The Real-World Value of Goodwill.
How to understand and enhance yours.
By Mark E. Kropiewnicki, J.D., LL.M

Do you know what your practice is worth as an asset that can and, at some point, will be bought and sold? You should. Practice valuation affects your finances not only when you sell, but also when you merge with another practice, or negotiate an associate physician buy-in or a multi-doctor buy-sell agreement. And you may need to know for other reasons, such as estate planning and divorce proceedings.

Practice value is measured by three major components: hard assets, accounts receivable, and goodwill. Of these three, the value of goodwill varies the most. Some ophthalmologists have a difficult time negotiating a goodwill buy-in or buy-out from associates, while others find that they have interested purchasers, even with a substantial goodwill price.

The components of goodwill

Goodwill is made up of many components, including the tendency of patients to return to the same place of business for a given service, and the patterns of physicians, optometrists, opticians and patients to keep referring to the same practice. This expectation of prospective business has market value. It also will benefit an associate physician buying into the practice. He or she won't have to develop a brand new patient base.

Goodwill also is defined as the "going concern value." This is the worth of having an ophthalmology practice that's fully operable, with a trained workforce, properly configured computer hardware and software systems, and properly configured office space. To an associate buying into the practice, or to another purchasing physician, these systems represent savings in time and money and are benefits of buying into the practice versus starting up a new one.

Any other intangible value associated with the practice also falls under the category of goodwill. Medical charts, patient lists, phone numbers, practice location, and perhaps even the practice name all have value associated with them.

What is the value of your goodwill?

All practices have these items of intangible value. However, not all practices can command a significant payment for them. Some practices have substantial goodwill value, while others have little or no goodwill value at all.

A major factor for this inequity is practice profitability measured by the compensation and benefits the doctor receives. If your practice is profitable, it can justify a considerable goodwill payment because this financial success would most likely be hard for the purchasing doctor to reproduce in a new practice. Profitability is attractive if a physician is considering a buy-in or practice purchase, as the high profits can be used to pay the goodwill premium to the seller and leave a substantial remainder for the buyer's personal living expenses.

In contrast, if a practice generates mediocre earnings for its doctors, it won't be attractive for a physician looking to buy-in or make a purchase. In this case, the associate or purchasing doctor will do better starting a new practice and avoiding the problems associated with a poorly performing practice. The current owner of a practice like this will have a hard time demanding any payment for goodwill.

Another significant factor in goodwill is geographic location. Buyers will always be more interested in practices in a warm climate or an attractive metropolitan area, rather than an area with a harsh climate or an otherwise undesirable location. The supply and demand principle works well with this factor. In an underserved rural area, a hospital might recruit new physicians with a package of incentives that will ensure the doctor is initially successful if he or she starts a new practice. In this situation, there is no incentive for a newly recruited doctor to spend a large amount of money on a goodwill buy-in.

Competition is a big factor as well. A reasonable amount of competition means a new physician could set up a competitive practice with small risk and little need to pay a high sum for an existing practice. But intense competition can lead to lower goodwill values as there's more risk that the practice's ability to generate income will be weakened.

The Goodwill Registry reports a practice's goodwill value as a percentage ("Goodwill Percent") of the practice's annual gross (cash receipts) revenue. It represents goodwill values for real-world transactions. Ophthalmology Goodwill Percent for various time frames since 1981. The trend for Goodwill Percent is sliding downward from earlier years to the present.

Goodwill Percent is moving downward, as illustrated by this downward-sloping trend line. The middle 1990s had higher Goodwill Percents than the years before and after. The PPMC purchases of ophthalmology practices in the mid-90s appears to be responsible for this upward spike.

Enhancing goodwill value

You can take steps to enhance your practice's goodwill value. Solid management is the best way to accomplish that goal. A well-managed practice generates the profits that all purchasers covet. A poorly managed practice generating average profits will discourage buyers. Other attributes that you need:

• well-designed and correctly operating billing and collections processes
• low staff turnover
• active marketing to patients and referrers
• solid financial tracking systems, such as receivables collection reports and CPT volume analyses
• a successful patient recall system
• well-designed and furnished space
• a well-designed and current computer system. 

There was an even steeper downward trend from 1996 to 2000. This isn't unexpected because the Goodwill Percent is retreating to a more normal range from the peaks of the mid-90s.

Although the Goodwill Percent is trending downward, the dollar amount of ophthalmology goodwill value is trending upward. The trend line is skewed, in part by the high average goodwill value of $963,710 in 1996. This extreme average goodwill value in 1996 appears to be the result of a few very large PPMC deals occurring in that year. Nevertheless, the average goodwill value of ophthalmology practices is increasing, and a substantial averaging well over $400,000 per practice exists even with the $963,710 aberration of 1996.

Mark E. Kropiewnicki, J.D., LL.M, is a principal consultant with The Health Care Group, Inc. and a principal and president of Health Care Law Associates, P.C., in Plymouth Meeting, Pa. He has valued and closed buy-in, buy-out, sale and merger transactions involving hundreds of ophthalmology and other medical practices. You can contact him at (800) 473-0032.