value of a mental health business

How to estimate the value of a mental health business

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When selling a mental health practice, we should understand how to determine its monetary value. Fortunately, the buying and selling of companies happen every day. Therefore, accountants have developed standard techniques for pinning a dollar value on any company. Additionally, the valuation of mental health practice is not that different from figuring out the value of any company.

What is the value of a mental health business?

There are many factors to consider when calculating the value of a practice. Several commonly used methodologies are available for estimating a business’ value. (For a discussion of six methods, look at this guide: How to value a company.) Seems a bit overwhelming but no worries. I will help us sort out the essential factors to examine. And fortunately, there are some companies whose mission is to determine the price tag on all types of corporations. Elsewhere I have written a more general introduction called: Selling a practice: How they become assets and how to maximize their value.

Rather than recommending a specific valuation method, let’s start with some basic accounting principles underlying many valuation methodologies. These principles will start you in the right direction no matter the specific method you use for determining the business’ value.  

1. Understanding Ebitda (Earnings before interest, taxes, depreciation, and amortization)

Establishing the value of your practice begins by considering Ebitda, that is, “earnings before interest, taxes, depreciation, and amortization.” (For an introduction, see: Earnings before interest, taxes, depreciation, and amortization.) 

To clarify, Ebitda is a standard accounting term commonly used to get at the core profit in a corporation. It is an attempt to address “How much profit does this money-making machine create?” Your accountant can easily calculate Ebitda based on your Balance Sheet and Profit and Loss Statement. I recommend calculating your company’s Ebitda every year and tracking it over time. It helps to see your company’s trends.

BTW, I have written more about Ebitda and how to influence it in this post: Build a more valuable practice by focusing on profit and Ebitda.

2. Replacement value for the existing owner

In addition to Ebitda, anyone estimating the value of a mental health business will look at the “replacement value of existing owner.” This number is as it sounds and is not hard to figure out. The goal here is to estimate what it would cost to replace the owner’s contributions to the practice. 

For example, these are common contributions an owner might make to a practice:

  • Clinical productivity: For example, how much income does the practice collect for the owner’s clinical work?
  • Supervision: For example, what would it cost to hire someone to do the supervision that the owner currently does?
  • Administrative work: For example, what would it cost to hire someone to do the owner’s administrative work?
  • Any other contributions the owner makes to the practice: For example, how much would it cost to replace these activities?

We can estimate the direct financial costs for the new owner and add them to the current expenses. This number is a new expense that the purchasing owner will need to cover after the sale. 

3. What happens to the seller’s salary and benefit costs?

Another aspect to note. The purchaser has one huge expense that will disappear once the purchase is made–the seller’s salary and benefits. The disappearance of these salary expenses is important because they typically offset the replacement value costs usually with a significant margin to spare. Additionally, that margin will improve the profit over what it would be then when just looking at Ebitda.

4. Profits over time

Typically, the last three to five years of Ebitda and Replacement Costs offset by the seller’s Salary Expenses are the basis for determining Net Income. Consequently, Net Income is multiplied by a “multiple of earnings” to estimate the value of the practice. Usually, this multiple is between 3 to 5 times Net Income.

There is a lot of debate about an appropriate multiple for mental health practices. Fundamentally, picking a multiple depends on what the purchaser expects the growth rate will be. But don’t get too hung up on the multiple. The valuation of mental health practice is an estimate. Eventually, there will be a negotiation that will determine the mental health business’s value.

Other methods for determining a business’s value

Sometimes an appraiser will use multiple methodologies when making an estimate. The actual methods are pretty complex, but they typically use Ebitda, Replacements Costs, and a Multiple. If you want to study these alternate methods more deeply, look up: Capitalized Cash Flow Method or Discounted Cash Flow Method

Another commonly used way to determine a practice’s value is to research one of the many Mergers & Acquisitions: Databases to find comparable companies that have already sold. This approach is called the Acquired Company Method. 

Getting to the value of your mental health business

You can see there are many assumptions and “rules of thumb” that go into determining a practice’s value. Focusing on Ebitda, Replacement Costs, and a suitable Multiple will get you started in the right direction. And just to be clear, these factors are ways for the buyer to have a more accurate estimate of what future earnings will be once the seller is no longer running things. Once that estimate is made, then it will be about the particular negotiation that grows out of these estimates.

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