalent to a payback period of around four to five years or a return on investment of approximately 20% to 25%. 

These earnings multiples are considerably lower than would be expected in a listed healthcare investment (listed meaning companies where their shares are traded on a stock exchange) where many international healthcare companies trade at considerably higher earnings multiples. 

Of course smaller practices are less liquid (i.e. it is hard to sell the shares) and more risky than larger listed businesses and hence “cheaper” to buy. 

What should you look for in the financial statements? 

As well as looking at the statement of financial performance to work out a future maintainable earnings figure, also spend some time looking at the balance sheet. 

Is there debt? Debt is not necessarily bad but it would be helpful to understand what the debt has been used for. Debt incurred to buy fixed assets like buildings, equipment or fitout could well be a positive thing (although you would need to consider the impact of the interest and debt repayments on the ability of the practice to pay out profits in the future and so it may reduce the amount that you are prepared to pay for the practice). Debt incurred to fund operating losses would likely be viewed differently!

It is also important to be clear whether the valuation being discussed is the value of the whole business before debt, or the value of the shares after allowing for debt. 

I would also want to understand:

• How consistently the practice has generated profits.
• Whether profits have generally been distributed or retained.
• Whether significant capital expenditure is likely to be required in the near future.
• Whether there are any unusual obligations or commitments that could affect future profitability.
• If the premises are leased, how secure is the lease and what renewal rights exist?

Every practice is different

Just like every patient is different, there are many ways to structure a GP practice or specialist group, and this structure will impact the value to a purchaser.

Ultimately, valuation is only a starting point. A practice may be “cheap” for good reasons and an apparently expensive practice may prove to be a better long-term investment. Understanding how the practice generates its profits, and whether those profits are likely to be sustainable, is often more important than arguing over whether the appropriate multiple is four times earnings or five.

Buying into a practice is often one of the larger financial decisions a doctor will make. While valuation is only one part of the picture, having someone independent review the financial information can be worthwhile.

At The Accounting Hub, we work with medical practitioners on their ongoing accounting and tax affairs, and from time to time we also assist doctors who are considering buying into a practice or specialist group. Reviewing the financial statements, understanding the ownership structure and considering the tax implications can often help bring greater clarity to the decision.

If you’re considering a buy-in opportunity and would like a second set of eyes over the numbers, we’d be happy to have a conversation.