Healthcare Valuation Methodologies: Moving beyond rules of thumb

Business owners who monitor their companies’ value have been shown to make better strategic decisions and run more profitable, higher care-quality businesses.  Estimating the value of a business based on rules-of-thumbs is fine if there are no strategic consequences to a decision.  However, if the decision relates to how to grow, or when to exit, a more precise method of valuing the company is required.  Below is an explanation of several types of healthcare valuation methodologies and considerations for getting to a clearer idea of value.

Transaction Comparables

The Transaction Comparable Methodology is the most widely used methodology to value a business.   Historical transactions of businesses of similar size and service offerings are analyzed to determine the median market multiple a buyer would use to value a company. If diligent when selecting the right historical transactions, this methodology is the most accurate way to determine value.  However, because purchase prices and the rationale behind them are rarely made public, finding more than a handful of examples can be challenging.  Professional business valuation experts usually compile transaction data, especially if they are specialist in a specific industry.

Trading Comparables

This methodology offers a real-time look at how publicly traded companies are being valued by the marketplace.  When using this method, evaluators search for publicly traded companies similar to the subject company.  The trading multiples of the publics are are then applied to the subject company’s most recent financials to determine the value.  While the public companies may provide the same services as a private company, the Trading Comparables are usually higher than private company Transaction Comparables.  Unlike a private company, public companies typically trade at a premium because their shares are freely traded, sometimes called a liquidity premium.  Trading comparables are a good benchmark to establish valuation trends, but are rarely used by buyers to establish a valuation.

Discounted Cash Flow (DCF)

This methodology values a business based on assumptions of the amount of cash it will generate over the next 5-10 years discounted back to present value.  DCF’s require the management team or the evaluator to make several assumptions about revenue growth, margins, discount rates, etc.  For this reason, buyers rarely use the DCF methodology when evaluating the purchase price of a company because assumptions are hard to agree on.  However, if a business owner is meticulous in their assumptions, the DCF tells them what the business is worth to them based on the future cash flows that will be generated by the business.  There are many factors to consider when exiting a company, but from a financial perspective, if the DCF valuation is lower than the Transaction Comparables, then it is often better to exit the company because the market is saying it is willing pay more for the company than the business owner can generate for themselves by operating the company.

When conducting a formal valuation, business evaluators will use two or three of the above methodologies to get a value range for the business.  Experienced evaluators will have a better sense of what subjective variables to use to narrow the range. Owners who are at the crossroads of either selling versus growing their companies should weigh the earning potential of their business against what the market says the business is worth.

Wyatt Matas can provide detailed valuations, based off market comparables from recently completed transactions in your industry segment.  We maintain a large database of proprietary healthcare transactions and would require minimal financial data from you to complete the valuation.   Contact chipm@wyattmatas.com for more details.