Balance Sheet Analysis and Practice Valuations

1. Balance Sheet Analysis andPractice Valuations January 10, 2017 Bruce S. Maller

2. Balance Sheet Analysis

3. What is a balance sheet? Why is it important?

4. Balance Sheet Terminology Basic Accounting Equation Owner’s Equity Assets Liabilities “On a given day what a practice owns must equal what it owes (either to creditors or its owners).”

5. Balance Sheet What to look for on the balance sheet Cash on Hand Current Assets Current Liabilities Long-term Debt Shareholder’s Equity Management Ratios: Current ratio Debt to equity ratio

6. Asset Categories Current Assets Cash or other assets that can be sold or consumed in the near future. Tangible Assets Non-current assets including furniture, equipment, and leasehold improvements. Other Assets Other non-current assets such as investments or deposits.

7. Liabilities Current Liabilities Liabilities due in the same interval in which current assets will be consumed. An interval of one year is normally used. Long-Term Liabilities Long-term loans or leases due, less amounts due within 12 months.

8. Shareholder’s Equity Two Basic Categories Paid-In Capital: Retained Earnings: Sum of all accumulated earnings after taxes and dividends paid Investment made by the owners

9. Accounts receivable are not normally included under current assets Accounts payable are generally not included under current liabilities Challenges When Evaluating Cash Basis Balance Sheets Lack of knowledge or experience of some clients

10. Management Ratios Test of liquidity to evaluate the degree to which a practice’s current liabilities can be met by utilizing current assets Current Ratio Current Assets ÷ Current Liabilities Current Ratio

11. Sample Current Ratio 1.33 to 1 Current Ratio $200,000 ÷ $150,000 Benchmark for Professional Practices: 2 to 1

12. Management Ratios Measure of the proportion of assets which are financed through debt and shareholder’s equity Debt to Equity Ratio Long Term Liabilities ÷ Total Equity Debt to Equity Ratio

13. Sample Debt to Equity Ratio 10 to 1 Debt to Equity Ratio $500,000 ÷ $50,000 Benchmark for Professional Practices: 5 to 1

14. Balance Sheet Highlights Current Ratio: 0.42 to 1 Debt to Equity Ratio: N/A Book Value of Fixed Assets: $38,539

15. Balance Sheet Highlights Current Ratio: Unable to Calculate Debt to Equity Ratio: .06 to 1 Book Value of Fixed Assets: $150,931

16. Balance Sheet Highlights Results at 12/31/15 Current Ratio: 0.36 to 1 Debt to Equity Ratio: N/A Book Value of Fixed Assets: $127,667

17. Balance Sheet Highlights Current Ratio: 0.87 to 1 Debt to Equity Ratio: N/A Book Value of Fixed Assets: $29,590

18. Financial Benchmarking Report

19. Practice and ASC Valuation Principles

20. What Is a Practice Valuation? An informed estimate of fair market value based on a reasonable assessment of: Practice Performance Context of Transaction Comparability to Similar Transactions

21. Critical Valuation Factors Goals and objectives of the seller Nature and history of the practice Operational and financial efficiency Market share and dominance Competitive assessment

22. Basic Components of Value Shareholder’s Equity/Tangible Assets The adjusted value of practice assets less practice liabilities Accounts Receivable The collectible value of patient accounts Intangible Assets/Goodwill The value of continuing practice income stream

23. Adjusted Shareholder’s Equity Usually adjusted to reflect fair market value of tangible assets using: • Appraisal; or • Percentage addback of accumulated depreciation; or • Restated depreciation over 8 to 12 years with defined percentage salvage value Adjusted to normalize anticipated pre-transaction events Commonly used to establish value of stock with inter-doctor practice sale transactions Practice assets less practice liabilities

24. Gross versus net totals Reductions for contractual adjustments Reductions for bad debt/write-offs Adjustments for aged accounts Collection costs Accounts Receivable The collectible value of patient accounts

25. Capitalization of excess earnings Percentage of revenue Intangible Assets/Goodwill The value of ongoing practice income stream

26. Calculating Expected Return on Investment Expected Rate of Return Divide 1 by the Multiple Examples 3 Multiple: 1 ÷ 3 = 33.3% Return 6 Multiple: 1 ÷ 6 = 16.6% Return

27. Commercial Approach to Valuation

28. Determine value based on a multiple of earnings Measurement of earnings is typically earnings before interest, taxes, depreciation, and amortization (EBITDA) Multiple of Earnings Approach Commonly used with valuing surgery centers and practice acquisitions facilitated by private equity

29. Key Elements of EBITDA Approach Determining EBITDA Normalization adjustments Determining the appropriate multiple Public vs. private transactions Minority interest discount

30. Discount Factors Discount for dependency on single or small group of surgeons Limited marketability of investment Discounts of 20% to 50% from “public” transactions quite common Discount for minority or non-controlling interest

31. Conclusion Both parties should employ experienced professionals in order to reach agreement on price while helping to facilitate an orderly sale process. • The ultimate determination of fair value is generally determined by good-faith negotiations between a willing buyer and a willing seller, neither under pressure to complete a transaction. The parties need to engage experienced health care legal counsel to avoid running afoul of the Federal Anti-Kickback Statue.

32. Valuation Case Study

33. Sample Practice Valuation

34. Sample ASC Valuation

35. Sample ASC Valuation

36. Business Plan for MD Buy-in

37. Sample 5-Year Business Plan: MD Buy-In

38. Sample 5-Year Business Plan: MD Buy-In