Determining the True Value of Primary Care Practices

An Accelerating Trend in Physician Practices

Over 100,000 physicians moved from independent practice to employment by hospitals and other corporations between 2019 and 2021,^[1] in a continuing trend of accelerated physician practice acquisitions. By the end of 2021, 74% of physicians were employed by health systems, hospitals, or corporate entities, and 22% of those physicians were employed by corporate entities.^[2]

While virtually every specialty has been affected, primary care practices have been in high demand—especially as health systems and other buyers have been able to realize significant value in shifting from fee-for-service contracts, where providers are paid for each service performed (for example, office visits and tests), to value-based contracts. With value-based contracts, physicians are incentivized to better manage patients’ treatment plans and eliminate unnecessary services, which reduces the cost of care, and this reduction in cost is then shared with the physician’s practice through risk-sharing arrangements.

High Primary Care Practice Purchase Prices

Over 35^[3] physician practice transactions with publicly available data have closed in the last five years and transacted with an EBITDA—earnings before interest, taxes, depreciation, and amortization—multiple of 10x or higher. Of those transactions, 12 were primary care, and none of the buyers were health systems. Many had significant purchase prices; the chart below lists some recent transactions.

The authors have seen the large multiples firsthand. Of the last 25 primary care practices they valued, more than half of those transactions have closed with EBITDA multiples greater than 10x.

Many non–health system buyers are not required to follow fair market value (FMV) standards: “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”^[4] Thus, they can offer more competitive bids for physician practices than health systems are able to. Health systems will need to match these bids while staying within FMV if they are to have a chance of acquiring primary care groups, including practices with only a few providers.

Three Valuation Approaches for Physician Practices

Valuation of a physician practice begins with three approaches: the income approach, the cost approach, and the market approach.

• The income approach estimates the value of a business or arrangement based on the present value of the cash flows that are expected to be generated in the future.
• The market approach estimates the value of a business by considering the prices of comparable businesses or the prices at which similar businesses have transacted. This approach also includes an analysis of past transactions, with adjustments for differences between the subject business and market data.
• The cost approach seeks to identify replacement costs and typically is performed through an analysis of the relevant assets and liabilities in a business valuation. In this approach, the tangible and intangible assets are individually appraised and then aggregated to estimate value. The cost approach entails estimating the cost of reproducing the benefits to be derived from the business or arrangement. This approach is most useful in the valuation of investment-holding companies, asset-intensive companies, and businesses considering or undergoing liquidation.

The income and market approaches require the practice’s EBITDA to be greater than zero; this value is unusual in smaller physician practices, where the physician-owners receive all income of the practice as a distribution. To support a purchase price, the owners would have to reduce their salaries after the transaction.

Without a salary reduction, the practice would be valued under the cost approach. Because physician practices have small asset bases—this is especially true of primary care practices—valuing the practice under the cost approach would result in a low valuation and a low incentive for physicians to consider selling their practice.

However, the income approach allows health systems to quantify the opportunity of entering into risk-sharing arrangements. There is significant value in effectively managing patient lives, especially Medicare Advantage patients, given the high cost of managing this population. Health systems and larger practices are putting a greater emphasis on value-based contracts and can take advantage of this additional income stream, whereas few physician practices are sophisticated enough to do this on their own.

How to Maximize Physician Practice Purchase Price

The FMV standard requires the consideration of a hypothetical buyer and hypothetical seller; meaning, the additional value of transitioning patients to value-based contracts can be considered when the valuation uses market data and is not specific to a particular buyer. While non–health system buyers might pay up to $12,000 per Medicare Advantage life, health systems cannot directly value a practice by the number of lives without running afoul of Stark law and Anti-Kickback Statute regulations. Instead, they need to work with skilled advisers who can appropriately forecast the future cash flow a hypothetical buyer could achieve from risk-based contracts.

To accurately reflect what would happen once a hypothetical buyer owns the practice, a portion of these incremental cash flows should be paid to the physicians as an incentive to continue seeing fewer patients per day when those patients need more of a provider’s time. Another portion of the incremental cash flow is for infrastructure and care management costs. The rest of the cash flow is then available to either reinvest in the company or make payable as distributions to the practice owners. Larger cash flow yields a higher valuation, in the same way as excess cash flow is quantified in the income approach and market approach, and makes it possible for health systems to offer purchase prices that are competitive with corporate entities.

A Comparison of Cost Approach and Income Approach

The example below lists a recent valuation with one physician and three APPs. It shows a traditional cost approach as well as an income approach that quantifies the value-based arrangement opportunity.

In addition, the graph below includes some examples of the difference in profitability between physician practices that maintain a fee-for-service approach and those that enter into two-sided risk arrangements in high-cost regions and successfully manage the patient population.

The Benefit of Quantifying Value-Based Arrangement Opportunity

As more primary care physicians are made aware of the value of their practices, they will no longer accept fixed asset purchase prices. A valuator who has a deep understanding of managed care and value-based arrangements can help by:

• Developing a detailed forecast of the potential value of moving to risk-based contracts.
• Supporting the health system in providing a competitive offer in a fast-changing landscape.

A valuation expert can help a health system quantify the value-based arrangement opportunity while ensuring the analysis is competitive and meets FMV standards.

_{Copyright 2023, American Health Law Association, Washington, DC. Reprint permission granted.}

_{Edited by: Sue Cook}

Published February 22, 2023