Doctors don’t just make money from salaries. Doctors often own their medical practices and those practices make money. A medical practice is an asset whose value can be divided in an Illinois divorce.
A Medical Practice Appraisal Must Begin With Defining What Is Being Valued
What is a medical practice worth?
Well, it depends. A medical practice does not have a single value that can be determined by using the same formula in every case. What matters is the purpose of the valuation. A court valuing a spouse’s ownership interest, a physician selling a practice to another physician, and a hospital purchasing selected practice assets are not necessarily valuing the same property.
In Illinois, the court must determine the fair market value of the property being divided in the divorce. Section 503(k) of the Illinois Marriage and Dissolution of Marriage Act provides that “the court shall employ a fair market value standard,” and the valuation date is usually the date of trial, unless the parties agree to another date or the court orders one. 750 ILCS 5/503(k).
Before an appraiser begins any calculations, the appraisal assignment should identify:
- The entity or entities being valued;
- The physician’s percentage of ownership;
- The legal rights attached to that ownership;
- The standard and premise of value;
- The valuation date;
- Whether the practice will continue operating as a going concern; and
- The assets and liabilities included in the valuation.
These are not technical details that can be looked into after the appraisal is finished. The BVR/AHLA Guide to Healthcare Industry Finance and Valuation explains that the valuation objective includes the subject ownership interest, the legal rights attached to that interest, the standard and premise of value, the applicable level of value, and the valuation date. Mark O. Dietrich ed., BVR/AHLA Guide to Healthcare Industry Finance and Valuation 706 (4th ed. 2016).
What Does The Physician Actually Own?
A physician may tell others, “I own my practice.” Yet that statement may describe several different things. For example, the physician may own the entirety of a solo medical corporation, an ownership interest in a professional limited liability company, or shares in a larger physician group.
Each ownership interest should be identified and valued separately. Otherwise, an appraiser may omit a valuable related entity or count the same income and assets more than once.
Thus, the ownership documents should establish what the physician actually owns. Relevant documents may include shareholder or operating agreements, buy-sell agreements, articles of incorporation or organization, partnership agreements, stock certificates or membership records, and other related materials.
The practice’s assets are not automatically identical to the physician’s ownership interest in the entity. A medical practice may own cash, equipment, supplies, contractual rights, leasehold interests, and intangible assets. The entity may also owe accounts payable, equipment loans, deferred compensation, accrued employee benefits, or other liabilities.
An appraisal of the physician’s shares must account for the assets and liabilities belonging to the entity and the rights attached to the physician’s particular interest.
An Asset Sale Is Not The Same As The Value Of The Practice
Medical-practice transactions are often structured as asset purchases, not purchases of the practice entity itself. In an asset sale, the buyer may acquire certain equipment, contracts, and intangible assets while excluding cash, working capital, or liabilities. So, the price paid for selected practice assets does not automatically establish the value of the physician’s stock or membership interest. Dietrich ed., BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 279, 330, 406-07.
The appraiser must determine whether the transaction involved assets or equity, which assets and liabilities were included, whether the seller agreed not to compete, and how the physician was compensated after the transaction. Importantly, physician-practice transaction data commonly omit information necessary to determine comparability, including post-transaction compensation, the local market, service mix, payer mix, and overhead. Id. at 727-29.
The Physician’s Percentage Of Ownership Is Only The Beginning
Owning 30% of a medical practice does not necessarily mean that the physician’s interest is worth exactly 30% of the entire practice. The appraiser must examine the legal and economic rights attached to the interest, such as voting and management authority, access to information, transfer restrictions, control over compensation and distributions, and the ability to compel a sale or liquidation.
Valuation analysts must identify whether the interest possesses control characteristics and review shareholder agreements, operating agreements, buy-sell agreements, loan covenants, and other restrictions impacting the owner and the interest being valued. Id. at 277-78.
A governing agreement may also establish a valuation or buyout procedure when an owner leaves the business, retires, becomes disabled, divorces, or dies. Whether that procedure affects the divorce valuation depends on whether the agreement applies to divorce and court-ordered transfers.
In In re Marriage of Schlichting, the operating agreement expressly addressed divorce, required the LLC to buy out the divorcing member’s interest, and restricted transfers without the other members’ consent; the appellate court held that ordering a direct transfer to the nonmember spouse was an abuse of discretion because the agreement “specified the valuation process in the event of a divorce” while allowing the nonmember spouse to contest the value. 2014 IL App (2d) 140158, ¶ 68.
The court distinguished In re Marriage of Gunn, where the agreement listed death, disability, retirement, and termination as triggering events, but not divorce. Id. ¶ 66. Thus, a contractual valuation provision should be neither automatically accepted nor disregarded, but the court and appraiser must determine what the agreement truly covers. Id.
The Practice’s Organizational Form Matters
The appraiser and divorce attorneys must figure out how the medical practice is organized and also determine whether Illinois law restricts who may own or control the entity.
For instance, 805 ILCS 15/13(a) requires a medical corporation’s officers, directors, and shareholders to be licensed under the Medical Practice Act of 1987. It further states that “[n]o person who is not so licensed shall have any part in the ownership, management, or control of such corporation.” 805 ILCS 15/13(a).
This ownership restriction does not mean that the physician’s interest cannot be valued as marital property. In In re Marriage of Alexander, the court valued the physician’s medical practice at $379,473, including $160,000 in enterprise goodwill, included that value in the marital estate, and divided the marital property equally. 368 Ill. App. 3d 192, 193-94 (2006).
However, a direct transfer of medical-corporation shares to an unlicensed spouse may not be legally available. Rather, the court may account for the practice’s value through the division of other marital property or an equalization payment. The exact result depends on the practice’s ownership restrictions, organizational form, and governing documents.
Is The Practice Being Valued As A Going Concern?
Additionally, the appraisal must identify the appropriate premise of value.
A going-concern premise assumes that the practice will keep operating and treating patients in the normal course. A liquidation premise assumes that the business will terminate and that its assets will be sold or collected separately. Under the liquidation premise, the value should reflect not just the amounts received for the assets but also the costs of winding down the practice and disposing of the assets. Dietrich ed., BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 405, 741-42.
The selected premise can substantially affect the treatment of accounts receivable, equipment, contracts, employees, and intangible assets. A practice that keeps operating may collect receivables through its current billing system and retain value associated with its organization, workforce, and contracts. A practice that closes may lose employees, acquire collection expenses, and receive liquidation prices for its equipment.
The ownership interest being valued matters, as well. As the BVR Guide explains, “the ability to cause liquidation is a necessary condition” when comparing a business’s going-concern and liquidation values; so, when valuing a minority interest, the appraiser would typically assume “business as usual” unless the facts support a different premise. BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 739-40.
Illinois courts recognize that valuing a closely held business or professional corporation is “inherently subjective.” In re Marriage of Grunsten explained that placing a fair market value on a professional corporation is “an art, not a science,” and “[t]here is no exact formula that can be applied,” so the trial court must evaluate the relevant evidence, the experts’ credibility and expertise, the reasonableness of their opinions, and the weight assigned to each valuation before determining fair market value. In re Marriage of Grunsten, 304 Ill. App. 3d 12, 17 (1999) (quoting In re Marriage of Gunn, 233 Ill. App. 3d 165, 183 (1992)).
Is A Medical Practice Marital Or Nonmarital Property In Illinois?
After the ownership interest has been identified, the court must classify it as marital or nonmarital property.
Marital property usually includes property acquired by either spouse after the marriage. Property acquired after the marriage and before the dissolution judgment is presumed to be marital; the spouse claiming otherwise must overcome that presumption with clear and convincing evidence. 750 ILCS 5/503(a), (b)(1).
Accordingly, a medical practice established or purchased during the marriage will likely be marital property, even if only the physician appears on the ownership documents, the other spouse never worked at the practice, or Illinois law allows just the physician to own the entity.
In other words, title and professional eligibility do not determine classification. The relevant questions are when the interest was acquired and what property was used to acquire it.
That is not automatically sufficient to make the practice marital. Property acquired during marriage through a loan secured only by nonmarital property may remain nonmarital, although marital repayment of that loan may create a reimbursement claim. 750 ILCS 5/503(a)(6.5).
A Practice Acquired Before Marriage May Be Nonmarital Property
Generally, a practice interest acquired before marriage is nonmarital. An interest acquired by inheritance, gift, an exchange for nonmarital property, or a valid premarital or postnuptial agreement may be nonmarital, too. 750 ILCS 5/503(a)(1)-(6).
For each ownership interest, classification should be performed separately. For example, a physician may have acquired an initial interest before marriage, then purchased additional shares during the marriage. The original and later-acquired interests can have different classifications.
This is also true of related entities. A premarital interest in a medical practice does not automatically determine the classification of an imaging company, real estate entity, surgery center, or other ancillary interest acquired later.
What Happens When A Nonmarital Practice Increases In Value?
The increase in value of nonmarital property stays nonmarital, even when the increase results from marital funds or the physician spouse’s personal effort. Instead, the marital estate may have a right to reimbursement. 750 ILCS 5/503(a)(7), (c)(2).
When a spouse contributes personal effort to nonmarital property, the marital estate is entitled to reimbursement “if the efforts are significant and result in substantial appreciation to the non-marital property,” unless it “reasonably has been compensated” for those efforts. 750 ILCS 5/503(c)(2)(B).
Thus, the physician’s compensation is important. The appraiser needs to distinguish compensation for clinical and management services from profits attributable to practice ownership. As the Guide states, compensation in a typical physician practice may include both “a return on labor and a return on assets or capital,” while profits from owned laboratories or imaging equipment “are not part of the physician work effort.” BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 418.
Marital Funds Can Create A Reimbursement Claim
When marital funds are contributed to a nonmarital practice, the marital estate may also have a reimbursement claim.
The contribution must be traceable by clear and convincing evidence. Further, the contribution cannot have been intended as a gift. The court may order reimbursement from the property being divided or impose a lien against the nonmarital property that received the contribution. 750 ILCS 5/503(c)(2)(A).
General ledgers, capital accounts, bank statements, loan documents, and acquisition records may be required to identify and trace the contribution.
Income And Ownership Are Different
The classification of the practice does not necessarily determine the classification of everything it produces.
Income from nonmarital property remains nonmarital only when the income is not attributable to a spouse’s personal effort. 750 ILCS 5/503(a)(8). Compensation earned by a physician for treating patients or managing the practice is attributable to personal effort. It must be distinguished from the economic return generated by ownership of the business.
The appraisal may need to make a distinction between:
- Compensation for the physician’s labor;
- Distributions or retained earnings attributable to ownership;
- Accounts receivable for services already performed; and
- Appreciation and enterprise value associated with the ownership interest.
These categories can have different consequences for classification, reimbursement, valuation, maintenance, and child support.
A medical practice can therefore stay nonmarital property while generating marital compensation or a reimbursement claim. By contrast, a practice acquired during the marriage can be marital property, even though most of its revenue depends on the physician’s individual labor.
What Makes A Medical Practice Different From Other Businesses?
A medical practice is not valued like a business that sells identical products to every customer at a posted price. A medical practice’s revenue depends on which services the physicians perform, who performs them, how those services are billed, which payers cover the patients, and whether the same work can continue after the owner leaves.
So, the appraiser must look beyond the practice’s total collections. Factors include the physicians’ specialties and productivity, the practice’s service mix, referral sources, payer mix, reimbursement rates, competition, staffing and billing efficiency, contractual relationships, and the risk that patients or referral sources will not stay with the practice after a transition; each of these factors may impact whether the practice’s historical income is likely to continue. Reed Tinsley, Rhonda Sides & Gregory D. Anderson, Valuation of a Medical Practice 23-53 (1999).
Different medical specialties require different equipment, staffing, malpractice coverage, referral relationships, and reimbursement. For example, a primary-care practice that depends mainly on patients returning for routine care likely will have different transition risks than a surgical specialty that depends on referrals from a small group of physicians.
The services performed must also match the assumed successor. If the owner performs procedures that an ordinary replacement physician would not perform, the appraiser cannot assume that all of those revenues will continue simply because they appeared on prior financial statements. This problem arises when the owner has stopped performing certain procedures, reduced hours, or refers services to another physician. The appraiser must determine whether the historical service mix is transferable and sustainable instead of automatically treating every past dollar as future practice income. Id. at 37-41.
These risks may affect value in different ways. A reasonably measurable change, like the expected loss of a payer contract, may be reflected directly in projected revenue. A less quantifiable risk, like possible future competition, may instead affect the capitalization or discount rate. The appraiser should explain where each risk was considered; this ensures that the same risk is not counted twice.
The Appraiser Must Understand How The Practice Earns Money
A medical practice’s tax returns and income statements show what was reported, but not necessarily what the practice can be expected to earn in the future.
First, the appraiser must determine which financial periods accurately reflect the practice’s current income stream. Valuation of a Medical Practice cautions against automatically including every available year and instructs the valuator to “[d]ecide which year or years best reflect the true earnings stream of the practice.” Id. at 24.
Reported revenue also cannot be accepted at face value. The appraiser should “never take a revenue stream for granted.” Id. at 25. Further, the “[r]evenues that would not transfer to a potential buyer or transferee should not be included in the valuation.” Id. So, royalties, temporary subsidies, special-service revenue, and other nontransferable income may need to be removed. However, the valuator should also investigate missing or understated revenue because the objective is to include “the accurate income stream of the practice,” supported by the practice’s billing records, reports, and other evidence. Id. at 27.
The appraiser needs to review billing reports to determine which services generate revenue, how often they are performed, and whether the reported coding and collections accurately reflect the practice’s work. Gross charges differ from actual collections. Accordingly, the analysis should also consider payer mix, contractual adjustments, capitation arrangements, reimbursement rates, and concentration among particular payers, referral sources, or contracts. In the end, value depends not just on what the practice collected historically, but also on whether that revenue stream is likely to continue after the valuation date. See id. at 40-53.
The Practice’s Financial Results Must Be Normalized
A valuation usually cannot use the practice’s reported net income without adjustment.
For many medical practices, their financial statements are maintained on a cash or tax basis. Those statements may omit accounts receivable, accounts payable, accrued payroll, and other items required to understand the practice’s economics. Converting cash-basis statements to the accrual method helps make sure that revenues and expenses are “accurately captured and reported.” The conversion may require estimates of receivables, payables, and accruals that do not appear on the cash-basis statements. BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 884.
Then, the appraiser must adjust the historical results to reflect the practice’s recurring and reasonably expected revenue and expenses. The objective is to produce “true, normalized expenses for the practice.” Valuation of a Medical Practice at 33-36, 108-10.
An adjustment is not justified simply because an expense looks high. For instance, a long-term employee may earn more than a survey median, but that employee may possess experience that cannot be replaced at a lower salary without harming billing, collections, or operations. The appraiser “cannot and should not increase the net earnings of the practice” merely by reducing the salary of a productive employee. Id. at 35. Similarly, retirement-plan costs should not automatically be removed when a continuing practice would maintain a comparable plan.
Normalization can either increase or decrease value. Getting rid of personal expenses may increase normalized earnings, whereas adding omitted staffing costs, accrued liabilities, capital expenditures, or market rent may reduce them. Overall, each adjustment should be supported by the practice’s records, interviews with management, and industry evidence.
Reasonable Physician Compensation Separates Labor From Ownership
A physician-owner may obtain economic benefits in two capacities: (1) compensation for personally treating patients and managing the practice, and (2) a return from owning the practice’s assets and business systems.
The appraiser must separate those returns by deciding what the practice would reasonably pay another physician to perform similar work. The analysis must consider the physician’s specialty, experience, clinical duties, management responsibilities, call obligations, productivity, hours, and benefits. Valuation of a Medical Practice at 38-41, 108-10.
In the Divorce Compendium’s discussion of Miller v. Miller, a Georgia medical-practice case, it explains that the excess-earnings method deducts a “reasonable salary, based on similarly situated professionals,” instead of just accepting the owner’s actual compensation. It also emphasizes the Miller court’s conclusion that a “normal salary hardly means that there are no excess earnings.” Business Valuation in Divorce Case Law Compendium 464 (5th ed. 2020) (discussing Miller v. Miller, 2010 WL 4704326 (Ga.)).
Of course, Miller is not Illinois authority. However, the case demonstrates the valuation principle: an owner may change salary, distributions, or retained earnings without changing the practice’s underlying economics.
Published compensation surveys and work relative value units can help the analysis, but neither should be applied mechanically. The appraiser should compare the physician’s productivity and work effort with the survey population before choosing reasonable compensation. BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 418. Further, compensation in a typical physician practice may include both “a return on labor and a return on assets or capital.” Id.
The appraiser must therefore identify where the practice’s profits originate. Treating all practice profit as physician compensation can understate the return generated by the practice’s assets and distort its value.
The compensation assumption can materially affect the conclusion. If reasonable replacement compensation is lower, more earnings remain as a return on ownership and the practice value increases. If reasonable compensation is higher, less income remains to be capitalized and the value decreases.
What Assets And Liabilities Belong To The Practice?
Before deciding how the practice’s assets and liabilities affect value, the appraiser first must identify what those assets and liabilities even are.
Possible assets include cash and working capital, accounts receivable, medical and office equipment, furniture, computers, inventory and supplies, leasehold interests, contracts, software, telephone numbers, trade names, an assembled workforce, practice systems, and other intangible assets.
Liabilities may include accounts payable, equipment debt, accrued payroll and benefits, deferred compensation, refundable patient balances, unfavorable leases, and continuing contractual obligations.
Many practices use cash-basis accounting. This means that accounts receivable and certain liabilities may not appear on the balance sheet. Fixed assets may require a separate appraisal, while supplies and intangible assets should be valued only if they are usable, owned by the practice, transferable, and capable of producing an economic benefit not already reflected in earnings or goodwill. Valuation of a Medical Practice at 141-44.
Medical records, contracts, and workforce show this distinction. An “inactive chart has no asset value” and may instead cause storage, retrieval, or conversion costs. BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 571. Similarly, leases and payer or service agreements may be assets or liabilities, depending on their terms. Id. The appraiser should use the practice’s records, agreements, interviews, and site inspection to decide whether each item truly contributes to continuing income. BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 571; Valuation of a Medical Practice at 145-56.
Medical Accounts Receivable Require Their Own Analysis
Accounts receivable are commonly some of the largest assets of a medical practice. In Illinois, receivables for services already performed are earned assets with an ascertainable value, rather than speculative future earnings. Thus, they should be considered when valuing the practice. In re Marriage of Schneider, 214 Ill. 2d 152, 169-72 (2005).
To be clear, the billed amount is not automatically the collectible amount. Receivables should be analyzed to obtain the “most accurate assessment of collectibility.” Valuation of a Medical Practice at 142. The appraiser should examine the receivables by payer and aging category, including denials, rejected claims, contractual allowances, historical collection rates, patient balances, changes in payer contracts, and balances that stay on the books without being written off.
The Divorce Compendium gives a helpful example in Settele v. Settele, an Ohio case regarding a dental practice. In that case, the valuation expert used the “standard method of aging accounts” to reflect collectibility risk before including the receivables in an adjusted net-asset valuation. Business Valuation in Divorce Case Law Compendium at 554-56 (discussing Settele v. Settele, 2015 Ohio App. LEXIS 3629).
Again, Settele is not controlling Illinois law, yet it illustrates why gross receivables cannot just be added to value without analyzing the likelihood of collection.
The underlying billing reports matter, too. A report organized by date of service may omit later payments when not enough time has passed, whereas a report organized by posting date may include payments for services performed in an earlier period. The appraiser must understand what the report measures before applying a collection percentage. BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 401-02.
Credit balances must also be reviewed. Some balances represent payments that were posted incorrectly. Others represent actual overpayments or refunds owed to patients or insurers. Those amounts might reduce the net value of the receivables.
Lastly, the premise of value impacts the analysis. A going concern may use its existing employees and billing systems to collect receivables in the ordinary course. A practice being liquidated may acquire additional collection and wind-down costs and may recover less from self-pay or older balances. Further, taxes and any related deferred-compensation liability should be considered where applicable.
The final receivables value should reflect the amount reasonably expected to be collected, net of applicable liabilities and collection costs, not the gross balance printed on an aging report.
How Is A Medical Practice Valued?
The appraiser must select the valuation methods that fit the assignment. As Valuation of a Medical Practice explains, “[d]epending on the purpose of the valuation, there may be one method or more than one method used to determine the value.” at 105. The three principal approaches are the asset, income, and market approaches. Each should be considered, and if an approach is not used, the appraiser should explain why. Id.
The Asset Approach
The asset approach values the practice’s assets minus its liabilities. It uses adjustments for items like receivables, equipment, inventory, debt, accrued expenses, and unrecorded intangible assets. This approach can be most helpful when little income remains after reasonable physician compensation, liquidation is contemplated, or asset value exceeds the value supported by earnings. However, it may value the practice only “at a specific point in time with no regard for the future potential of the practice as a going-concern.” Id. at 141.
The Income Approach
The income approach values the economic benefits the practice is expected to produce. The appraiser may capitalize a representative level of normalized earnings or project future cash flows and discount them to present value. A discounted cash-flow analysis considers “the working capital, capital expenditures, and so on that are needed to generate a profit” and may be proper when future performance is expected to be different from historical results. Id. at 129.
Under either analysis, reasonable physician compensation must be deducted so the resulting value reflects the return on ownership other than the physician’s future labor. The capitalization or discount rate must also account for practice-specific risks; these risks may include concentrated payers or referral sources, dependence on one physician, expiring contracts, and reimbursement changes. A measurable change may be reflected in projected cash flow, and a less quantifiable risk may affect the rate. However, the same risk should not be counted twice.
The Market Approach
The market approach compares the practice with sales of reasonably comparable practices or ownership interests. Similarity is about more than the percentage of collections paid. The appraiser should examine location, profitability, speciality, payer and service mix, assets and liabilities transferred, post-transaction compensation, and the remaining deal terms.
Importantly, “rules are not methods” and “[i]t is not possible to value any practice by taking a percentage of its receipts.” BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 365-66. So, a percentage of revenue or physician compensation may provide a rough reasonableness check yet cannot replace an analysis of the practice. Two practices with identical revenue may have substantially different values if their profitability, contracts, systems, providers, and transferable income differ. Likewise, the IRS recognizes the asset-based, market, and income approaches, while emphasizing that professional judgment must determine which approach best indicates value.
Personal And Enterprise Goodwill In An Illinois Medical Practice
Goodwill refers to the intangible value of a business beyond its identifiable physical assets. In Illinois, the appraiser must distinguish enterprise goodwill from personal goodwill.
Enterprise goodwill exists independently of the owner’s personal efforts and outlasts the owner’s involvement. Personal goodwill depends on the owner’s reputation, skill, and continued participation. In In re Marriage of Talty, a case involving a car dealership, the Illinois Supreme Court held that goodwill existing independently of the owner “should be considered an asset of the business,” but goodwill that depends on the owner’s efforts and ends with the owner’s involvement “should not be considered property.” 166 Ill. 2d 232, 239-40 (1995).
In re Marriage of Schneider reaffirmed that personal goodwill cannot be included as a divisible asset simply because maintenance was not awarded. 214 Ill. 2d 152, 166-68 (2005). Because the elements of personal goodwill are already considered under Section 503(d), including that goodwill in the practice’s value would be considered impermissible double counting. Id. However, the court noted that this restriction applies to personal goodwill, not enterprise goodwill.
In re Marriage of Alexander applied that distinction to a physician’s medical practice and affirmed the inclusion of enterprise goodwill in the marital estate; the expert considered personal factors like reputation, referrals, and specialized knowledge, as well as enterprise factors like office locations, multiple providers, staff, systems, marketing, and years in business. 368 Ill. App. 3d 192, 195-202 (2006). The trial court described the approach as “thoughtful and persuasive,” even though it rejected the expert’s total goodwill figure and accepted only some of the analysis. Id.
Thus, the classification depends on whether patients, referrals, staff, systems, contracts, and profits would stay after the physician leaves. Put differently, “[h]ow a practice is transitioned has a direct impact on the future income stream of the practice.” Valuation of a Medical Practice at 48. Noncompetition agreements, employment agreements, and realistic post-transaction physician compensation may also impact whether goodwill belongs to the practice or stays personal to the physician. BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 328-29.
The goodwill analysis must identify what generates the practice’s income, whether that value belongs to the enterprise, and whether it will survive the physician’s departure.
Healthcare Law Limits What Can Be Treated As Value
Medical-practice valuation must account for federal healthcare law because a buyer’s price may reflect anticipated referrals instead of the practice’s transferable value. Under the Anti-Kickback Statute, remuneration intended to induce federally reimbursable referrals is prohibited, while the Stark Law typically restricts certain Medicare referrals that involve a physician’s financial relationship. 42 U.S.C. § 1320a-7b(b).
It is best to avoid “ascribing value to prior or anticipated referrals” and make sure to distinguish legitimate practice revenue from hospital or health-system revenue expected from future referrals. BVR/AHLA Guide to Healthcare Industry Finance and Valuation at 129-30, 141-42. Accordingly, a hospital’s willingness to pay more for imaging, laboratory business, or expected admissions does not necessarily establish the fair market value of the physician’s ownership interest.
Even in a divorce valuation, an appraiser who relies on a hospital acquisition, employment arrangement, or noncompetition payment needs to determine whether the reported price included strategic or referral-dependent value that would not transfer with the practice itself.
The Appraiser Must Investigate The Actual Practice
A medical-practice valuation cannot be completed from only spreadsheets and tax returns. The appraiser must review general ledgers, financial statements, receivable and billing reports, contracts, compensation records, equipment schedules, employee information, and related-entity records. If necessary, interviews with the physician and office manager or a site inspection may show billing weaknesses, staffing issues, unused space, outdated equipment, or dependence on one physician or employee.
It is important that the valuator “take logic and common sense into consideration when valuing medical practices.” Valuation of a Medical Practice at 156. When requested access or information is unavailable, the expert should identify that limitation and explain any alternative evidence used. In Business Valuation in Divorce Case Law Compendium, it describes a medical-practice valuation in which the expert relied on financial records, industry data, and the practice’s website after not being able to interview the office manager or accountant. at 503-04.
The Expert Must Reconcile And Test The Result
The final value cannot be an unexplained average of unrelated methods. The appraiser must decide which approaches best fit the practice, why they produced the results they did, and how much weight each one deserves. Professional judgment “plays a critical role in completing the process and generating a meaningful and accurate conclusion.” Valuation of a Medical Practice at 165.
For example, an asset approach may deserve greater weight when there is little income remaining after reasonable physician compensation. An income approach may work better for a profitable practice with stable, transferable operations.
The appraiser should perform a “reasonableness check” or “gut check” by asking whether the indicated value produces a plausible return, can be supported by the practice’s earnings, and is consistent with its risks and transferable cash flow. Id. at 169. It is good to “[b]eware of relying on valuation software without a complete understanding of the valuation process.” Id. at 144.
Valuation Must Avoid Counting The Same Economic Benefit Twice
A medical-practice valuation must make a distinction between existing assets, future labor, and the return generated by business ownership. Without that, the same economic benefit may be counted more than once.
In In re Marriage of Zells, a case involving a lawyer’s practice, the Illinois Supreme Court stated that “[g]oodwill represents merely the ability to acquire future income” and held that professional goodwill should not also be divided as a marital asset; the court decided that “[a]ny additional consideration of goodwill value is duplicative and improper.” 143 Ill. 2d 251, 254, 256 (1991).
In re Marriage of Schneider reaffirmed that rule as to personal goodwill. The court stated that the duplication concern is limited to personal goodwill and does not extend to enterprise goodwill existing independently of the professional. 214 Ill. 2d 152, 166-68 (2005).
Accounts receivable are different. Schneider stated that, even though receivables have not yet been collected, they are “assets that have been earned and have a known value” and are different from future earnings or income-generating ability. Id. at 170-71. Their later collection “does not transform those assets into speculative or future income.” Id. So, including existing receivables in the practice’s value does not constitute improper double counting simply because the money will be collected later.
Additionally, reasonable physician compensation must be separated from the return on ownership. If an income approach capitalizes earnings only after deducting reasonable compensation, the resulting value reflects the practice’s excess economic return instead of the physician’s normal labor. Business Valuation in Divorce Case Law Compendium’s discussion of Miller v. Miller explains that the excess-earnings method deducts compensation for professional services and capitalizes the leftover historical earnings. at 464.
The appraiser should therefore identify exactly what is being counted:
- Existing receivables are earned assets;
- Reasonable compensation pays for the physician’s labor;
- Enterprise earnings may support business value;
- Personal goodwill reflects future earning capacity; and
- A separately valued intangible should not be added again when its economic benefit is already captured in capitalized earnings.
Saying an issue is “double dipping” does not establish that duplication occurred. The expert has to identify the specific asset or income stream, where it entered the valuation, and whether the same economic benefit is being counted more than once.
How The Practice’s Value Affects The Property Division
Valuing a medical practice does not automatically mean that the practice will be sold or that the nonphysician spouse will obtain an ownership interest.
Under Illinois law, the court is directed to divide marital property “in just proportions” after considering all relevant circumstances. 750 ILCS 5/503(d). These factors include each spouse’s contributions, the value of the property assigned to each spouse, the parties’ economic circumstances, their income and liabilities, their opportunities to acquire future assets and income, and the tax consequences of the division. Id.
Most times, the physician will keep the practice, as the physician is licensed to operate it, dividing the ownership interest would disrupt the business, or the governing agreement restricts transfers.
The court can account for the marital value by ordering an equalization payment, structuring payments over time, or awarding the other spouse additional property. The proper method depends on the liquidity of the marital estate, existing debt, taxes, the physician’s ability to pay without hurting the practice, and the rights of other owners.
The valuation report should be clear on what the conclusion includes. A practice value that includes cash, equipment, accounts receivable, and working capital should not be treated as though those assets are still available for a second distribution. Likewise, any taxes, discounts, ownership restrictions, or deferred-compensation liabilities relied upon by the appraiser should be identified clearly. That way, the court can understand the economic value truly assigned to the physician.
The Bottom Line For Medical Practice Valuation And Divorce In Illinois
What is this medical practice worth? This question cannot be answered by multiplying annual collections by an industry percentage or accepting the net income reported on the practice’s tax returns. Rather, the analysis begins by identifying the physician’s ownership interest, the rights and restrictions attached to that interest, the assets and liabilities included, the valuation date, and whether the practice is being valued as a going concern or in liquidation.
Then, the appraiser must normalize the practice’s financial results, separate reasonable physician compensation from the return on ownership, determine the collectible value of accounts receivable, distinguish personal goodwill from enterprise goodwill, and apply the valuation approaches that fit the particular practice. Specialty, productivity, payer mix, referrals, reimbursement, transition risk, healthcare regulations, and the practice’s ability to continue without the physician can all impact the end value.
Even then, valuation is only one aspect of the divorce analysis. The court needs to translate the appraised value into an equitable property division that accounts for licensing and transfer restrictions, other owners’ rights, debt, liquidity, taxes, and the practical consequences of requiring an equalization payment without damaging the practice.
Russell D. Knight is a Chicago divorce and family law attorney who has practiced family law since 2006. He represents clients in complex Illinois divorce matters involving high-net-worth marital estates, medical and professional practices, closely held businesses, business valuations, and other difficult-to-value assets. His Chicago practice focuses on Illinois divorce and family law.
CASES, STATUTES, AND OTHER SOURCES REFERENCED IN THE MEDICAL PRACTICE VALUATION AND DIVORCE IN ILLINOIS ARTICLE
750 ILCS 5/503(a), (b)(1) — Definition And Presumption Of Marital Property
750 ILCS 5/503(a)(1)–(6.5) — Property Acquired Before Marriage, By Gift Or Inheritance, Or Through Nonmarital Property And Collateral
750 ILCS 5/503(a)(7)–(8) — Appreciation Of And Income From Nonmarital Property
750 ILCS 5/503(c)(2) — Reimbursement For Contributions Between Marital And Nonmarital Estates
750 ILCS 5/503(d) — Factors Governing The Division Of Marital Property
750 ILCS 5/503(k) — Fair Market Value Standard And Valuation Date
805 ILCS 15/13(a) — Licensing And Ownership Requirements For Illinois Medical Corporations
42 U.S.C. § 1320a-7b(b) — Federal Anti-Kickback Statute
42 U.S.C. § 1395nn — Federal Physician Self-Referral Law, Commonly Known As The Stark Law
In re Marriage of Zells, 143 Ill. 2d 251 (1991)
In re Marriage of Talty, 166 Ill. 2d 232 (1995)
In re Marriage of Schneider, 214 Ill. 2d 152 (2005)
In re Marriage of Alexander, 368 Ill. App. 3d 192 (5th Dist. 2006)
In re Marriage of Grunsten, 304 Ill. App. 3d 12 (1st Dist. 1999)
In re Marriage of Gunn, 233 Ill. App. 3d 165 (5th Dist. 1992)
In re Marriage of Schlichting, 2014 IL App (2d) 140158
Miller v. Miller, 288 Ga. 274, 705 S.E.2d 839 (2010) — Illustrative Non-Illinois Medical-Practice Valuation Case
Settele v. Settele, 2015-Ohio-3746, 42 N.E.3d 243 — Illustrative Non-Illinois Accounts-Receivable Valuation Case
Mark O. Dietrich ed., BVR/AHLA Guide to Healthcare Industry Finance and Valuation (4th ed. 2016)
Reed Tinsley, Rhonda Sides & Gregory D. Anderson, Valuation of a Medical Practice (1999)
Business Valuation in Divorce Case Law Compendium (5th ed. 2020)
Internal Revenue Service, Internal Revenue Manual § 4.48.4, Business Valuation Guidelines
FREQUENTLY ASKED QUESTIONS ABOUT MEDICAL PRACTICE VALUATION AND DIVORCE IN ILLINOIS
Is A Medical Practice Marital Property In An Illinois Divorce? This depends on when and how the ownership interest was acquired. A practice established or purchased during the marriage is usually presumed to be marital property. Yet, an interest acquired before marriage or through gift, inheritance, or qualifying nonmarital property may be nonmarital, even if marital contributions and personal effort may create reimbursement claims.
How Is A Medical Practice Valued In An Illinois Divorce? Illinois courts implement fair market value. The appraiser can consider the asset, income, and market approaches after identifying the ownership interest, normalizing the practice’s finances, deducting reasonable physician compensation, valuing receivables and other assets, and accounting for practice-specific risks.
Is Goodwill Included In The Value Of A Medical Practice? Enterprise goodwill that exists separately from the physician and is expected to stay after the physician leaves may be included. Personal goodwill attributable to the physician’s reputation, skill, relationships, and future earning ability is not treated as divisible marital property.
Are A Medical Practice’s Accounts Receivable Included In Its Value? Typically, yes. Accounts receivable for services already performed are earned assets, not speculative future income. Their value should be adjusted for contractual allowances, denials, aging, collection history, credit balances, and collection costs.
Can The Nonphysician Spouse Receive Shares In The Medical Practice? Not necessarily; Illinois law may restrict medical-corporation ownership to licensed professionals, and the practice’s governing documents may impose additional transfer restrictions. Instead, the court may account for the marital value through other property, an equalization payment, or structured payments.
