“Adding an associate makes sense when your volume grows to the point

             you ability to maintain your PVV at or above the $90 to $110 level.  When

             you begin to have a decline in PVV your ability to treat patients effectively

             and efficiently is no longer occurring.  You (as the doctor) have become

             more concerned about the patient in the next room than the patient in front

             of you.  Therefore, adding an associate to see the excess patient load can

             result in growth for the practice, both economically and clinically.”

Think about it, you want to be paid for what you do and you want to do what is best for the patient. 

April 17, 2009

Cash Flow

The most prevalent question about valuing a practice is – what is the single biggest factor affecting value?  It is cash flow.  The cash flow of the practice starts at the amount of monies collected from services and ends with the amount of monies remaining once the overhead expenses of the practice have been paid.  The amount of monies remaining once the overhead has been paid can be used for compensation to the owner and debt repayment.  These factors are the most critical in determining the cash flow matters for a practice which influence the value and pricing of a practice.

Infrastructure

The next consideration is what type of infrastructure exist in the practice?  Are policies and procedures in place for the accomplishment of task, assignment of duties and responsibilities and the allocation of resources?   Infrastructure also includes the process for compliance with government and regulatory matters such as OSHA and HIPAA.   The infrastructure of a practice will be a major component in the ability to transfer the revenue stream of the practice from one owner to another.  When a highly structured practice is sold or adds an associate the risk is reduced for the new owner/associate due to the consistency developed and the fundamental operating process put in place.

Staff

The staff of the practice are generally the first contact with the practice a patient has.  If the staff is well trained, understands their role and responsibility the opportunity for the patient to have a positive experience is greatly enhanced an also allows the doctor greater flexibility and time to treat the patient.  An appropriate level of staffing is what fits the particular situation of the practice.  An industry benchmark is 4 staff for each doctor.  This may be adjusted based upon the scope of care in the market, the patient base and the preferences of the doctor.

Accounts Receivable Management

While this overlaps with the cash flow it is important to note the management of accounts receivable.  A consistently applied policy related to copays and deductibles, as well as a consistent approach to turning accounts out to collection are important.  Further, one of the most important issues in the management of accounts receivable is developing a complete file for all payors under contract.  The development of a comprehensive file with the contract and lead schedule with the key attributes of the contract will provide the accounts receivable staff with a quick reference regarding the agreed upon payment structure for the payor.

Payor Mix

The payor mix of the practice has a direct impact on the cash flow of the practice and very often the staffing requirements for the clinical process.  The general benchmark for a podiatric medical practice is Medicare composes approximately 40% of the total payor mix.  This varies by state and practice type but this is the general industry bench mark.  Additionally, patient payments compose approximately 15-20% of the practice payments as well.  The balance is split among the various commercial payors in the market.

Location

This variable is a key ingredient of what matters most in a podiatric medical practice.  We realize that practices come in all sizes, shapes and forms; however, location matters.  The location of a practice can have a significant impact on the type of patients generated and the sources of those patients.  In today’s environment the hours of operation are dictated by the location and the ability of the patients to “get to” the office.  A well located office with an easily accessible entrance well marked and positioned in a “comfortable” setting will lend itself to attracting both patients and referrals.

Referral Sources

A practice with a well established base for referrals provides a consistent source for new patients.  Referrals from MD specialties such as: family practice, vascular, plastics, internal medicine, endocrinology, and orthopedics provide a practice with a strong basis for a consistent patient flow.  Further, a strong word of mouth from existing and former patients provides the practice with patients that come due to a positive personal experience.

We have addressed the issues of what matters most in today’s podiatric medical practice valuable matters for consideration.

To find out more about practice valuation and what matters about your practice you can contact Mike Crosby at Provider Resources, LLC.  Our email is mcrosby@providerresources.com and our phone number is (888)-776-2430.

The first step in evaluating the addition of an associate to a practice is to define the objective of why an associate is wanted/needed in this medical practice.  Often, the need is defined as the desire for the current owner to have a plan of succession of services for the community in which he serves.  Many established practitioners became doctors because of their desire to provide a service for a community of people.  With this in mind, the practitioner begins the search for a person who meets his criteria as a suitable associate who would be able to provide services in the same manner in which he does.  Additionally, other needs arise when the question is raised about adding a partner.  In many markets, the need is for expansion.  The senior doctor has decided that he can no longer service his patients or provide the services that are needed within the given market in a solo practice.  Therefore, he determines that he will add an associate and expand the practice to meet the ever-growing needs of the community.  Further, many physicians decide at a stage in practice after building to a certain level and establishing and maintaining a level of income, that it is now time to begin to enjoy life more.  Therefore, their goals are to improve their quality of life.  When this is the goal, the physician may decide to add a person who has similar skills, yet brings a new set of services to the practice.  In the podiatric community, often a podiatrist who has been in practice 15 to 20 years with limited surgical training will decide to add an individual with additional training over and above their current level, which would allow the practice to expand services and take over part of the owner’s existing business.  Finally, many physicians determine that the best way to insure a smooth and enjoyable retirement is to add an associate who will be able to assume the practice and take it over in an effective and efficient manner over a period of time.  Often, while it is not stated, this becomes a primary goal as the physician wishes to have an exit strategy for himself from his practice when he is ready to retire.

Once the objective is defined and outlined, there are several steps that must be undertaken.  The first step would be a thorough and complete evaluation of the market.  Questions such as “How much competition exists in the market?” must be addressed.  The APMA has information contained on its website and in various APMA publications which indicates that the ratio is approximately one podiatrist for every 24,600 people in the population.  Given this information, the practice should begin to compute the ratio of podiatrists to population within their given market to determine the demand for podiatric services within their market.  Additionally, they should also evaluate who else in the market (family practice, internal medicine, foot and ankle orthopedics) are delivering services for the foot and ankle diagnoses.  Once this is determined, the practice should evaluate the overall market, reviewing sources of information such as the APMA website, using the phone book, having conversations with the local podiatric and state associations, as well as completing additional research as provided through internet and World Wide Web.  Overall, a critical success factor in evaluating the market will be to insure that one understands the current market and what the potential impact for growth is.  It should be noted that in many markets today, the population trends are significant that while the current ratio for podiatric provider to population is below the APMA national information, the potential for this to grow in the coming years is at best estimated by having conversations and obtaining documentation from the local and regional chamber of commerce.

A complete and thorough review and evaluation of the cost structure of the practice will need to be undertaken.  A thorough review of the overhead ratio based on current level of income as well as the potential for both growth and shrinkage within the practice.  One of the key issues related to adding an associate is what is the current space capacity of the practice.  What would be the impact of additional space as well as the need for new equipment and incremental increase in supplies? These cost factors are important to evaluate when looking at the addition of an associate.  The key question it becomes is “If the associate is to drive/generate new business for the practice, how will he be able to support these patients in the existing space, if he can?”  Next, the practice will need to evaluate the staffing level.  Will there be additional staff needed to support the new associate?  Can the existing administrative staff support a new doctor, or will additional staff be needed to support the patient volume generated through the billing and collections process.  In our article we will assume that the new doctor will have a podiatric medical assistant once his patient volume reaches ten patients per day.  This will allow the practice a period of time to absorb new patients without taking on immediate staffing costs.  In relation to the staff, we must also consider the benefit plans which the practice has.  Benefit plans, such as health insurance and retirement, are a direct result of having staff within the practice that participate in both of these employer contributed payment plans.  Should additional staff be hired, and health insurance and retirement contributions provided, there is an approximate increase over and above the base compensation of 20% – 25% for such benefits.  These are significant and should be reviewed as an important part of the staffing complement.  Finally, the malpractice insurance environment should also be evaluated.  In many markets today the malpractice situation has made it almost cost prohibitive for new providers to enter the market.  Therefore, providing an environment which allows a new provider to enter the market with a reasonable basis to provide risk-based insurance is extremely critical.

Once the cost structure is evaluated, an overall analysis of the impact on cash flow should be completed.  In reviewing the impact of cast flow, can the revenue (cash collections) grow at a rate that would provide for positive cash flow within a reasonable time frame?  The evaluation should include the timing of growth (based on a projected basis 6, 12, and 24 months) to allow the practice the ability to evaluate the needs for cash resources and cash infusion into the practice.  The impact of expense growth will be the single biggest issue which will impact the current owner.  Reasonable and accurate cost estimates for staff and incremental changes for things such as space/rent, staffing and benefits, new equipment, are critical to the overall success of the addition of any associate.  An owner who does not go through this process may become highly frustrated after a short period of time of having a new associate when he realizes that his compensation is dropping because he has brought a new associate into the practice.  This turnaround time must be evaluated so that the current owner understands the short-term impact and the long-term benefit of having a new associate in their practice.  An effective return on investment model should be developed for a three to five year period so that the owner and the associate can understand the underlying expectations and assumptions which have been developed for his addition to the practice.  In today’s market, an owner should evaluate their practice based on driving a return which is greater than their current investment portfolio, which when evaluated, would be above a 12% to 18% after-tax return.

In summary, if you are able to meet your objectives and survive the challenges and changes in your practice based on your analytical review and analysis, you are ready to add an associate and you have determined the appropriate timing for making the decision to bring a new partner into your practice.

First, we will explore the “Salary Override” or Indirect/Inexact Method. In this approach, the compensation is set below standard levels so that excess earnings (those collections which exceed the cost of direct overhead, an allocation for indirect overhead and their compensation), accrue to the owner.  In this model, the owner receives the benefit of the associate’s production for a period of years (4-8) and the purchase, price is reduced to account for the receipt of these “indirect” payments using this approach. The key in this approach is for the owner to realize the benefits of the associate through greater personal flexibility and higher ordinary income (credited to the buy-in by the associate).

The benefits to the purchaser are:

• Pre-tax dollars used as credit against the eventual buy-in.
• Buy-in over period of time giving him/her a chance to learn the business
• Reduced lump sum payment required (generally at the end of the buy-in period).

The benefits to the seller are:

• Higher income stream for period of years
• Ability to maintain control
• No significant tax “hit” in year of purchase

The weaknesses in this approach for the buyer are:

• Long period of time for ownership and change in control to occur.
• No write-off for goodwill on amounts credited during buy-in period
• Minority position for a number of years

The weaknesses in the approach for the seller/owner are:

• Payments during buy-in period treated as ordinary income and taxed at higher rates
• Based on time value of money- net realizable amount may be reduced
• Taking risk and “playing” role of banker
• Allows associate to buy-in without risk for timely payments

Second, we will explore the immediate buy-in or partial sale method. In this approach the new associate obtains financing (or has it) to purchase a portion of the practice immediately. The associate immediately starts sharing in the operations of the practice.  To the extent purchased, the new associate has a role and voice in the day-to-day operation and decision-making process.

In this approach the benefits to the seller/owner are:

• Immediate sharing of practice duties
• Immediate cash
• Payment treated as capital gains and taxed at lower rate
• A fully committed and vested interest by the associate to a long term business relationship
• No risk for financing

The benefits to the buyer are:

• Immediate sharing of practice profits
• Equal role in decision making and practice operation
• Equity stake in business

The weaknesses in this approach for the seller are:

• Relinquishment of total control
• Lump sum payment and tax hit in one year (generally taxed at 20%)
• Potential drop in compensation and sharing of excess earnings with new partner.

The weaknesses in this approach for the buyer are:

• Ability to obtain financing
• Making debt/buy-in payments with after tax dollars
• Lack of business knowledge requires intensive commitment to learning and understanding practice operation.
• Risk for making debt payments- production pressure.

A third method would be a hybrid of the two combining pre-tax and after tax payments.  In this method an initial payment of 20-25% of the purchase price is required.  Then in years 1-5 (or whatever time frame is agreed upon) the owner takes a salary override from the associates’ production.  Then at the end of the buy-in period a lump sum pay-out is required from the buyer to the seller.

In this approach the benefits to the seller are:

• Initial payment is treated as capital gains (20% tax rate)
• Immediate cash
• A fully committed and vested interest by new partner
• Final lump sum payment also treated as capital gains

(With imputed interest portion treated as ordinary income)

The benefits to the buyer are:

• Equity stake in business
• All monies not required up front
• Clear pathway established for buy-in
• Buy-in with pre-tax and post after-tax dollars.

The weakness in this approach for the seller are:

• Risk of new partner not being as productive
• Relinquishment of total control
• Receipt of payments “during the term” taxed at ordinary rates.

The weaknesses in this approach for the buyer are:

• Making payments on initial down payment (if borrowed)
• Finding funding source.
• Lack of ability to exercise control during term.
• Pressure to generate production at appropriates level

Each method/approach has strengths and weaknesses for the buyer and seller.  The best approach will emerge when the buyer and seller evaluate how the needs of each are met and compromise reached upon a thorough analysis!

Considerations

1.  Do I have a plan for my life after I quit practicing podiatry?

All that most podiatrist have done for many years is practice podiatry; generally, spending 40 to 70 hours per week seeing patients, completing minor repairs, monitoring and managing staff, completing billing forms and trying to stay current with medical developments. With this much of your life consumed by the practice, what will you do once you are no longer responsible for seeing patients and “running” the practice? If you don’t have a clear answer and plan, then you probably are not ready to quit.

2.  My practice is very busy, I have worked hard to build it, will I be able to sell it?

This is a very common question, the key is not can I sell it, but at what price can I sell my practice? Being prepared to sell your practice is 90% emotional and 10% physical. More than likely, a new buyer will not “see-it” (your practice) in the same way you do. Today’s generation X (as they- the under 30-somethings) are not as concerned about the financial reward, but rather, how it fits into their life. Most practices will sell in some manner- but the “emotional” and financial return on investment will not be at a level you probably expect.

3.  How will I price my practice for sale?

My buddy says…. First, the buddy method is not a recognized method to assign value or price. (We define the “buddy method” as the pricing and valuation of a practice based on the same methodology of as your buddy did. This “method” assumes that all factors affecting price and/or value between two practices are identical. So, if your market demographics, payor mix, operating infrastructure, patient volume and other relevant factors are similar, you buddy’s method may work.) However, we believe that each podiatric practice is unique.  Therefore, it should be evaluated accordingly.

The true value of a practice is based on the cash flow generated. Practice cash flow is defined as the amount of cash remaining after overhead expenses are paid, dollars available to be distributed to the owner. Additionally, hard assets (computer technology items, podiatry chairs and office equipment) plus accounts receivable (value based on collections/collection ratio).

A percentage of the cash flow is computed for goodwill and the three components are then summarized. (goodwill, hard assets and accounts receivable)

4.  Who will buy my practice?

It depends, maybe no one. If you have expectations, (to be discussed next) which are outside of the market, your practice may not sell.  If you will only accept an all cash deal it will be much more difficult. To be attractive to a buyer a practice must:

• Be reasonably priced.
• Have a revenue stream, which can be transferred.
• Have flexible financing and transition terms.

Available buyers today include:

• residents
• Individuals looking to relocate (one to two years out of residency)
• Another local practice
• Associate within the practice.

It is important to note that it is not uncommon for young practioniers to have school debt in excess of $150,000. Therefore, flexibility and creativity in financing becomes imperative.

4.  Would I (the seller) be willing to purchase the practice at the asking price based on the cash flow, the condition of the equipment and the condition of the books and records?

Fundamental to the considerations of selling a practice is the issue of reasonableness. Does the goodwill value make sense? If overhead is unreasonably high or low, can it easily be explained and can a purchaser convince a lender of the “realness/believability” of the adjustments to cash flow. What condition is the equipment in? In many practices the treatment room chairs are more than 15-20 years old. If this is the case, then how can any salvage value be allocated to them. Additionally, adjustments may be required so that cash is available for the purchaser to update the equipment. Lastly, in many practices, deductions for various expenses are included on the practice tax returns in order to take advantage of favorable tax treatment. However, this may become an issue when lenders review tax returns during evaluation of practice cash flow. This is an important consideration when the discussions begin regarding terms, conditions and financing.

Expectations

1.  How much should I expect to sell my practice for?

Practices today are selling between 45% and 70% of collections (on a rolling three year average). Many factors influence the selling price including , but not limited to financing capacity of a buyer, overhead, transferability of contracts, ease of transaction, carry-back of debt by owner.

2.  How long should it take to sell my practice?

The average time to sell a practice is 18 to 24 months. On occasion it may be shorter; however, generally 18 to 24 months is the time required.

3.  What should I expect form a potential buyer when a site visit occurs?

A seller should be prepared to open the books and records of the practice. The buyer will want (and need) to see surgery logs, tax returns, production information (such as CPT analysis and Diagnosis Reports), daily schedules, (appointment books) and managed care contracts. Full and adequate disclosure is required. Additionally, during a visit the potential buyer will want to see how the staff interacts with patients, as well as how they get along.

4.  What are the cost related to selling a practice?

The seller will have the following estimated cost: a. Practice valuation and analysis cost $ 5,000-$10,000. b. Attorney’s fees $5,000-$10,000 c. real estate appraisal fee (if needed) $4,000-$8,000 d. Tax planning and personal financial planning $3,000-$7,000.

5.  If it takes 18-24 months to sell a practice at what point should I begin to consider starting the process?

If an individual has determined a stopping point for practice i.e. 60 years of age, 10 years from today, etc. an appropriate time to consider would be to back up five years from the ending target date. This would allow for delays, miscalculations and other unexpected events to be encountered and not interrupt making the target date.

Selling a practice is an important personal decision, which should be undertaken with serious thought and planning. The expectations and considerations discussed in this article only outline a few of the key issues, we recommend the use of trusted advisors to guide in the process.

To find out how Provider Resources, LLC can help you in the process. contact us at (888) 776- 2430 or by email consulting@providerresources.com.

While buying-in to a practice is common, the road to the summit can be filled with potholes and detours.  Those potholes and detours often take the form of the practice blowing up, realigning services and offices, de-employing a physician, alienating physicians and friends, and confusing the staff and local medical community.  Why does this occur?  We believe a these problems occur due to lack of clear expectations and stated assumptions of what will happen after the buy-in.

Expectations of the Associate:

• Value of the practice: An associate may not understand the value in a practice that has been in existence for more than 15 to 20 years since the “rough spots” of the start-up occurred before he/she came to the practice. The concept of value is part of the process which requires education. It is important that the associate understands the environment in which the practice operates and the investment necessary to start and maintain the operation. Today’s associate adds value to the practice when the services he/she performs are reimbursable. However, value exists at the time the associate joins the practice and depending on the risk assumed, growth may not be solely attributable to their services.

• Effort: Buy-ins require money, and some more than others. Money earned by an associate is a direct result of the effort he/she puts into growing and developing the practice. One of the biggest hurdles to making the buy-in successful is determining the compensation plan for the associate before he/she becomes a partner. If the associate is paid at a rate which is above the overhead rate, the owner is subsidizing the associate’s compensation. This situation is acceptable until the associate decides to buy-into the practice. When an associate begins the buy-in only to realize he/she will take a cut in pay, the buy-in often fails. Therefore, knowing the effort required once the buy-in occurs is as important as knowing the practice.

• Timing: This is often one of the most discussed issues. When the timing or offer is not clearly addressed, the possibility grows for all parties to become confused and frustrated. Generally, most associates are not prepared in the first year to discuss a buy-in. Many things change, and the option is generally available after the end of the second year of employment. However, just because the option is available does not mean the associate is prepared to take action. It is our experience that the buy-in option can best be explained by having a time line for the associate to declare his/her intent. It is at this point in the process that the clock starts ticking – when the buy-in will occur or how long it will take. Each buy-in is unique and should not be viewed only as a sentential event. A buy-in by the associate is a commitment that has been thoroughly evaluated and planned. Both parties should be patient as the buy-in process may take up to nine months to complete.

There are foundational rules for completing the associate buy-in that apply to both the employer and the associate:

• Determine that both parties want the best for the practice and each other.
• The “deal” will not be discussed in front of the staff or patients in the office.
• All information will be kept confidential.
• Each buy-in is unique.
• Taxes are a concern for all parties.
• When in doubt, get a third party involved to assist in completing the transaction.
• Always use an attorney.
• Share information.
• Disagree without being disagreeable.
• Plan for the future.

For more information, contact Mike Crosby, president of Provider Resources, LLC at (888) 776-2430 ext. 2042.