How Practitioner Dependence Affects Business Value

What is practitioner dependence, and why does it change the value?

Practitioner dependence is the extent to which the earnings of a healthcare business rest on one individual rather than on the business itself. Valuers call it key-person risk: the risk that the earnings a buyer is asked to pay for would not survive the departure of a particular person.

It matters because of what a buyer acquires. A practice is normally valued on maintainable earnings, the level of profit it can reasonably be expected to sustain, converted into a value by a multiple reflecting the risk attaching to those earnings. If a large part of those earnings is really the product of one person's clinical work, reputation and relationships, the buyer is acquiring less a business than an opportunity to employ themselves.

The Australian Taxation Office draws the same distinction. Taxation Ruling TR 1999/16 describes what judicial decisions have called personal goodwill as the personal skills and abilities, reputation, character and personality of the people working in a business. Those attributes, the ruling says, are so intimately identified with and inseparably attached to those persons that if they withdraw the value of the goodwill diminishes, and they are not capable of transfer or assignment.

Goodwill here is the value of the business as a whole above its identifiable net assets. The ruling then makes the point that is easily lost: a purchaser might still pay for the goodwill built up from those attributes and other sources, because other sources, including the habit or inertia of customers, continue to draw custom. Dependence is a matter of degree, not a switch, and the practical question for an owner is how much of last year's profit rewarded one person's effort. See what is goodwill in a medical practice.

How is practitioner dependence measured?

Dependence is measured, not impressionistic, and most of the measurements already sit in the practice management and billing systems.

Share of billings and clinical hours

The first measure is the proportion of gross billings generated personally by the owner, tracked across several years rather than one. A practice where the principal produces most of the fees is a materially different asset from one where associates or contractors produce the bulk of them, even where the two report the same profit.

Clinical hours are the companion measure, because billings alone conceal an owner who works longer sessions, and carries more unpaid management work, than a replacement would accept. A third measure sits alongside them: whether new patients arrive through the practice or by asking for one person. See what is maintainable earnings.

Who holds the referral relationship

Referral relationships sit either with the practice or with the person, and the difference shows in the data: how many referrers send work, how concentrated they are, whether referrals are addressed to the practice or to a name, and what happened to referral volumes the last time a practitioner joined or left.

The rules are more flexible than the habit. At the time of writing, Services Australia states that a referring practitioner does not need to refer to a specific specialist or consultant physician and that patients can choose where to present the referral. A general practitioner referral runs twelve months from the specialist's first meeting with the patient unless the referral says otherwise, and may be written indefinitely; a specialist to specialist referral runs three months unless the patient is admitted.

So the instrument is portable; the habit behind it may not be. Where referrers have written to one name for years, the referral stream tends to follow that person. See patient, participant and referral concentration in healthcare valuations.

Clinical specialisation and substitutability

The narrower the clinical work, the harder the practitioner is to replace. A proceduralist with a subspecialty interest, a dentist doing complex implant work or a clinician holding a specific therapeutic credential cannot be swapped out by advertising a vacancy, and substitutability turns on the labour market for that discipline in that location. Where a replacement could only be attracted on better terms than the owner accepted, the cost of that difference belongs in the earnings. What happens to billings when the principal takes leave usually settles it. See how the clinical workforce affects healthcare business value.

Why the dependence is structural, not just cultural

Part of the dependence is built into the way Australian healthcare is funded and delivered.

Medicare provider numbers belong to individuals. Services Australia issues one to an eligible health professional who must first hold registration with the Australian Health Practitioner Regulation Agency (Ahpra) or an approved body, records the name against the number exactly as it is registered, requires a separate number for each practice location, and states that a practitioner cannot use another health professional's provider number. No sale contract moves that billing capacity from one person to another.

What transfers is the premises, the systems, the patient records, the staff and the opportunity to bill through the numbers of whoever works there afterwards, which is why the agreements and intentions of the practitioners who are staying are central to the valuation. See payroll tax, contractor arrangements and medical practice value.

How does a valuer reflect dependence in the valuation?

Three mechanisms do the work, and they operate together. Applying one and stopping there is the most common error.

Normalising the owner's remuneration

Normalisation means adjusting reported profit to remove items that do not represent the earnings a purchaser would inherit. In a practitioner-dependent business the largest adjustment is remuneration: the owner's drawings, dividends or trust distributions are replaced with the market cost of paying someone else to do the clinical and management work the owner performs.

That cost is not a single number: clinical sessions are costed at the market rate for that discipline, and management time separately at what a practice manager would be paid, in each case including superannuation and on-costs. This step reveals dependence before it prices it. Once a market rate for the owner's clinical output is deducted, some practices retain a substantial surplus and others almost nothing. That surplus, usually expressed as earnings before interest, tax, depreciation and amortisation (EBITDA) or earnings before interest and tax (EBIT), is what the rest of the valuation works on, and what any goodwill has to be paid out of.

The risk applied to maintainable earnings

The second mechanism is risk. Capitalisation of future maintainable earnings applies a multiple, or its inverse a capitalisation rate, to sustainable earnings, and that multiple is a judgement about how certain and how durable those earnings are.

Dependence pushes the multiple down. A buyer whose return depends on one person continuing to attend, or on recruiting a replacement in a tight labour market, requires a higher return for the risk taken, and a higher required return produces a lower multiple on the same earnings. A multiple quoted without reference to a specific business, its earnings definition and its risk profile carries no information. See EBITDA multiples for healthcare businesses.

The discipline is to avoid counting the same fact twice: the remuneration adjustment prices replacing the owner's labour, the risk adjustment prices the chance that patients and referrers do not stay. Loading both with the whole of the dependence understates value; pricing only one overstates it.

Which method the dependence points to

Dependence also affects which method carries the conclusion. Capitalisation of future maintainable earnings suits a practice with a settled earnings history and a credible succession. A discounted cash flow, which projects future cash flows and discounts them back to a present value, is often the better tool where the transition itself is the issue, because a recruitment gap or locum cost is then modelled explicitly rather than buried inside a multiple. Where little surplus remains after a market rate for the owner's work, the earnings methods can produce a figure at or below the identifiable net assets and the net asset method takes over: the business is worth its equipment, fit-out and working capital, with little or nothing for goodwill. Market evidence from comparable sales is a cross-check, not an answer, because reported prices rarely disclose the dependence profile or the terms.

A capitalised earnings conclusion is normally an enterprise value: the business and its operating assets, including a normal level of working capital, before borrowings. The equity value the owner receives is that figure adjusted for debt, cash and any shortfall in working capital, which is why a practice carrying slow receivables or an unfunded leave provision can be worth less than the headline suggests. See healthcare business valuation methods.

Transition assumptions, restraints and deferred consideration

The third mechanism is the assumption set. A valuation must state what it assumes about the principal: an immediate exit, a defined handover, or continued clinical work for a stated term, and what restraint the principal gives. Each produces a different maintainable earnings figure and a different risk assessment: a value calculated on a long transition is not a value on a clean transfer. TR 1999/16 accepts that a sole practitioner whose goodwill came principally from personal attributes can still transfer the goodwill of the practice, protected by a restrictive covenant given to the purchaser, but whether a particular restraint is enforceable is a legal question for the parties and their lawyers.

Dependence then tends to appear in the structure rather than the headline price: deferred consideration, retention amounts and performance conditions. Price is what particular parties agree in their own circumstances; value is an assessment on stated assumptions, so a headline price that is largely contingent is weak evidence of either. See preparing a healthcare business for sale.

Does the purpose of the valuation change the answer?

It can, because the purpose fixes the question, and the valuation date fixes the facts: value is assessed at one stated date on what was known then. A valuation for a market sale asks for market value, what a hypothetical willing but not anxious purchaser would pay a hypothetical willing but not anxious vendor, and that purchaser prices the risk of the principal leaving. A valuation for the entry or exit of a partner asks a narrower question: the continuing practitioners already know the practice and may be buying into earnings they help to produce. Where a parcel of shares rather than the whole business is valued, dependence interacts with control: a minority interest, one that cannot direct the business, can neither compel the key practitioner to stay nor force a sale, and that is usually reflected in a discount from a proportionate share of the whole. See share and equity valuations, valuing a healthcare business for a shareholder exit and internal transaction valuations.

Family law and tax matters raise it differently again, because value is assessed without a transaction taking place. Personal goodwill is still not capable of transfer, but the standard of value and the evidence required depend on the purpose. See valuing a healthcare business for family law.

How much dependence is normal in each sector?

Dependence is not evenly distributed across healthcare.

Community pharmacy typically sits at the low end. Custom follows the location, the approval and the script file rather than the dispensing pharmacist, and the conditions of approval require every dispensing step to happen at the approved premises by an Australian registered pharmacist, not by one named individual. The personal element is structural rather than clinical: PBS approval is available to a registered practising pharmacist who owns the pharmacy business, and under section 90 of the National Health Act 1953 approval must be sought from the Department of Health, Disability and Ageing to establish a new pharmacy or to change the ownership of an approved one, with the approval number used solely for the approved premises. A change of ownership is a regulatory question as much as a goodwill question. See pharmacy valuations and how to value a pharmacy.

Chiropractic typically sits at the high end. Medicare support is confined to the chronic condition pathway, so the rest of the work is paid for by patients directly or through private health insurance. At the time of writing, a patient with a GP chronic condition management plan or a multidisciplinary care plan can generally use up to five individual allied health services per calendar year across all disciplines combined, ten for eligible Aboriginal and Torres Strait Islander patients, with chiropractic claimed under item 10964 on referral from a general practitioner or prescribed medical practitioner. Outside that pathway patients pay for the visit and choose a person. See chiropractic practice valuations and how to value a chiropractic practice.

Psychology typically sits between the two, and the funding rules help. Under the Better Access initiative, Services Australia states that referrals are valid for the number of services shown on the referral letter even if the patient changes their treating allied health professional, and that a patient can claim up to ten individual services in a calendar year, with a maximum of six in the initial course of treatment. A practice that can move a referred patient to another psychologist without returning them to the referring doctor keeps more of its earnings when a clinician resigns, provided the intake, waiting list and referrer relationships belong to it. See psychology practice valuations.

NDIS providers are different in kind, because registration sits with the organisation. A registered provider has applied to the NDIS Quality and Safeguards Commission, been audited against the relevant NDIS Practice Standards, undergone a suitability assessment of the provider and its key personnel, and been issued a certificate of registration, generally for three years. Dependence here is administrative rather than clinical: on whoever holds the compliance system, the rostering and the participant and support coordinator relationships. Because key personnel are assessed for suitability and changes must be notified, a change of ownership is a regulatory event as well as a commercial one. See NDIS business valuations.

Medical and dental practices span the whole range. A medical centre where several doctors work under service agreements and patients attend an established location is far less dependent than a single-doctor practice, or a specialist practice whose referrals arrive addressed to one name. Dependence is a fact about the particular practice, not about its sector. See medical practice valuations and does a medical practice have transferable goodwill.

What reduces practitioner dependence over time

The changes that shift earnings from a person to a business are slow. They are observations, not recommendations for any particular practice.

• Additional practitioners who each hold part of the patient base spread the risk, provided they are engaged on terms that survive a change of owner and patients actually see them.
• New patient acquisition through the practice. Where patients arrive through the location, the website, the recall system and a practice identity rather than a personal one, the attractive force sits in the business and survives an individual leaving.
• Documented systems. Clinical protocols, billing routines, recall processes, rostering and induction material are what let a replacement clinician produce comparable output.
• Separating clinical from management work. A practice manager or clinical lead removes one of the two roles the owner performs and makes the other easier to cost.
• Written agreements. Practitioner agreements, an assignable lease and documented third-party arrangements turn informal relationships into things a purchaser can rely on.

A valuer weighs the record rather than the intention: data showing earnings held while the principal reduced clinical hours is stronger evidence than a plan. See succession planning valuations and what drives the value of a healthcare business.

What a valuer will ask you for

Expect to provide billings by practitioner across several years, the owner's clinical hours, new patient numbers and their source, referrer analysis, practitioner and staff agreements, and the record of what happened when a practitioner last joined, left or took extended leave. See what information is needed for a business valuation, how it works or request a valuation.