MERCER CAPITAL Understand the Value of an URGENT CARE CENTER Understand the Value of an Urgent Care Center August 2014 Urgent Care Centers provide personal health care consultation and treatment outside of the traditional emergency room and primary care physician models. Per industry data, both the number of Urgent Care Centers and the volume of services provided by Urgent Care Centers have increased rapidly over the past decade. Current industry factors point to a continuation of this growth. Given this, if you own a Center, or an interest in one, now is an important time to understanding the key elements underlying the value of your investment. Introduction At Mercer Capital, we developed the “Ownership Transfer Matrix” (Figure One) to help describe different ownership transition scenarios. As shown in Figure One, the events The ownership of every closely held business entity changes that trigger ownership transfer can be categorized as either hands eventually. Whether you are selling out, buying in, voluntary or involuntary. Voluntary transfers occur in a or creating a new Center in partnership with others, an variety of ways. The business may be sold under favorable understanding of its value and the drivers of value for your circumstances, or perhaps pre-sold through a buy-sell business will temper the financial success of the entity, agreement. Involuntary transfers occur just as frequently enhance rapport among your business partners and provide and often under the most adverse circumstances. Death a reasonable basis for any transaction. is the ultimate involuntary transfer. Divorce may result in a valuation need for what could be a family’s largest marital It is important for owners to consider the universe of ownership asset. Alternatively, the business may need to be sold when transfer possibilities because, sooner or later, you will be the physician(s) and investing partners are required to sell involved. In many cases, these transactions are among the due to financial or business conditions. An understanding most important of the owner’s business and personal life. of the value of your business is an important component in This article is written to inform you about key concepts of preparing yourself and your partners for these eventualities. business value and provide a framework for understanding the value of an Urgent Care Center. © Mercer Capital 2014 | 901.685.2120 | www.mercercapital.com 2 Understand the Value of an Urgent Care Center August 2014 are significant nuances to each of the following topics, our purpose here is to help you combine the economics of valuation with the legal framework of a voluntary or involuntary transfer. Valuation Date Every valuation has an “as of date” which It comes as a surprise to many simply means that it is the date around owners to learn that there which the analysis is focused. This date is no single value for their may be set by legal requirements, such Urgent Care Center or for their as death or divorce, or may be implicit, ownership interest. Numerous such as the closing date of transaction. legal factors play important Figure One roles in defining value based upon the circumstances of Purpose equity ownership transfer The purpose of the valuation is important. A valuation Defining the “Value” of an prepared for one purpose is not necessarily transferable Ownership Interest to another. There is no such thing as a “one-size-fits-all” approach in valuation. As previously stated, all business ownership interests will eventually be transferred. It comes as a surprise to many owners to learn that there is no single value for their Urgent Standard of Value Care Center or for their ownership interest. Numerous legal The standard of value is an extremely important legal factors play important roles in defining value based upon concept. It will help determine the rules of the game. There the circumstances of equity ownership transfer. While there are many standards of value just as there are many types of © Mercer Capital 2014 | 901.685.2120 | www.mercercapital.com 3 Understand the Value of an Urgent Care Center August 2014 ownership transfers. The standard of value will influence the Levels of Value selection of valuation methods and the level of value. The most familiar standard is fair market value, which is most When owners think about the value of their business, they commonly used in tax matters. Other important standards almost always implicitly think of the value for the company include investment value (purchase and sale transactions), in its entirety. In a control block, the value of a single share statutory fair value (corporate reorganizations) and intrinsic or LLC member interest, for example, is the value of the value (public securities analysis). Matching the standard whole divided by the number of shares or member units of value with the valuation method is crucial to obtain an outstanding. In the world of valuation, however, this will not accurate determination of value. be true if the aggregate block of stock being considered for sale does not have control of the enterprise. The determination of whether the valuation should be on a controlling interest or on a minority interest basis can be a complex question, yet it will be of great importance. A minority interest value can include discounts for lack of control and marketability. It is quite possible for a minority interest to be worth proportionately far less than an ownership interest comprising part of a control block. The traditional Levels of Value chart is presented in Figure Two. Figure Two © Mercer Capital 2014 | 901.685.2120 | www.mercercapital.com 4 Understand the Value of an Urgent Care Center August 2014 Approaches to Value of tangible assets and liabilities to their estimated fair market values. Some appraisers advocate determining the value of There are three general approaches to valuing a business. intangible assets and using them in the asset value method. These include the cost approach, the income approach and Doing so however, merely converts the asset method into a the market approach. As a general rule, every valuation version of the income approach since the intangible assets should address value using these three approaches. While are typically valued using an income method. some of these approaches may not be indicative of the overall value, each approach incorporates procedures that The Income Approach may enhance awareness about specific business attributes that may be relevant in determining the final value. Ultimately, The Business Valuation Standards of the American Society the concluded valuation will reflect consideration of one, or of Appraisers describes the Income Approach as “a general perhaps a weighting of several approaches, which will best way of determining a value indication of a business, business reflect the value for the subject interest under consideration. ownership interest, security, or intangible asset using one or more methods that convert anticipated economic benefits The Cost Approach into a present single amount.” The most common methods in the Income Approach are This approach is rooted in determining the value of the discounted cash flow (DCF) and single period capitalization of assets. According to the Business Valuation Standards of income. Simply put, the value of a business is directly related the American Society of Appraisers, the cost approach is “a to the present value of all future cash flows or earnings that general way of determining a value indication of an individual the business can reasonably be expected to produce. The asset by quantifying the amount of money required to replace mechanics of the income methodology require an expression the future service capability of that asset.” The net asset of future cash flows or earnings, a growth rate in cash flows value method is in simple terms, a balance sheet approach to or earnings and an appropriate discount rate with which to value. The aggregate value of the assets, net of the liabilities calculate the present value of such cash flows or earnings. of the business, may be indicative of the equity value in the The capitalization factor is simply an algebraic simplification business. There are numerous methods employed to develop of its more detailed counterpart – the discounted future this indication of value. The method Mercer Capital employs earnings method (DFE). Value is negatively correlated to risk most often is called the “net asset value method.” This and positively correlated to expected growth. The scope of process involves identifying and adjusting the reported value © Mercer Capital 2014 | 901.685.2120 | www.mercercapital.com 5 Understand the Value of an Urgent Care Center August 2014 this article limits the depth of our discussion since this aspect The Single Period of valuation has been memorialized in countless academic Capitalization Method and investment publications over scores of years. Another method under the income approach is referred to The Discounted Cash Flow Method as a single period capitalization method. As opposed to a detailed projection of future earnings, the analyst determines The most common application of the income approach in a base level of annual earnings and then determines a The most common application the valuation of Urgent Care Centers is the discounted cash multiplier appropriate to that earnings expression. The most of the income approach in flow method. Revenue and expenses are projected over familiar form of this approach is the Price/Earnings (P/E) the valuation of Urgent Care reasonable periods of time, typically five years. method, which is the primary valuation metric observed in Centers is the discounted the public securities market. Key variables in revenue analysis are the sources of payments, cash flow method. breadth of services offered and doctor/facility productivity. Use of any income approach requires identification However, this revenue analysis is only as good as the of a normalized earnings cash flow on a stand-alone latest set of Medicare and insurance reimbursement rules.