Valuing a Medical or Dental Practice in Divorce: What Drives the Number

Physicians and dentists often assume their practice is worth a fixed percentage of annual collections. That rule of thumb is common, easy to repeat, and a poor substitute for analysis.

The insight: a practice is valued on what a buyer could keep, and in a professional practice that is less than it looks

A practice generates income because a licensed professional works in it. The value question is how much of that income would continue under a different owner, and at what cost. That is why compensation, payor relationships, and goodwill, not revenue alone, drive the conclusion.

What drives the number

1. Collections and production. Collections are cash received. Production is what was billed at full fees, before insurance write-offs. A dental practice with high production and heavy write-offs earns less than its production suggests, so collections and net revenue are the better starting points.

2. Owner-provider compensation. The owner typically works as the main clinician. Normalizing compensation means separating what the owner earns for clinical work from what the business earns as a business. The clinical portion is priced at what a replacement provider would cost, by specialty and region.

3. Associate and staff compensation. Compensation paid to associates, hygienists, and staff should be compared with market levels. Unusually low or high pay distorts earnings.

4. Payor mix. The share of revenue from insurance plans, government programs, and fee-for-service patients, and the trend in each. Reimbursement changes and the loss of a major contract can change value quickly.

5. Overhead. Compare the practice's overhead ratios with industry benchmarks for the specialty. A practice with high overhead may have a fixable inefficiency or may have a real problem.

6. Equipment, technology, and real estate. Equipment is a real asset, often with significant value. Real estate frequently sits in a separate entity owned by the doctor, and the rent paid to that entity should be tested against market rent.

7. Personal versus enterprise goodwill. The largest and most contested component (see article 1).

8. Accounts receivable and work in process. How they are treated depends on whether the practice reports on a cash or accrual basis. The report should say which, and avoid counting them twice.

Why rules of thumb mislead

Percent-of-collections multiples come from reported practice sales, and the sales behind them are not a random sample. They vary by specialty, region, payor mix, and the structure of the deal. Two practices with the same collections can differ a great deal in value when their margins, associate production, and patient retention differ. A rule of thumb can be a useful cross-check, but it cannot be the opinion.

Practical points for attorneys

• Ask whether the practice is held in a professional entity and whether licensing rules limit who can own an interest. That affects both value and the form of any buyout.

• Ask for several years of production and collection reports by provider.

• Ask for payor contracts and the last three years of reimbursement schedules.

• Ask whether anything has changed since separation, such as a new associate, a new location, or a change in the owner's schedule.

Questions to ask your expert

• How was the owner's clinical compensation separated from the return on the business?

• What share of collections is produced by providers other than the owner?

• How does payor mix affect the concentration of risk?

• Was a rule of thumb used, and if so, only as a cross-check?

• How was personal goodwill separated from enterprise goodwill, and what evidence supports it?