May 2010

Goodwill Value — Is There Any
in Today’s Radiology Practices?

By Timothy W. Boden, CMPE
Radiology Today
Vol. 11 No. 5 P. 18

Goodwill value, for all practical purposes, is dead among radiologists calculating and negotiating their partnership buy-sell agreements, according to veteran management consultant Daniel R. Corbett of Radiology Business Solutions. Corbett, whose recruiting work finds him talking with about 100 radiologists each week, says when it comes to paying for goodwill, today’s job candidates “simply aren’t buying it.”

Many senior partners feel cheated by the fact that they generally can’t recoup the sizeable investments they made when they bought into their practices back in the mid- to late-1990s. Corbett describes the pre-1998 radiology market as markedly different from what we see today. Back then the surplus of new recruits created a buyers’ market for practices looking to bring on new associates. Starting salaries were very low, partnership tracks were often several years long, and buy-in prices were sometimes breathtaking—including a significant amount for goodwill. New associates agreed to the terms or forfeited their chances to join the best groups practicing in the most desirable locations. There were always more candidates waiting in line right behind them.

Since about 2000, the recruits who previously worked long and hard to line the pockets of their senior partners and paid dearly to become partners themselves have found themselves competing for new associates in what became a sellers’ market. The demand for new radiologists suddenly outstripped the supply. Starting salaries skyrocketed, partnership tracks plummeted, and buy-in costs almost disappeared in some practices. Candidates who didn’t like one group’s terms could simply move on to another of the many radiology groups looking for a new doctor.

It’s no wonder there’s a lot of ill will about goodwill in the radiology market. Senior doctors tend to feel that young candidates want them to give away partnership shares in their hard-earned investments, while new recruits vocally complain about those practices that have the nerve to demand a sizeable buy-in price.

Receivables Buy-In
Consultant L. Michael Fleischman agrees almost no radiology practices can get new candidates to pay for goodwill today. Fleischman, a principal with Gates, Moore & Company in suburban Atlanta, notes that hospital-based groups seldom require any buy-in costs beyond an equal share of the existing accounts receivable (A/R) aged to about 90 days. Groups with freestanding imaging centers usually require the new partner to pay for an equal share of the practice’s hard assets—that is, the depreciated value of real estate and equipment equity.

A qualified appraisal and some fairly straightforward math will yield an appropriate buy-in price for A/R and hard assets, but arriving at a fair market value for intangibles such as goodwill is far less exact. Much of the controversy begins with defining goodwill in the first place. Even experts in the field don’t always agree on what constitutes goodwill in a medical practice; it’s no surprise that it is difficult to calculate its worth.

The simplest definitions of goodwill describe the “attractive force that generates … revenue … and adds value to [a firm’s] assets …and is reflected in the firm’s selling price by the amount in excess over the firm’s net worth,” according to BusinessDictionary.com. In other words, after you calculate the balance sheet value of a business, anything you pay over that amount can be called goodwill. Traditionally, that includes the value of the effort and often-considerable costs expended to promote a medical practice; develop and maintain relationships with hospitals, patients, referrers, and payers; and create a reputation as a high-quality medical provider delivering excellent service. It is the worth of your good name and your hard-won position in the marketplace as a going concern. How can it not have value? The problem is no one can agree on a method to calculate that value for a medical practice.

Back when partner incomes eclipsed the low starting salaries of new associate radiologists, the value of becoming a partner was rather obvious. Young doctors grumbled over the high buy-in prices, but they paid up to share in the profits and gain admission to the decision-making table. But declining reimbursement and the expected cuts yet to come have reduced or threaten to reduce profits. In addition, starting salary offers in the upper $300,000 range for young associates have reduced the incentive to ascend to partnership. Groups that try to require all associates to become partners often find themselves struggling with long physician searches or high physician turnover, both of which are incredibly expensive.

“In the end,” Corbett says, “goodwill is only worth whatever someone else is willing to pay for it.” The most accurate appraisal of any asset is the amount written on the buyer’s check. And if no one is willing to write that check, the market value is clearly zero.

Mergers and Acquisitions
Although radiology practice goodwill has become all but impossible to sell to new partners, its value is often recognized in other deals—namely acquisitions and mergers. When a hospital, a health system, or a national enterprise tenders an offer for a freestanding imaging center, the proposed price usually exceeds the fair market value of the bricks, mortar, and magnets. Fleischman recounts serving as an advisor for a radiology group looking at a local hospital’s offer to buy its freestanding center. Each party obtained independent appraisals yielding multimillion dollar valuations. Even though one estimate was 50% higher than the other, they each included substantial amounts for intangible assets such as the following:
• physician workforce in place;
• physician covenants not to compete for two years;
• trained support staff in place;
• medical records;
• published phone numbers;
• licenses and certification, including certificates of need; and
• equipment leases.

These intangibles aren’t necessarily considered goodwill—at least by the IRS. On its Form 8594 Asset Acquisition Statement, the IRS separates these assets from goodwill or “going concern” value and advises filers to basically use the goodwill section as a catch-all for assets that don’t fit other categories.

A seller would probably be better off financially by classifying those intangible assets as something other than goodwill wherever possible. In most situations, says Fleischman, the seller will pay a hefty capital gains tax on goodwill payments he or she received. One way to avoid that capital gains tax is to negotiate higher compensation for the selling physicians in the new arrangement. In most cases, the hospital wants the physicians to become its employees. Not only does this help simplify compliance with Stark and antikickback rules, but it also helps assure that goodwill actually transfers with the practice. If the hospital acquires a freestanding facility without physicians, patients and referring physicians are less likely to remain loyal.

Corbett agrees: “A hospital can own, manage, and bill for an imaging center, but without the physicians, it can’t grow the business. It’s the physicians who will drive the referrals from the medical staff.” Therefore, hospitals buying imaging centers will usually pay something for goodwill, but it may not show up in a dollar figure in the sales contract.

Even in cases where the physician group continues as an independent contractor, the buyer can still pay for goodwill through means other than salary, such as the following:
• long-term management and medical director contracts;
• marketing budgets;
• higher salary, per-study, or relative value unit guarantees; and/or
• arriving at a price.

Even if you line up a buyer who is willing to pay for your practice’s goodwill, the appropriate dollar value remains difficult to determine. Hospital administrators and other MBA-types often talk about using an income approach to calculate goodwill value. As taught in business school, this method focuses on an asset’s income potential—especially as it compares with another investment opportunity with similar risk. A buyer who expects a greater return will be willing to pay more to acquire the asset in the first place.

For hospitals, this usually means projecting the profitability of purchasing your existing center and employing your physicians compared with the profit they would expect to make by building and staffing a competing center from scratch. If buying your business looks more profitable than competing with you, the hospital will try to negotiate a sales price that both satisfies the sellers and preserves an acceptable profit margin. Whatever you receive beyond the net value of your hard assets and certain intangibles is considered goodwill or going concern value. So despite the fact that administrators and accountants can toss around technical terminology and complicated calculations for valuing goodwill, they will finally pay just what they think it’s worth. Your goodwill is still worth only what someone is willing to pay for it.

— Timothy W. Boden, CMPE, has spent 22 years in practice management as an administrator, consultant, journalist, and speaker. He has led medical groups of various specialties and authored or edited eight books and hundreds of articles on practice management.

 

What About the Value of My Contracts?
Consultant L. Michael Fleischman has served as an expert witness in contentious divorce cases when the court is hearing arguments concerning how much alimony a divorcee can demand from a radiologist. The spouse’s attorney looks at a radiologist’s hospital contract more or less as a guarantee of future income.
Fleischman has had to point out that even if the contract is structured as an annual agreement—even with an “evergreen” clause—the termination language requires a notice period of 90 to 120 days prior to cancellation. In effect, he argues, that makes it a 90-day contract because the hospital can terminate the agreement three months from any date. He says the court has always agreed. While a contract with a long history should give a buyer confidence about the future of that relationship, it certainly gives no guarantee that the relationship will continue. So it won’t do much to enhance your practice’s goodwill value.

— TWB