Prior to instructing a valuation for allied health practices, the 4 W’s need to be addressed:
- What is being valued? Is it the business or the equity? Is it the whole entity or a specific interest?
- Why is the valuation being undertaken?
- Who is the valuation for?
- When is the valuation date?
In this article, it’s assumed that only the business is being valued, otherwise known as the enterprise value. As such, the legal structure and financing are irrelevant.
The most common way to value a medical practice, and other allied health practices, is the capitalisation of future maintainable earnings (“FME”) method. This methodology is appropriate for medical centres with sustainable profits and continuing operations.
A valuation based on the FME methodology requires an assessment of the following:
- Future maintainable earnings of the business; and
- An appropriate capitalisation rate (also known as a multiple).
1. Future maintainable earnings
In determining FME, ideally using the last three years of accountant prepared financials and any forecast information, the following should be considered:
- Replace any non-arm’s length expenses with the equivalent expenses at market rate, such as rental expenses and remuneration for owners/associates;
- Exclude items which are not related to the ongoing operations of the business or relate to financing decisions, for example insurance claim receipts, profits on sale of assets, hire purchase charges and private use of mobile phones or motor vehicles;
- Exclude non-recurring items, such one-off consultant fees, government grants or relocation costs;
- Ensure that accounting policies are consistently applied; and
- Ensure all relevant business income and expenses are included.
2. Capitalisation rate
In selecting an appropriate capitalisation rate, the valuation specialist will obtain trading multiples of comparable companies listed on the ASX and review transaction multiples for recently acquired businesses in the health and medical industry.
Using the trading multiples of comparable companies listed on the ASX and recent transactions as a starting point, the valuer will carry out adjustments to reflect the following:
- Premium for control – the trading multiples of the comparable companies and transactions relate to portfolio (or minority) holdings. As the valuation relates to the entire business, a control premium is applied;
- Size discount – the size of the allied health practice is likely to be smaller than the listed companies. As such, a size discount needs to be applied to the multiple for comparable companies and transactions; and
- Business specific considerations – a further discount may be required to reflect additional risks in the medical practice being valued, compared to the comparable companies.
The following are examples of business specific considerations:
- The reliance on one practitioner, specialist or doctor with regular patients;
- Whether the practitioners are on contracts with restraint conditions and if they are not, the likelihood of patients following an exiting practitioner or doctor;
- Whether the business is affiliated with a health fund;
- Whether the practice is bulk-billed only or has private patients also;
- Location of the health practice, such as being on a busy road or close to public transport;
- Terms of the property lease for the practice;
- Whether the practice has other complementary businesses located nearby, such as a general practice, hospital, pathology, pharmacist or various other allied health providers;
- Demographic and socioeconomic status of the patients, noting that bulk billed practices typically wait longer to receive payment from Medicare but experience higher demand from patients;
- Changes in the local health care industry and whether patients have easier access to public hospitals instead of visiting a medical centre; and
- Changes in state government policy, which impact prices the medical practice is allowed to set. General practitioners are able to set prices based on market conditions, and although the Australian Medical Association publishes a consultation fee guideline, it is not binding.
Once the above considerations have been assessed, the valuer determines an appropriate range for the capitalisation rate. This is then applied to the future maintainable earnings from step one, and the resulting value is the enterprise value.
Adopting an FME valuation approach, a medical or allied health centre can be valued as follows:
FME x Capitalisation Rate = Value of business (Enterprise value)
Enterprise value does not include related party loans, borrowings, cash or debt like items such as income tax. These items would need to be included if an equity value (i.e. shares in the entity) was required to be determined.
In order for the above steps to be carried out most efficiently by a valuation specialist:
- Ensure the business financials have been prepared by a qualified accountant on a consistent basis;
- Review for income and expenses not relevant to the business operations and one-off/non-recurring items;
- Compile relevant leases and employment contracts; and
- Note the business specific considerations relevant to the allied health or medical practice that differentiate it from its competitors.
How can RSM help?
No matter where your practice is located, RSM has both health specialist advisers and valuations experts, ready to assist your business and practice goals. If you require further information on the above, please contact your local RSM office today.