What Is Goodwill in a Medical Practice?

What goodwill means, in law and in accounting

Goodwill has two settled meanings, and confusing them causes most arguments about what a practice is worth.

The legal meaning comes from the decision of the High Court in Federal Commissioner of Taxation v Murry [1998] HCA 42, adopted by the Commissioner of Taxation in Taxation Ruling TR 1999/16. Goodwill is property because it is the right or privilege of the owner to use the other assets of the business, to make use of all that constitutes the attractive force which brings in custom, and to conduct the business in substantially the same manner and by substantially the same means that have attracted custom in the past. Custom means patronage: patients choosing to attend, and to return.

Three points follow. Goodwill has sources rather than elements, so the useful question is what draws patients to this practice. Goodwill is one whole and is legally distinct from those sources, so selling a source of it, a piece of equipment for example, is not a sale of any part of the goodwill. And it cannot be dealt with separately from the business: what the cases call site goodwill, personal goodwill and name goodwill describe sources, not separate assets. A bulk billing medical centre on an arterial road and a single-doctor practice built on patients who ask for that doctor by name have goodwill made of very different things.

The accounting meaning is narrower. Under AASB 3 Business Combinations, goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. It is measured as a residual: the excess of the consideration transferred, plus any non-controlling interest and any previously held equity interest, over the net of the acquisition-date amounts of the identifiable assets acquired and liabilities assumed.

That residual only ever appears when a business has been bought. AASB 138 Intangible Assets provides that internally generated goodwill shall not be recognised as an asset, because it is not an identifiable resource that can be measured reliably at cost. A practice built up by its own owners therefore shows no goodwill in its accounts however valuable it is, and one that has acquired others carries a historical figure that says nothing about present value. TR 1999/16 makes the same point: goodwill can exist even though it does not appear in the books of account.

Where the goodwill of a medical practice comes from

Identifiable net assets are the assets a valuer can point to and value one by one, such as fitout, equipment, stock and debtors, less the liabilities that go with them. Goodwill sits above them, and in a practice it is built from things that either stay with the business or leave with a person.

Location, premises and the lease

Site is often the strongest single source. Catchment population, visibility, parking, a co-located pharmacy or pathology collection point, and whether a competitor has opened nearby all bear on whether patients keep attending. Because that goodwill is tied to an address, the lease is part of it: a short remaining term, an unexercised option or a landlord who has not consented to assignment can strip value from a sound practice. See premises and lease terms in healthcare business valuations.

Systems, patient records and recall

The practice management and clinical software, the appointment book, billing and claiming routines, recall and reminder systems and documented procedures are what allow a new owner to keep the same patients returning through the same door. Chronic disease management, care planning and screening recalls are the machinery of patient retention, and they sit in the practice, not in a person.

MyMedicare, the voluntary patient registration model administered by the Department of Health, Disability and Ageing, aims to formalise the relationship between patients, their general practice, their general practitioner and primary care teams. A registered patient base sits with the practice, although because registration is voluntary it evidences patient attachment rather than securing it.

The clinical and administrative team

A practice manager who has served several principals, experienced nurses and reception staff, and salaried or contracted doctors with their own following are all sources of goodwill. TR 1999/16 notes that where key employees are not employed by the purchaser on the sale, the part of the goodwill emanating from their personality, reputation, skills or attributes is not transferable either. A valuation therefore reads the employment and service agreements as closely as the profit and loss. See how the clinical workforce affects healthcare business value.

Referral relationships and the practice name

For a specialist practice, referral relationships with general practitioners and other specialists are usually the main engine of new work, and they are frequently held by the individual specialist rather than by the entity. For a general practice, the equivalent is the reputation the name carries in its suburb. The ruling treats the get-up of a business, its name, logos and signage, as a source of goodwill rather than goodwill itself. See patient, participant and referral concentration in healthcare valuations.

Contracts and program participation

Practitioner service agreements, aged care facility arrangements and corporate or occupational health contracts all support the earnings stream, and each is a separate asset from goodwill, so a valuation should not value a contract and then count it again as goodwill.

Practice-level program participation belongs here too. Applying for the Practice Incentives Program requires a current accreditation certificate, or a registered for accreditation certificate, a practice ownership details and declaration form and evidence supporting the ownership structure. These payments therefore attach to the accredited practice and its notified ownership, not to an individual doctor, so a change of ownership has to be dealt with rather than assumed. See government funding exposure and healthcare business value.

Personal goodwill and practice goodwill

Personal goodwill is the source of goodwill made up of the personal skills and abilities, reputation, character and personality of the people working in a business. TR 1999/16 describes those attributes as so intimately identified with, and inseparably attached to, the individuals that if they withdraw the value of the goodwill diminishes: they are unique to the individual and are not capable of transfer or assignment.

Transferable goodwill, sometimes called commercial goodwill, is everything that keeps drawing patients once a particular person has gone: the site, the systems, the records, the remaining team, the name and patient habit.

The distinction is not a legal division of the asset: goodwill remains one thing. The ruling is explicit that although the personal skills and attributes of an owner or employees are not transferable, a purchaser might still be prepared to pay for the goodwill built up from those attributes and other sources, because those other sources continue to draw custom. Its worked example concludes that a sole practitioner whose goodwill is principally, though not solely, the product of her own skills and reputation can still transfer her practice goodwill, protected by a restraint.

The restraint is not itself goodwill. TR 1999/16 treats a restrictive covenant given on a sale as a separate asset created in the purchaser, inextricably linked to the value of the goodwill sold: where arm's length parties allocate nothing to it in the contract it is treated as ancillary to the disposal of goodwill, and where they allocate a separate amount that allocation is generally accepted. A restraint is often what stops transferable goodwill walking back out the door, and how the contract deals with it carries tax consequences worth raising with your accountant.

For a valuer the question is practical: how much of the earnings stream survives the departure of the person who created it, and can that be shown? A practice where several practitioners each hold part of the patient base, and where new patients arrive through the location rather than one doctor's name, keeps more of its value than one built around a single person. See does a medical practice have transferable goodwill and how practitioner dependence affects business value.

Why provider numbers and patient relationships complicate the question

The first complication is that the capacity to generate Medicare revenue belongs to individuals. Services Australia issues a Medicare provider number to an eligible health professional who must first hold registration with the Australian Health Practitioner Regulation Agency (Ahpra) or an approved body, and one practitioner cannot use another's number. No sale contract moves that. A purchaser buys the premises, systems, staff and records, and the opportunity to bill through the numbers of whoever works there afterwards, which is why a valuation asks who is staying, on what terms, and how quickly a vacated room could be filled. How practitioners are engaged also affects payroll tax exposure. See payroll tax, contractor arrangements and medical practice value.

The second complication is that patients are not property. A patient chooses their practitioner and may leave at any time, so a practice can never assign its patients. What it can transfer is the record base and the systems that bring patients back. Records hold personal information regulated by the Privacy Act 1988, and the Office of the Australian Information Commissioner's guidance on selling a business suggests a vendor consider de-identifying information, avoid providing customer names and identifiers, and keep physical and legal control of anything disclosed. A purchaser therefore tests the patient base through de-identified activity data and billing analysis rather than by inspecting records.

How goodwill is measured in a valuation

Goodwill is almost never valued directly. It falls out of the valuation of the whole business, and the usual route for a profitable practice is capitalisation of future maintainable earnings. Maintainable earnings are the profits the practice can be expected to sustain, assessed from historical results after normalisation, the removal of owner-specific, one-off and non-commercial items so that the earnings represent the business, not the owner's arrangements. In a practice that means replacing the owner's drawings with a market rate for the clinical sessions and management hours they actually work, putting related-party rent on market terms, and removing items that will not recur. Where a service entity is used and the doctors bill in their own right, the earnings valued are the service fee income less the cost of running the practice, not the doctors' gross billings. Earnings are usually stated as EBITDA, earnings before interest, tax, depreciation and amortisation, or EBIT, before interest and tax. See what is maintainable earnings.

Those earnings are then capitalised by applying a multiple, a factor that reflects this practice's risks and growth prospects. That produces the enterprise value: the value of the business operations, before borrowings and before assets the practice does not need to trade. Goodwill is what is left once the identifiable net assets are taken out. TR 1999/16 describes the same arithmetic as the Commissioner's preferred approach to valuing goodwill on the sale of a profitable business: the present value of the predicted earnings, less the market values of off balance sheet assets and of all identifiable net assets other than goodwill.

Identifiable net assets means more than the fitout and the medical equipment. It includes working capital, being the trade debtors and consumable stock the practice needs in order to operate, less its trade creditors and accruals. Premises work the other way around: where the practice owns its rooms, a market rent is normally imputed in the maintainable earnings and the property valued separately, so it sits outside the capitalised figure. Drawing these boundaries loosely is a common way a goodwill figure ends up overstated.

Two things follow. Goodwill absorbs risk before anything else does, so key-person risk, meaning the risk that earnings depend on one individual, along with lease insecurity, patient or referrer concentration, workforce shortages and compliance exposure, reduces the earnings or the multiple, and the reduction lands on the residual. And if maintainable earnings do not exceed a fair return on the assets employed once the working owners are paid properly, there is no residual and no goodwill. That is common in owner-operator practices.

Market evidence is a cross-check rather than the primary method. Recorded practice sales are thin, rarely disclose what was included, and often bundle property, plant, restraint payments and transitional services into one number. Price and value differ too: a price is what particular parties agreed in particular circumstances, while market value is an assessment on a defined basis, commonly put as the price that would be negotiated between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller dealing at arm's length. See business valuation versus business appraisal.

Where the future will not resemble the past, because a new practitioner is building a list or a lease is about to end, a discounted cash flow, which values projected future cash flows in today's money, may fit better. Where earnings do not support goodwill at all, a net asset approach values the identifiable assets less liabilities. Every conclusion is stated at a valuation date and for a stated purpose. See how to value a medical practice in Australia and medical practice valuations.

Where the subject is a parcel of shares or units rather than the practice itself, enterprise value is converted to equity value by deducting borrowings and adding surplus assets. The parcel is then considered on its own terms, because a minority interest, one that cannot by itself direct dividends, remuneration or a sale, need not carry the same value per share as a controlling one. Whether a control premium or minority discount applies depends on the purpose and on what any shareholders agreement says about paying a departing owner. See share and equity valuations.

Goodwill in a tax matter and in a dispute

Two settings are worth flagging, as general information rather than advice. For tax, TR 1999/16 treats the goodwill of a business as a single capital gains tax asset, so the whole of the goodwill of a practice that commenced before 20 September 1985 remains the same single pre-CGT asset for as long as the same business is carried on. The ruling adds that if a business changes so much that it is no longer the same business, the old goodwill ceases and new goodwill is acquired. How that applies depends on the structure, the history and the terms of the transaction, and should be confirmed with your accountant. See tax and restructure valuations.

In family law matters and shareholder disputes the argument is usually not whether goodwill exists but how much of it is personal to a practitioner, since that governs how much survives a change of hands. The evidence is the same: the spread of billings across practitioners, the patient base, the referral pattern and the practitioner agreements. See family law business valuations and partnership and shareholder dispute valuations.

What makes practice goodwill more durable

Goodwill is not fixed. Owners who want more of it to survive a sale usually work on the same list: spreading the patient base across more than one practitioner, documenting systems so the practice runs the same way when the principal is away, securing the lease well before a sale, formalising practitioner agreements including sensible restraints, keeping accreditation and program registrations current, and putting related-party arrangements on commercial terms. Each converts something personal into something that belongs to the practice.

For an independent view of what a practice is worth, and how much of it is transferable, request a valuation. See also what reduces the value of a medical practice and preparing a healthcare business for sale, or the healthcare business value drivers collection.