In Physician Buy-Out Agreements, Determining a Valuation Formula is Critical

Enumerate Specific Assets, and a Specific Methodology for Those Assets

If a fair market value is determined by multiple appraisers, it’s likely to be too high—and lead to a rush for the door, where the first doctor out wins. Here’s why.

I’ve preached for years about the importance of a periodic review of the provisions of the practice agreements so that there is greater assurance that the document is providing the protections and guidance that it was intended to. It helps the review process immensely to know in advance some of the areas that are most likely to require scrutiny.

One of the more important aspects of a practice agreement, the valuation formula provides the definition of which assets will be included and how those assets are to be valued in the event of a physician’s termination of employment (and required disposition of their interest in the practice) whether by death, disability, retirement or any other termination.

Some agreements simply stipulate that a fair market valuation is to be determined by one or more appraisers. I am generally opposed to this type of valuation clause for several reasons.

• First, the fair market value of a practice (unless otherwise defined by the document) will value intangible assets to include, but not be limited to, workforce in place, going concern, and goodwill. Under such a formulation, it can become financially difficult for a practice to provide the required consideration to a terminating physician. In fact, the corresponding buyout amount may be so high that it becomes a race for the door, meaning the first doctor out wins.  After the first valuation is completed this way, the other doctors—seeing the resulting value and its consequences—will frequently revert to a specific valuation methodology (as discussed below).

• Another weakness of using this type of overly-general valuation clause is that medical practice valuation experts will likely differ as to the value. As a result, a practice can spend a lot of time and fees with valuation experts in an attempt to come to agreement as to the fair market value.

Instead, consider having in place a more specific formula enumerating the specific assets that are to be included in the valuation and that the agreement provide a specific methodology on how those assets are to be valued. To wit; agreeing how the fixed assets are to be valued, will an intangible be valued as a percent of the physician’s prior collections, or maybe set the buyout based on prior compensation taken out. The main point is that the agreement should provide the valuation formula so that the valuation calculation becomes a simpler more mechanical function; thereby avoiding significant fees, conflicts, and hard feelings over the myriad potential valuation issues.

Reed Tinsley, CPA is a Houston-based CPA, Certified Valuation Analyst, and healthcare consultant. He works closely with physicians, medical groups, and other healthcare entities with managed care contracting issues, operational & financial management, strategic planning, and profit strategies. His entire practice is concentrated in the health care industry. Reach him at reedT@rtacpa.com