Most doctors tell me their practices are well run and firmly believe it based on growth in revenue, tenure of staff and patients who seem to be pleased with the services they receive. But a businessperson might look at that same practice and see something different: out-of-whack operating costs, duplication of effort, low productivity of doctors and/or staff, and patient reviews that indicate significant room for improving the customer experience.
Indeed, the definition of a well-run practice depends on who you ask.
Doctors who think they are good businesspeople are shocked to find out they “don’t know what they don’t know,” especially when a professional buyer comes to evaluate the practice.
Private equity firms look closely at how much profit is generated after all expenses are paid including market-rate salaries for current physician owners. The term for this is “normalized EBITDA” and is a measure of the cash flow generated by the practice each year. A multiple gets applied to this number to determine the value of the practice, essentially meaning the number of years of future profitability the buyer is willing to pay today to assume ownership of the practice. This valuation can get very large, which is why PE firms spend a lot of time and money scrutinizing the financials. They need to be certain that the quality of the earnings generated are both high and sustainable going forward.
It’s almost comical to see the difference in how this number gets calculated by a doctor vs. a professional buyer. The PE firm ends up modifying the doctor’s version with a number of additions (“add backs”) and subtractions to have an apples-to-apples comparison for acquisitions across the many practices under consideration and/or industries in which they participate. In this sense, it’s all about the numbers.
But there is another less tangible aspect of value that I look at closely, and that is the culture of the practice. As hard as it is to run a financially sound practice, it is even harder to develop an organization with a strong positive culture that attracts and retains the best employees and customers. Doctors (and many businesspeople) have given short shrift to the satisfaction and wellbeing of employees (“those who serve”) and patients (“the customers who are served”). I can walk into any practice and in a matter of minutes have a good handle on the culture, which has been formed since Day 1. Doctors who take this “soft stuff” seriously have seen their practices thrive in new and unexpected ways, as employees who embrace the culture end up re-creating it daily with the patients they encounter. It’s a beautiful thing to see in action. And guess what? It ultimately adds to the financial value of the practice, a phenomenon that has been documented in companies where the focus on employee experience (eg, Costco, Danny Meyer) translates into higher revenue, income and market value.
Disclosure: As president of SM2 Strategic, Mahdavi can be reached via his firm’s website www.sm2strategic.com or office 925-425-9900.
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