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January/February 1996

What is Your Practice Worth?
Six TOP EXPERTS SHOW YOU HOW To Value Your Practice

Where do you begin? If you're an associate considering the purchase of a practice that could change your life, if you're thinking of retiring in a few years, or if you're somewhere in the middle, you need to know what your practice is worth to determine how much to pay or whether you'll be able to retire. Do you know all of the tax and legal advantages of knowing what your practice is worth?

We have consulted with six top practice valuation professionals who will explain the benefits of knowing your practice's value and why it's important to know at any given time. You'll learn how to prepare for a purchase or sale, what the different valuation methods are and how to determine the impact of tangibles, such as office equipment, and intangibles, such as future earnings income.

With the shift to managed care, increased competition, personal financial planning, marriage and divorce contracts, bank loans, IRS inquiries, partnership agreements, damage lawsuits, disability and death, it is imperative to plan ahead now. The valuation of a chiropractic practice is a complicated undertaking, and should be accomplished with a professional familiar with chiropractic practices. Let's now look at the issues in detail.

Why You Need a Practice Appraisal Now

f you are like most chiropractors, you probably have not had your practice appraised. It is estimated that only 10 to 20% of chiropractors truly know what their practice is worth, and even less have a bonafide professional practice valuation substantiating practice value.

While most chiropractors wait until they want to buy or sell a practice before looking into a practice valuation, there are vital reasons to know what your practice is worth at any given time.

The value of your practice is critical to decisions that affect your financial health. Having a practice valuation is essential for IRS inquiries, attaining major loans from banks or other financial institutions, marriage contracts or divorce matters, partnership agreements, buy-sell agreements, and perhaps, most importantly, personal estate planning to insure the financial security of your family upon your death.

A Substantial Portion of Your Net Worth

If you are typical of most chiropractors, then your practice accounts for a significant part of your net worth. Knowing this fact can be a key element in your financial decisions. The pitfalls that can result from not having a complete and accurate appraisal can damage you--and particularly in the case of your death--could have a damaging impact on your family.

For example, when your life insurance agent analyzes your family's needs for life insurance, your practice must be included in the assets necessary to provide income to the family in case of your death. An accurate appraisal also helps insure that the life insurance you purchase is sufficient, and not excessive or deficient.

A Practice Appraisal--Literally a Matter of Life and Death

Also, should you die, an appropriate estate plan bolstered by a practice valuation is essential to safeguard the distribution of assets properly and reduce or eliminate estate taxes and administrative costs. Without an appraisal, upon your death, the IRS or another court-appointed entity will be called upon to determine your practice's value. Since estate taxes can run as high as 50% or more of your taxable estate, providing a professional practice valuation accepted by the courts and/or tax authorities is especially important. This fact alone could save your loved ones thousands of dollars, because professional practices are typically "overvalued," resulting in an excessive estate tax burden.

Invaluable for Complex Personal and Business Decisions

In the matter of a matrimonial dispute or pre-nuptial agreement, an accurate and timely practice valuation by an independent expert in chiropractic practice appraisals helps to avoid disputes and misunderstandings.

The key ingredient to a fair buy/sell and/or partnership agreement is a practice valuation. An initial appraisal along with periodic updates insures fairness for both the buyer and seller: An unchallenged, consistent and accurate method of appraisal is always a necessary element for successful agreements.

Additionally, loan requirements from virtually all lending institutions must include a practice valuation. In many cases, a practice valuation submitted along with the loan request documents can help swing a favorable decision.

Chiropractic Practice Appraisals Require a Special Expertise

Too often, the standard business appraisal formulas used by accountants, business brokers, professional appraisers and lawyers are highly inaccurate when applied to the chiropractic practice. Such elements as patient management, number of new patients and office visits, patient retention efficiency, collection ratio and procedures, staff function and training, patient education, case average, office visit average, and several other statistical parameters unique to chiropractic are totally missed or unaccounted for by standard appraisal methodology. This knowledge is uniquely critical and without it a chiropractic practice can be over or undervalued by thousands of dollars.

In addition, it is of paramount importance that an appraiser understand the marketplace for the buying and selling of a chiropractic practice. All too frequently, a lack of such knowledge results in an inaccurate assessment of fair market value, which is the "bottom line" in terms of what a practice is truly worth.

Only a tested mathematical formula that assigns specific true dollar value to every statistical, financial and human resource of a practice can be considered fair and accurate to all parties concerned. This coupled with an intimate knowledge of the marketplace are the two components necessary for valuing the chiropractic practice.

Impact of Managed Care on Valuing Your Practice

he number of sales of chiropractic practices in the United States has risen dramatically in recent years. Chiropractors reaching retirement age are realizing that their practices have value. New chiropractors are seeing the benefits of buying an established practice, rather than building one from the ground up. In addition, substantial restructuring in the health care field, due to major payment reform and a changing regulatory environment, has significantly affected the purchase and sale of chiropractic practices.

As a result, hospitals, insurance companies, multi-specialty group practices and a variety of others are acquiring chiropractic practices. In response to managed care, chiropractors are grouping with each other, with hospitals, and with others to form contracting entities to allow them to compete. Also, the glut of chiropractors in certain specialties has led to chiropractors seeking to purchase an interest in a practice rather than start up a chiropractic practice.

Managed Care

Concern over rising health care costs, an increasing public responsibility for those costs, as well as an aging population, are all factors contributing to accelerating momentum for payment reform in the health care industry. We are seeing a vigorous movement to managed care. Effective practice management and higher practice value in a managed care environment requires a much more sophisticated approach to managing both the clinical and business aspects of the practice than was required in a more traditional fee-for-service type of practice.

Effective reporting and control systems are essential in a managed care environment. Contract management is vital as well. The value of any practice operating in a full risk capitated environment should consider the incurred, but not reported claims (IBNRs), as well as claims payable. Primary care providers who serve as gatekeepers must be excellent business as well as clinical managers to be most valuable in today's environment. Quality of patient care must be managed and measured, and is more important today than ever before. All of these factors influence practice value.

Integrated health care delivery systems are developing to meet the requirements of managed care. Transactions necessary to form integrated delivery systems require sophisticated valuation analysis. A thorough understanding of the health care industry and payment reform issues is essential to effectively perform chiropractic practice valuation.

Regulation

In the current environment, a chiropractic practice appraiser must have an appreciation for the rapid evolution of the health care industry, including the numerous regulations affecting the delivery of health care.

Increased intervention by regulators in practice transactions requires an understanding of regulations and their impact on the value of a practice, as well as careful documentation of the methodology, assumptions and support underlying the value conclusion.

The major regulations affecting the valuation of chiropractic practices include Medicare Fraud and Abuse regulations, antitrust laws, corporate practice of medicine laws, Occupational Safety and Health Administration (OSHA), Clin-ical Laboratory Improv-ement Act (CLIA), and the Internal Revenue Code. The Medicare Fraud and Abuse regulations can affect a hospital's ability to pay for the intangible assets of a chiropractic practice if regulators consider the payment an inducement for referrals.

Adjusting the Chiropractic Financial Statements

Managed care can have a dramatic impact on the revenue stream of a chiropractic practice. Therefore, all managed care contracts must be carefully reviewed to identify the probable effect on income in all areas of the practice. Changes in demographics of the patient population must be anticipated. Shifts in the amount of care required by a given population due to changes in payor policy must be considered. In addition, managed care contract provisions influencing the selection of the provider of care, ranging from chiropractor to physician to nurse practitioner or other provider can have a significant influence on projected revenues. Any anticipated change in supply of providers should be addressed.

The process of valuing tangible and intangible assets in a chiropractic practice is generally complicated by the use of cash basis accounting by most chiropractic practices. There may be a significant amount of value in assets not recorded on the balance sheets of a cash basis entity, such as accounts receivable, work-in-process assets and prepaid expenses. Furthermore, fully depreciated equipment still being used by the practice may have been removed from the balance sheet, and leasehold improvements may form an integral part of the operation of the chiropractic practice. At the same time, liabilities such as accounts payable, accrued vacation time for employees and accrued taxes may not be recorded on the balance sheet.

Additional liabilities for any practice operating in a full risk capitated environment should include the incurred, but not reported claims (IBNRs). IBNRs are claims for which services have been rendered, but which have not yet entered the payor's accounts payable database as of the moment an accounts payable report is generated. IBNRs would exist only for those chiropractors who are accepting capitation for services, and then referring patients for the capitated covered services to other providers for care.

Also, costs required to bring the practice into compliance with regulations discussed above must be considered. The appraiser must use judgment to determine which assets and liabilities are necessary to the practice operations and how they affect value.

Summary

The number of sales of chiropractic practices in the United States has risen dramatically in recent years for a variety of reasons. In addition, dramatic restructuring in the health care field due to major payment reform and a changing regulatory environment has significantly affected the purchase and sale of chiropractic practices. While there are many ways to value a practice, the choice of actual methods will depend on the purpose of the valuation, the nature of the practice and the availability of data.

Three Very Different Valuation Methods

here are three generally accepted approaches used to determine the value of a chiropractic practice: Income Approach, Market Approach and Cost Approach.

1. Income Approach

The Income Approach either capitalizes1 current earnings or cash flow or discounts future earnings or cash flow to determine the present value of the future benefits of an ownership interest in a chiropractic practice. There are several variations of the Income Approach.

A. Capitalized-Return Method

The Capitalized Return method converts a current stream of income into a standard of value. The capitalization rate is a divisor or a multiplier that is used to compute the present worth of a single-period benefit stream. The single period benefit stream is the net earnings or net cash flow that the practice is expected to generate in the future.

The Capitalization of Earnings method, Debt-Capacity method, and the Excess-Earnings method are three of the most widely used versions of the Capitalization-Return method.

Debt-Capacity Model

The Paragon Group Debt-Capacity Model is designed to place a value on a practice that will simultaneously provide the buyer with enough time and cash flow to service debt, compensate him/her for rendering professional services, and give the seller a realistic value for professional goodwill.

The focus is on the break-even point or the amount of projected income collected that must be generated to meet all fixed and variable practice expenses, pay the doctor a market rate of compensation for rendering professional services, and amortize the debt required to purchase the practice.

For more detailed information on the Debt-Capacity Model, please turn to page

B. Discounted-Future-Return Method

The Discounted-Future-Return method discounts a future stream of income in order to determine its present value. The discount rate is the rate of return, ie, current income plus capital appreciation, that a practice owner or buyer expects to receive from his/her investment in the practice. The discount rate determines the present value factors that are used to compute the present value of multiple benefit periods.

2. Market Approach

The market approach assumes that the value of a specific practice can be determined by the sales price of other similar chiropractic practices in your catchment. The more similar practices used in the "average," the more realistic the valuation will be.

The market approach is based upon the principle of substitution, which states that a prudent buyer will pay no more for a practice than what it would cost to acquire a substitute practice that provides the same benefits. For example, if the sale price of a practice similar to yours is selling for approximately 75% of gross receipts and/or four times the net earnings, this might be a good starting point of valuation for your practice.

3. The Cost Approach

The focus of the cost approach is on the value of a specific practice's assets, not its earning capacity. Since the cost approach does not take into account the earnings or cash flow that the assets produce, it disregards intangible assets such as goodwill and patient records, and instead concentrates on tangible assets that are minimal. The Cost Approach is generally not used to value professional practices.

How to Convert Goodwill into Real Numbers

As a practice management consultant, I have seen many changes in the health care field over the last decade. None of these more pronounced than the appraisal for the sale of medical practices to potential buyers. The form of purchase may develop in part, or in full to an outside buyer or an empoloyee doctor wishing to become an owner.

It has finally become apparent that a health care practice has value, and as with any service organization, there are prospective buyers who see the value. Prospective buyers include:

1. Other medical entities wanting to expand or secure markets.
2. Hospitals who want geographic control.
3. Employee chiropractors who want to buy in 100% to ownership in a chiropractic practice.

One of the problems in selling a practice today comes from the valuation and its methodology. As history has shown, there are many ways to complete a practice valuation as there are specialties. I have personally reviewed over a dozen and found little continuity. The evaluator, no matter how objective, must use some subjectivity in this process. Most appraisers tend to use a two-prong approach. The first part of the equation is easy: tangible, physical assets. The problem comes to the forefront in phase two, intangible assets, better known as "goodwill."

History has shown us tangible assets such as bricks and mortar, tables, computers and charts have real value. You determine "fair market value" and go to the bank. However, in determining "goodwill" you find many methods of calculations. Is it...

A. Purchasing accounts receivable at some percentage of value, or
B. Dollar value per chart, or
C. Based on the seller's restrictive covenant, or
D. Pie in the sky

Too many times, it is a blend of all four, with a heavy weight on point D. Furthermore, the word "goodwill" scares away more buyers by the nature of this nebulous term.

I suggest that health care move with all other service industries and make goodwill a tangible, real asset number. Let's say goodbye to goodwill and hello to a measurable, tangible asset to support our tangible, physical assets.

I believe that two methodologies should be formalized to replace the antiquated goodwill.

1. Excess Earnings model
2. Future Income potential

To understand these formulas, you must understand the methodology of each.

The concept of excess earnings allows a definitive measurement of the seller's ability to exceed his or her specialties normal earnings. So the buyer is buying into the cash flow and excess earning potential of the seller. A specific example of this methodology is as follows:

Excess Earnings Model

1. If statistically reliant data indicates a chiropractor should reflect on their W-2 tax form, an amount such as $75,000 to fit in normal, average salary; yet, a chiropractor consistently and historically proves that he/she generates, on the W-2, $175,000, then that chiropractor's excess earnings are $100,000. Using a capitalization rate of four (normal in service industry,) then the excess earning potential for the buyer is $100,000 x 4 = $400,000).

Of course, I am simplifying the concept immensely since the appraiser needs to apply appropriate weights and evaluate many items over a long span of time to validate concepts. However, in terms of the concept, this becomes more palatable to the buyer due to the tangible nature of "excess earnings." Add your tangible assets and you have your value. Cash flow earnings are much better understood than "goodwill."

Future Income Potential

2. A second method of future income potential attempts from a factual standpoint, to measure the impact of future income. Again, the method should be explained. The evaluator has already determined earnings past and present day. Now we need to look to the future income stream of the practice. We recognize that this chiropractor has been $100,000 above the norm for earnings. However, we must consider what the net income will look like after we have discounted future monies and projected a total revenue for three to five years in the future. His/her net income will approximate, on a weighted basis, $425,000 as an average over the next four years, and future, determine a loss of 15% due to:

Third party reimbursement
Lower patient volume
Different patient make-up
More competition

Multiplying the $425,000 x .85 will give you a tangible future earnings evaluation of $361,125. If you further average that with excess earnings, then the goodwill is $380,563. Added to physical assets, you have the value.

Again, I have simplified this process tremendously. A proper evaluation takes time and review of much material over many years and confidence from historical data for the future. The application of proper weights is vital to get a complete picture of the practice. No one will accept guess work.

I believe the argument with goodwill is that it is too subjective and creates an inability to quantify what a buyer is purchasing. This type of subjectivity denotes goodbye to the sale of the practice and goodbye to a successful buy-in.

In the last ten years we have seen a large jump in practice sales volume whether from an outside buyer or an inside employee. It is not only vitally important to understand the practice and quantify not only assets, but earnings and income as well.

The understanding of the excess earnings model and the future income potential will quantify the process once known as "goodwill." It is a proper value of the seller based on his/her hard work and allows the buyer to buy-in to a cash flow stream, considering the future that would be above the "normal" practice income.

After accomplishing many negotiated appraisals and buy-ins, I can assure you that this formula works. It allows the appraiser to quantify the category of "goodwill." May I assure you it is much easier to sell cash flow than it is goodwill.

In 1996, practice sales will continue to rise. The ability to quantify value is an imperative and will be expected. These methods of excess earnings and future income appear to be the most logical, quantifiable and negotiable. It is time to say goodbye to the old subjective goodwill, and hello to new strategies that show the true value of today's medical practice.

How to Set the Right Price for Your Practice

Doctor Doktor is 62 years old and has been in solo practice since 1963. Last year his practice produced gross billings of $322,578; the collection ratio was 91.1%. The doctor rents 1,200 square feet in a 15,000 square-foot professional building. He is not incorporated. The doctor would like to sell his practice, introduce the buyer to the patients of record, and then retire.

He has discussed the sale with a number of prospective buyers, but he doesn't know how to set the right price for his practice. How can he determine how much it is really worth?

If the buyer requires financing, should Doctor Doktor finance the sale? If so, how much of the purchase price should he finance? If the buyer wants to purchase the doctor's accounts receivable, should he sell them? How much should he sell them for?

What can Doctor Doktor do to minimize the tax consequences of the sale? Since he will continue patient care, is patient abandonment an issue? Does each patient have to give his/her permission to transfer their records to the buyer or can Doctor Doktor transfer them?
he sale of a chiropractic practice is a complicated transaction. Get professional help. Retain an expert in practice valuation. Hire an accountant and an attorney who are experienced in the nuances of practice appraisal and sale.

A valuation expert can help you determine what your practice is really worth. A good accountant can answer tax questions, and a transaction attorney will help you prepare a purchase-and-sale contract. These professionals will provide you with the expertise that will enable you to make the right decision and avoid potential problems.

Setting the right price for your practice is not easy. Rules of thumb are arbitrary and do not work; and since few, if any practices are comparable, the market-data method of appraisal does not apply. Value can only be determined by capitalizing practice earnings at a capitalization rate that reflects the quality of the practice, the clinical excellence and unique characteristics of the doctor, and the perceived risk of attrition.

Although market value will depend on the circumstances in each case, the value of any chiropractic practice depends upon its earning capacity, as well as the optimism or pessimism that a buyer has regarding the reliability and continuity of that earning capacity. In the final analysis, value is determined by the likelihood that existing and potential patients will continue to purchase chiropractic products and services from the practice.

There are three generally accepted approaches that are used to determine the value of a chiropractic practice: Income Approach, Market Approach and Cost Approach. For an in-depth look at these valuation methods, please see "Three Very Different Valuation Methods" on page 30.

The Debt-Capacity Model is designed to place a value on a practice that will simultaneously provide the buyer with enough time and cash flow to service debt, compensate him/her for rendering professional services, and give the seller a realistic value for professional goodwill.

The focus is on the break-even point or the amount of projected income collected that must be generated to meet all fixed and variable practice expenses, pay the doctor a market rate of compensation for rendering professional services, and amortize the debt required to purchase the practice. Please refer to Debt-Capacity Model diagram on page 37.

Definitions:

Adjusted Net Cash Flow

Adjusted net cash flow is the cash flow that is available for debt amortization before income taxes, but after fixed and variable practice expenses and professional compensation are paid. Non-recurring or extra-ordinary expense items as well as excess professional compensation and discretionary fringe benefits are eliminated in order to normalize gross practice income and arrive at the true earnings or cash flow of the practice.

Capitalization Rate

The capitalization rate, which is determined by the credit risk that is inherent in the earnings or cash flow of the practice, will determine the maximum amount of money that a prudent lender would extend to a qualified borrower. This is the maximum amount of money that a willing buyer can afford to pay a willing seller.

The capitalization rate reflects the credit risk that is peculiar to a specific practice as well as the general economic outlook for the health care industry and chiropractic. The capitalization rate indicates the potential erosion of professional goodwill. The lower the credit risk, the lower the capitalization rate and the higher the value of the practice.

The precise capitalization rate depends upon chiropractic economics, the quality of the practice, and the perceived risk of attrition regarding the amount of professional goodwill that can be transferred from doctor to doctor as of the date of appraisal.

Amoritization Factor

The amortization factor, which is the statistical summation of the terms and conditions of a credit accommodation, reflects the principal ratio and the term of the loan.

The principal ratio, which is the percentage of each loan payment that is applied to principal, is a function of the interest rate and the term of the loan. The term of the loan is the repayment period of the debt. It is determined by the term limits for commercial loans set by a lender according to credit policy.

Since chiropractic practice accounting is a cash-basis of accounting, income is recognized when services are collected, not billed. Since accounts receivable reflect future, not current, income, The Debt-Capacity Model does not take into account the value of the accounts receivable. These assets should be valued separately.

CASE STUDY

Table One illustrates how to value Doctor Doktor Chiropractic Center. Adjust the income statement and strip out any non-recurring expense items, excess professional compensation or fringe benefits. In other words, eliminate all extra-ordinary expenses and determine the true net practice income and cash flow of the practice.

For example, Insurance, Legal and Professional Fees, and Office Supplies and Expense are extra-ordinary; Automobile Expense and Travel and Entertainment are discretionary fringe benefits, not practice expenses; Seminar Expense and Miscellaneous are optional; and Repair and Maintenance is non-recurring.

ince the buyer assumes that all assets are owned free and clear of all liens, the seller must liquidate all equipment leases. Equip-ment Rental is a non-recurring item. Professional compensation is 30% of total income collected.

Factors that Determine the Selection of a Capitalization Rate

The external factors that determine the selection of a capitalization rate are industry-specific and beyond the control of management:

1. Existing economic conditions and the general economic outlook.
2. The economic conditions of the health care industry.
3. The nature of the chiropractic profession and the outlook for the delivery of chiropractic products and services.

The unprecedented shift to managed care during the 1990's together with the market forces that are shaping health care reform, as well as health care regulation and Medicare and Medicaid reform, have a material impact upon the degree of optimism or pessimism that a buyer has regarding the reliability and continuity of the earnings of a specific practice.

The internal factors that determine the selection of a capitalization rate are practice-specific and within the control of management:

1. The history of the practice that is being appraised.
2. The financial condition of the practice.
3. The earnings of the practice and the quality of said earnings.
4. The quality of management.
5. The financial policies as well as the operating procedures and accounting
systems of the practice.

Internal factors, including, but not limited to the clinical focus, case mix, payor profile, patient census, referral patterns, and the length of stay have either a positive or negative impact on the actual earnings and the quality of the earnings. The buy-sell provisions of a partnership or shareholder agreement could restrict the right to transfer the property at a price that would be equivalent to fair market value.

Pre-Valuation Strategy

To enhance the value of your practice, you have three options: First, increase your gross billings, second, control your overhead costs; third, combine greater production with lower practice overhead expenses.

Following are some tips on valuing your practice:

The most valuable aspect of your practice is your patient base, so you must grow the size of your active-patient population. Make your patients think of you first when they have a health care problem they must solve. Institute discharge planning. Implement a recall plan. Develop a wellness program. Communicate with your patients on a regular basis and strengthen your referral base.

Get into managed care. A doctor who is on the panel of a managed care plan or is a member of a physician network will add value to his/her practice. A practice that implements practice guidelines, renders cost-effective care and self-regulates will enhance its marketability and raise its value.

Operate a lean practice. Think of yourself as a cost center. If you control operating expenses, you will increase practice earnings and add value to your practice.

Manage your practice. In the past, doctors compensated for poor management and administrative weakness by practice-building and raising fees. In the future, this will not be an option. Managed care contracts neutralize practice-building efforts. Utilization review holds back patient visits. Cost containment suppresses fees.

Today, expense management and quality control are fundamental to success. Trim the excess from your practice overhead. Clean up your patient records. Modernize your information systems. Make your computer user-friendly. Focus on data collection as well as billing. Maintain your equipment. If you don't, tangible assets will be a liability. Let me show you how these tips can enhance the value of your practice.

In the aforementioned case, Doctor Doktor generated gross billings of $322,578; the collection ratio was 91.1%; the adjusted overhead expense ratio was 40.4%. After adjustments and professional compensation, the practice generated adjusted net cash flow of $78,759. The Debt-Capacity Model produced a value of $192,000.

If the doctor increased the collection ratio to 93.5% and reduced the adjusted overhead expense ratio to 38.5%, he would increase the adjusted net cash flow 17.3% or $13,808. Apply the Debt-Capacity Model and Doctor Doktor would increase the value of his practice $33,000 to $225,000.

Should the Seller Finance the Sale?

The inability of a buyer to access capital is a strong impediment to the sale of any practice. If the seller steps into the shoes of a lender, he/she will increase the marketability of the practice, but if the buyer defaults on the note obligation, the seller will have to litigate, and he may not receive any additional money.

Doctor Doktor should analyze his personal finances; determine his liability as well as his desire to assume capital risk, and decide how badly he wants to sell his practice. Unless the sale is urgent, the doctor should limit the amount of the seller note to 25% to 35% of the purchase price. If the sale is urgent, the doctor could finance up to 75% or 80% of the purchase price, but never 100%. The credit risk increases as you finance a greater percentage of the sale.

lways qualify the borrower and support the note with life insurance in the amount of the note and disability-income insurance with benefits equal to the amount of the monthly payment. The term of the loan should not exceed seven years and the rate of interest should be 1% to 3% above the bank lending rate. Secure the note with a lien on the assets of the practice.

Should the Seller Sell the Accounts Receivable to the Buyer?

In my opinion, the sale of accounts receivable is not in the best interest of either the seller or the buyer, and since there are no tax advantages for either party, the transaction does not make any sense.

To compensate for the collection risk and the time that it will take to collect the accounts receivable, the buyer must purchase them at a discount. The seller may also have to finance the purchase. If the buyer defaults, the seller will have to litigate.

The purchase of the accounts receivable can increase the cost of the sale to the buyer and raise the break-even point. The purchase discount may not compensate the buyer for the collection risk and collection time and, although the accounts receivable provide working capital, it is cheaper and and less risky to borrow the working capital from a bank.

Allocating the Purchase Price Among the Individual Assets

The sale of a chiropractic practice is not one sale, but a series of sub-sales. For tax purposes, market value must be allocated to each asset sold. Gain or loss is computed, and each asset is taxed individually.

If the seller is a Schedule C taxpayer or Sub-chapter S corporation, he/she can minimize the tax consequences of the sale if they allocate as much of the sale as they can to assets that will be taxed at capital gains rates, such as goodwill and patient records, and allocate minimum value to assets that produce ordinary income, such as covenant-not-to-compete, clinical equipment, office furniture, supplies, and leasehold improvements.

Since the Revenue Reconciliation Act of 1993 allows the buyer to depreciate tangible assets, as well as intangible assets such as goodwill, patient records, and covenant not to compete, the buyer can maximize the amount of the purchase price that is subject to depreciation and maximize the tax benefits of the sale.

If the practice is a C corporation, the seller can minimize the tax consequences of the sale if they sell their capital stock in the corporation and pay capital gain tax on the gain-over-basis. However, if the buyer purchases the capital stock in the corporation, he/she will be subject to any corporate liabilities or potential corporate liabilities. Although the seller can indemnify the buyer against any loss, he/she cannot eliminate the risk. In addition, capital stock is not depreciable.

There is another problem. If the stockholder(s) sell corporate assets, the corporation will pay corporate income taxes on the gain-over-basis, and then when the corporation distributes the sale proceeds to the stockholders(s), they will pay ordinary income tax on their gain-over-basis. The combined federal marginal tax rate could be as much as 73% of the gain. This is a complex tax problem. Talk to your accountant.

Patient Abandonment:

Is it an Issue?

According to the Legal Guide for Physicians 2.04(1),

Once a doctor commences the doctor/patient relationship, he may not abandon the patient without running the risk of incurring liability for resulting damages. Treatment must continue until either the patient's condition no longer warrants treatment, the physician and patient mutually agree to discontinue treatment by the physician, or the patient discharges the physician. However, the physician may unilaterally withdraw from treatment if he gives the patient appropriate notice of his intent to withdraw and an opportunity to secure a competent replacement.

Every doctor has the right to withdraw from the care of a patient provided that he/she follows the appropriate procedures. Once you decide to terminate the doctor/patient relationship, evaluate the condition of the patient. If the patient is not in immediate danger, notify him/her of your intent to withdraw, apprise him of the need for follow-up care, and give them adequate time to obtain another chiropractor.

What About Patient Records?

Patient records are the legal property of the doctor, not the patient, but they can only be transferred to another doctor with the consent of the patient. There are three legal issues that you must consider regarding the transfer of patient records:

1. Retention. A practitioner must retain patient records for six years and until one year after a minor reaches the age of 21.

2. Confidentiality. It is a violation of a person's civil rights to have a health practitioner reveal confidential information about a patient to another practitioner without that patient's prior approval.

3. Professional liability. Patient records are essential in any suit that claims professional negligence. In a California case (Thor vs. Boska, 38 Cal. App. 3rd 558, 1974), the court stated that the inability of the physician to produce the original clinical record concerning his treatment of the plaintiff creates a strong inference of guilt.

To avoid the risk of confidentiality, notify your patients of the sale of your practice. State in your letter that you intend to transfer the records to the buyer unless they object. Indicate that their objection must be made known within a reasonable time period such as 30, 60 or 90 days. If you do not hear from a patient, that constitutes a waiver and you are protected.

To comply with retention requirements and protect yourself in the event of a malpractice action, enter into a safekeeping agreement with the buyer or microfilm the records until the statutes of limitation for malpractice and patient abandonment expire.

Considerations Prior to Buying/Selling a Practice

What is it Worth?

This age-old question is a matter of objectivity or subjectivity, depending on whether you are the seller or prospective buyer. Many say that the fair market value of a practice is what a reasonable buyer will pay and what a reasonable seller will accept; but, this philosophy offers little practical advice to the seller or buyer.

A buy/sell should be made based on the business, not on the emotions of the parties and should have a professional's help to guide negotiations, prepare proposals or contracts required. For the most part, sellers have usually spent a great deal of their professional lives building their practice and want to receive the greatest amount possible to reward their accomplishments and to provide for their retirement. Whereas, the buyer most likely is just beginning their professional career and usually will have limited assets or funds, is likely to have considerable debt, and will require financial help with buying the seller's practice. Thus, the parties are worlds apart.

A seller must plan for the sale of their practice well in advance, keep their practice modernized and up-to-date, (this is a most important factor in obtaining maximum return from the sale of a practice, and should maintain the practice at a reasonable level of activity if they hope to obtain a fair value from the sale.

Seven factors that can severely reduce the value of the practice to a potential buyer are:

1. Failing to update the office and continuing to use old or outdated equipment that will have little or no value to the buyer.
2. Failing to have an active or aggressive working recall system that assures the buyer of continuous patient flow.
3. Little or no marketing of the practice.
4. Failing to participate in third party health reimbursement plans, which diminishes the potential patient base of the practice.
5. Inadequate or non-utilization of Medicare or Workmens' Compensation.
6. Cutting back on practice time in the office, which reduces the gross and net income of the practice.
7. A facility not allowing evening or Saturday working hours.

Assuming that a buy/sell will be forthcoming, the most importunate aspect of the buy/sell will be the tax ramifications to the seller and buyer. Allocation of assets for tax purposes will be of greatest interest to the buyer and depreciation recapture income will be one of the major concerns of the seller along with deferring taxes. See Table of Allocation of Assets for Tax Purposes on next page.

With most practice purchases, it is highly recommended that the buyer purchase only the practice assets, not the corporation/business; this limits liability and maximizes tax benefit for the buyer, helping to enhance the purchase.

Most practice sales will have to be self-financed by the seller due to the fact that the buyer will most likely have very few assets and heavy in-debtedness, and thus, will be unable to acquire formal financing from a lending institution. The seller, if offering financing, will still have to get enough down payment at the time of sale to at least cover the first year taxes due.

Conclusion

Regardless of the specific formula or method used to determine the final buy/sell price, every purchase will have unique variables unto itself; thus, always use a professional to negotiate and prepare any and all proposals or contracts. It is definitely worthwhile to utilize an appraiser experienced in the chiropractic profession to obtain the most realistic fair market value for the buy/sell. For the record, the worth of something ultimately is the joy or pleasure it brings to someone.

   
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