Demystifying Valuation and Deal Structuring in Physician Practice Acquisitions: EBITDA vs. EBPC

Private equity’s interest in physician practice acquisitions has surged over the past decade, driven by factors such as rising healthcare costs, an aging population, and increased demand for medical services. Recently, however, regulatory challenges, economic pressures, and industry-specific headwinds have cooled investor enthusiasm. Despite these changes, physician practices continue seeking larger platforms and capital partners to help manage persistent operational demands.

When structuring these acquisitions, two primary valuation methods are employed: Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) and Earnings Before Physician Compensation (EBPC). While EBITDA is widely recognized, EBPC offers unique advantages in aligning physician incentives with practice growth and profitability.

Despite the continued transaction activity and the importance of these valuation and deal structuring mechanisms in driving alignment, value, and profitability, there is frequent misinterpretation and misapplication. This article aims to provide a clear overview and comparison of these approaches to help stakeholders make more informed decisions in M&A.

Valuation Multiples and Key Drivers

Valuing a business using a multiples approach is conceptually straightforward. This method involves multiplying a financial metric, such as EBITDA, by a corresponding multiple to estimate the company’s value.

EBITDA is commonly used for profitable companies because it reflects the cost structure and serves as a proxy for cash flow. Normalization adjustments—such as removing non-recurring items and aligning related-party agreements with market levels—ensure the valuation accurately represents the company’s financial performance, creating a strong basis for negotiations. Physician compensation must also be adjusted to align with post-transaction expectations.

Once this normalized metric is established, an appropriate multiple is applied, with factors like size, growth, profitability, and risk influencing the multiple. Larger, more profitable companies with lower risk typically command higher multiples.

Value Drivers in Physician Groups

In addition to the general drivers listed above, several factors unique to physician practices play a key role in their valuation:

• Reputation for Clinical Care: High-quality care and strong patient satisfaction often lead to higher multiples, attracting buyers.
• Geographic Location: Practices in favorable regions, with better demographics and reimbursement rates, generally achieve higher valuations.
• Growth and Expansion Opportunities: Practices with clear growth strategies, including ancillary services, command higher multiples due to potential new revenue streams.
• Physician Composition: Teams nearing retirement can present risks, while cohesive, committed teams typically drive higher valuations.
• Referral Network: A strong, diversified referral network that provides consistent patient inflow is appealing to buyers and enhances valuation.
• Physician Recruitment and Retention: Success in recruiting and retaining physicians signals stability and growth, positively affecting valuation multiples.

Valuation multiples in physician practice acquisitions are shaped by buyer motivations, competition, and perceived synergies. A key distinction is whether the acquisition is an add-on to an existing platform or large enough to be a platform acquisition, capable of supporting future add-ons.

For smaller add-on acquisitions, EBITDA multiples typically range from 6.0x to 9.0x. Larger platform acquisitions, however, often command higher multiples due to their capacity to support future add-ons and generate greater synergies. Understanding these dynamics helps buyers and sellers align with market expectations and make more informed decisions during negotiations.

Post-transaction Compensation and Valuation Adjustments 

A key adjustment in valuing physician practices is addressing physician-owner compensation, as many practices distribute most or all of their earnings to shareholders, often leaving little or no profit. In cases where financials are near breakeven, synthetic EBITDA is created by reducing post-transaction compensation, forming the foundation for deal pricing.

There is an inverse relationship between post-transaction physician compensation and EBITDA—lowering compensation increases EBITDA and, in turn, the practice’s valuation. Accurately managing this adjustment is critical to ensuring proper deal pricing.

Compensation structures vary, including fixed salaries, profit splits, and productivity-based models. Private equity-backed acquisitions often favor productivity-based compensation as it aligns physician and investor incentives.

Ideally, physicians who are both owners and clinicians would receive compensation reflecting both their clinical work and the investment risks they take as owners. However, compensation often doesn’t fully account for both roles due to economic pressures.

As physician-owners transition to employees, the acquirer assumes more investment risk, justifying reduced compensation post-transaction. To mitigate reduced compensation post-transaction, acquirers often implement an income repair strategy, using operational improvements to restore or even exceed pre-transaction compensation levels over time.

Valuation and Deal Structuring Approaches

In physician practice acquisitions, selecting the right deal structure is essential for aligning the goals of both buyers and sellers. Investors must carefully weigh factors such as physician compensation, post-transaction growth potential, and long-term profitability. While the EBITDA and EBPC (also known as the Scrape Model) approaches often result in similar valuations under comparable assumptions, differences—such as post-transaction compensation—can lead to varying outcomes. Each method, therefore, offers distinct advantages for structuring compensation, depending on the specifics of the deal.

For add-on acquisitions, investors typically choose between the EBITDA and EBPC approaches based on their platform’s previous deals, ensuring consistency in economic and administrative integration. In platform acquisitions, however, the choice is more flexible, driven by buyer and seller preferences and negotiated as part of the deal structure. The EBPC model aligns compensation with both productivity and overall practice profitability, while the EBITDA model generally emphasizes physician productivity, with variations depending on how the compensation plan is structured.

EBITDA Multiple Approach

The EBITDA multiple approach is a widely used valuation method across industries, including healthcare, and is frequently applied in private equity acquisitions. EBITDA serves as a proxy for cash flow but excludes capital expenditures and changes in working capital. It’s calculated after physician compensation, including salaries and benefits, has been paid out.

In practices with marginal profitability, synthetic EBITDA is often created by reducing post-transaction physician compensation—typically ranging from 20% to 40%. These reductions are negotiated based on practice dynamics and historical compensation, often transitioning to a productivity-based model to keep physicians motivated.

The acquirer’s goal is to generate sufficient earnings while maintaining physician motivation through compensation that supports long-term growth.

The following example illustrates how EBITDA is adjusted in a hypothetical physician group acquisition to determine valuation.

EBITDA Example

To illustrate the EBITDA multiple approach, consider a hypothetical physician group with five owner-physicians. The group generates $7.5 million in total revenue and incurs $5.0 million in operating expenses, leaving $2.5 million in earnings before physician compensation (EBPC). Historically, the entire $2.5 million has been distributed to the shareholders, with each physician receiving an average of $500,000.

In this scenario, the acquirer plans to reduce physician compensation by 30%, lowering total compensation from $2.5 million to $1.75 million, or $350,000 per physician. This adjustment creates $750,000 of EBITDA, the cash flow available after operating expenses and compensation.

Applying an 8.0x multiple to the $750,000 EBITDA results in a purchase price of $6.0 million for 100% of future EBITDA, assuming a full control acquisition.

This example illustrates how reducing physician compensation post-transaction generates EBITDA, allowing the acquirer to value the practice based on the newly created cash flow.

EBPC Multiple Approach

While EBITDA is widely recognized as a proxy for cash flow after physician compensation, many private equity firms use EBPC as a proxy for cash flow before physician-owner compensation. Both are non-GAAP metrics, but EBPC excludes physician-owner compensation, providing a clearer view of earnings available for distribution after operating expenses. This approach is particularly valuable when acquirers aim to align post-transaction compensation with not only top-line productivity and revenue goals but also operational efficiencies and profitability.

Unlike the EBITDA approach, which adjusts compensation directly at the individual level, the EBPC model splits cash flow into two streams. Post-transaction, the acquirer typically takes 20% to 40% of EBPC, while the remaining cash flow is distributed to the partner physicians based on a custom compensation model, often linked to productivity. The exact percentage of the “scrape” depends on practice dynamics, profitability, and historical compensation levels.

Though structured differently from EBITDA, EBPC similarly reduces the overall compensation pool for physicians, thereby creating profitability for the acquirer. Conceptually, the portion of EBPC acquired can be viewed as “effective EBITDA,” representing cash flow after factoring in normalized physician compensation.

EBPC Example

To illustrate the EBPC method, consider a physician group with five owner-physicians. Like the EBITDA example, the practice generates $7.5 million in revenue and incurs $5.0 million in operating expenses, leaving $2.5 million in earnings before physician compensation (EBPC).

Unlike the EBITDA method, where compensation is directly reduced to create EBITDA, the EBPC approach involves the buyer acquiring a portion of future EBPC. In this case, the buyer acquires 30% of EBPC, or $750,000, while the remaining 70% is allocated to the physician partners through an agreed compensation plan. This reduces the total compensation pool available to physicians.

The EBPC approach adjusts compensation indirectly by allocating cash flow between the acquirer and physicians. The acquired portion effectively represents “normalized EBITDA” after accounting for physician compensation.

To determine the purchase price, the buyer applies a multiple to the acquired portion of EBPC. Using an 8.0x multiple on the $750,000 portion results in a purchase price of $6.0 million for 30% of future EBPC. While the buyer acquires 30% of EBPC, they legally gain control of the entire practice, similar to an EBITDA-based transaction.

A common misconception is that if 30% of EBPC is worth $6.0 million, then 100% of the business must be worth $20.0 million. This is incorrect because enterprise value is based on future cash flows after all operating expenses, including physician compensation, are paid. The additional “implied value” simply represents the present value of future physician compensation, which will be derived from the allocated pool of 70% of EBPC. An analysis of the present value of future compensation to physicians, as they transition from owners to employees, is rarely done under the EBITDA approach and should be viewed with caution.

Valuing the entire practice based on 100% of EBPC ignores required compensation expenses, making it an inappropriate comparison. The true enterprise value remains $6.0 million, despite the difference in calculation methods between EBPC and EBITDA.

Comparing EBITDA and EBPC

Both the EBITDA and EBPC approaches assess cash flow but differ in how they handle physician compensation.

• EBITDA focuses on cash flow available to the acquirer after all operating expenses, including physician compensation. Adjustments to physician compensation at the individual level are factored directly into EBITDA, impacting valuation by reducing compensation to create EBITDA.
• EBPC represents a shared cash flow pool between the acquirer and physicians. The acquirer’s portion reduces the compensation pool for physicians, which is then distributed according to an agreed plan. Unlike EBITDA, compensation adjustments in EBPC are handled indirectly, through the allocation of the overall pool.

Under the EBPC approach, compensation plans are typically more complex, allowing for customized methods to allocate the compensation pool among physicians. This flexibility accommodates unique practice dynamics.

The EBPC method may also provide better alignment between physician incentives and long-term profitability, offering a more balanced approach that rewards both productivity and overall practice performance.

Beyond the Multiple: Comprehensive Deal Evaluation

When comparing multiple offers or reviewing other physician groups’ experiences with acquisitions, it’s important to remember that not all valuation multiples are equal. This makes direct comparisons challenging and, at times, misleading.

While valuation multiples reflect the total purchase price, deal structures vary significantly. For instance, two deals priced at 8.0x EBITDA may appear similar, but one offering 80% cash and 20% rollover equity is fundamentally different from one with 50% cash, 20% rollover equity, and 30% seller financing. The amount of cash upfront, the risks tied to seller financing, and post-transaction compensation all shape the attractiveness of the offer, depending on the seller’s objectives.

Post-transaction compensation also directly impacts EBITDA and the long-term economics for physicians. Significant proceeds rolled into equity bring opportunities and risks, as acquirers may differ in growth, profitability, and timelines for liquidity events.

Some deal structures include post-transaction costs, such as management fees or overhead allocations, which benefit the acquirer but may reduce future earnings for physicians. These costs are often not reflected in the normalized EBITDA or EBPC used to price the deal, effectively lowering the real multiple being paid.

Beyond just the valuation multiple, it’s crucial to evaluate the deal and compensation structure, post-transaction costs, and equity rollover implications. These factors directly impact long-term economic outcomes for physicians. A well-structured deal aligns with the financial goals of the physician group and ensures future profitability.