What's the impact of compensation when valuing a medical practice?

BVWireIssue #74-1
November 5, 2008

In valuing medical practices using the excess earnings method, the most important adjustment is the one for reasonable compensation, explains Mark Dietrich, who along with Cindy Eddins Collier, served as editor of our new BVR's Guide to Healthcare Valuations. “Determining the reasonable compensation for a physician requires more than merely looking at a statistical source and choosing the mean or median.  The valuation analyst needs to first compare the physician’s productivity or work effort to statistical norms and then base the reasonable compensation on that productivity,” he writes. Dietrich, who also served as technical editor for the Guide, notes that the following are additional considerations that must be taken into account:

1) Does the practice own laboratories or imaging equipment, e.g., x-ray, ultrasound, CT Scan or MRIs? If so, there may be significant profits from such operations and these profits need to be determined to correctly perform the valuation.  To the extent that the profits are attributable to ownership of the equipment (the technical component of revenue/expense) as opposed to interpretation of the test (professional component), they are not part of the physician work effort.  Moreover, they may not be part of personal or professional goodwill in a divorce context and should be factored out of that debate in those jurisdictions where personal goodwill is not a divisible asset.

2) How does compensation “fit” within the broader sense of fringe benefits, retirement plan contributions and other perquisites?  For example, the compensation data in the Medical Group Management Association's (MGMA) Physician Compensation and Production Survey includes only W-2 compensation; retirement plan benefits are reported separately.  As such, when figuring reasonable compensation in a valuation model, if the valuation analyst adds back the retirement plan contribution to available earnings, he/she then needs to add the MGMA retirement plan contribution to whatever (W-2) earnings are selected from the MGMA data.

Want to know more? We’ve included an excerpt from our much anticipated BVR's Guide to Healthcare Valuations (which is set to ship in about two weeks) in our November issue of Business Valuation Update™. 

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