When physicians or physician groups seek to sell their practice, a variety of issues must be addressed given the heavily regulated healthcare industry. One such issue is determining how to best consummate the sale to achieve maximum value while also ensuring compliance with applicable laws. Ensuring fair market value transactions is critical to navigating healthcare compliance issues; this is why many seek the services of independent third-parties with experience in healthcare valuations.
ByrdAdatto is happy to present this article contribution from guest author John Meindl. John is a manager with VMG Health specializing in healthcare valuation and transaction advisory services. Since valuations are outside ByrdAdatto’s expertise, this article does not express any opinions of ByrdAdatto and should not be construed as legal advice. If you have questions regarding healthcare valuations, please contact John directly.
Physician Practice Acquisition Valuations – A Primer on Fair Market Value
In the era of healthcare reform, physicians are increasingly choosing to merge or sell their professional practices to larger groups or hospital affiliated entities instead of navigating the increasingly complicated regulatory environment on a stand-alone basis.
Beginning in 2010, the Affordable Care Act (“ACA”), the Medicare Access and CHIP Reauthorization Act of 2015 (“MACRA”), and the Centers for Medicare and Medicaid Services (“CMS”) have drastically reshaped the landscape of the insured population in the US and set in motion fundamental shifts in the way in which healthcare providers are paid for their services. Many solo practitioners are finding that the new regulatory environment has increased their administrative burden and are therefore increasingly considering selling or merging their practices as a way to remain competitive.
When contemplating a transaction with a physician practice, the regulatory environment is not as straightforward as it used to be. The Stark Law (42 C.F.R. § 411.351), the federal Anti-Kickback statute (42 U.S.C. § 1320a-7b), and the Private Inurement Statute (Regs. 1.501(c)(3)-1(c)(2)) individually and collectively regulate the price at which a transaction can occur involving a physician practice and a larger physician practice, hospital, or health system (or other non-profit entities in the case of the Private Inurement Statute).
Each of the statutes above require the consideration of Fair Market Value (“FMV”) when setting price in a contemplated transaction. Fair Market Value is defined by the Stark Law as “the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party . . .” (42 C.F.R. § 411.351).
Therefore both buyers and sellers are increasingly turning towards third-party appraisers to determine the FMV of a physician practice when evaluating contemplated transactions.
In order to value a physician practice, an appraiser must consider the following four primary components. Transactions can be structured to include some, or all, of the following items:
- Working Capital: (i.e., cash, accounts receivable, inventory, accounts payable, and accrued liabilities). Typically, the physician contributes inventory and retains the other working capital accounts.
- Fixed Assets: (i.e., machinery and equipment, and real estate). Often times the book value of the fixed asset does not reflect FMV due to a physician electing accelerated depreciation for tax purposes. If sold in the transaction, consideration should be given to the FMV of the fixed assets.
- Intangible Assets: (i.e., goodwill, trained and assembled workforce, trade name, non-compete agreements, etc.). Intangible assets are often not accrued on the balance sheet. In valuing intangible assets, consideration should be given to the return on the asset, the cost to replicate the asset, and/or an observable transaction market for similar assets.
- Post-Transaction Compensation: The physician’s post-transaction compensation should be considered in tandem with the FMV of the practice. Generally, the higher the post-transaction physician compensation, the lower the value of the practice and vice-versa.
After determining the treatment of the four primary factors above, an appraiser must consider the three generally accepted valuation methodologies in order to value the practice.
The first method is the income approach which determines value by converting future economic benefits into a single present amount.
The second method is the asset approach which determines value based on the assets net of liabilities. This method can involve a “build-up” of the different asset values by adjusting the practice’s balance sheet.
The third method is the market approach which compares the practice to other similar transacted entities. Due to the many unique variables affecting every physician practice, it is often difficult to find data for similar transacted entities. Therefore, the market approach is rarely relied upon in the valuation process of a physician practice.
Finally, in assessing value an appraiser cannot factor any sort of revenue enhancement or buyer specific benefit or synergy into the analysis. The transaction must be valued at an “arm’s length” consistent with the definition of Fair Market Value.
Therefore the key factors in determining the purchase price of a physician practice can be summarized as:
- The purchase price calculation should be consistent with the Fair Market Value guidelines as outlined in the Stark Law Statute.
- Post-transaction compensation should be considered in setting price. The level of post-transaction compensation can affect the economic return available to a buyer. Similar to the purchase price, the post-transaction compensation should consider FMV standards as well.
- The book value of the assets may not reflect FMV. Certain entities elect to take accelerated depreciation of their assets for tax purposes. Additionally, many intangible assets are not recorded on the balance sheet.
- Intangible assets (including goodwill) must be considered in conjunction with the operating performance of the practice.
- The presence of significant ancillary services (i.e., imaging and radiology, physical therapy, clinical lab, etc.) may result in an economic return to the business owner. This economic return must be considered in a valuation analysis.
- The level of competition and demographics in the practice’s local market can affect growth rates, economic return, and/or economic obsolescence
- The risk associated with the practice’s operations include market risk, business risk, and specific company risk. Factors affecting the specific company risk of a practice can include the physician’s age, specialty, location, market position, payer mix, payer contracts, size, and other factors.