Physician Practice (

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Physician Practice ( Ancillary Business)
Valuation Appraisal Theory and Applications

Presented by Randy Biernat, CPA/ABV BKD, LLP
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Introduction

• Assumed Knowledge Level
• Types of Businesses to be Discussed
• Level of Detail for Presentation
• Standard Disclaimer

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Content Overview

• Current Trends Market Conditions
• Healthcare-specific Standard of Value
• Regulations Affecting Standard of Value
• Physician Practice Valuation Methods
• FMV in Physician Compensation
• Case Study
• Enforcement

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Healthcare Market Overview

• Consolidation Trends
• Push for Clinical Integration
• Impact of Healthcare Reform
• Reimbursement Trends
• Enforcement

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Drivers of Acquisition

• Consolidation of Market Share
• Declines in Reimbursement / Payor Mix
• Practice Recruitment / Succession Issues
• Capital Needs / EMR
• Anticipated Healthcare Reform Impact

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Anticipated Physician MA Activity

• Per 2011 Accenture physician employment survey

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What Physicians are Saying

• Only 29 of physicians are not in
• a financial relationship with a hospital.
• 56 of physicians want alignment to increase
  their incomes.
• 40 want to align to ensure a more consistent
  income stream.
• 90 thought physicians should be involved in
• Hospital performance improvement
• Hospital executive leadership
• Hospital board

We are ready
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Regulatory Environment

• Non-profit Compliance
• Anti-Kickback Statute
• Stark Law

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Non-profit Compliance

• What is it? Many hospitals are 501(c)(3)
  organizations and must be operated for public
  benefit (private benefit to insiders must be
  incidental)
• How does it apply to valuation? Payments in
  excess of FMV can trigger loss of non-profit
  status or intermediate sanctions

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Anti-Kickback Statute (AKS)

• What is it? A prohibition on the paying,
  receiving or offering remuneration in exchange
  for or to induce the referral of any item or
  service for which payment is made under a
  government program (e.g. Medicare)
• How does it apply to valuation? The explicit
  sale of referrals as developed in a valuation can
  be an indicator of an AKS violation

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Stark Law

• What is it? A prohibition on certain referrals
  which limits entities from billing government
  payors for services furnished, unless an
  exception applies
• How does it apply to valuation? The appraiser
  must understand the exception being utilized and
  the general implications of not paying for the
  value or volume of referrals

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Standard of Value

• From R.R. 59-60 to Healthcare FMV
• Entity to Compensation Valuation
• Implications to Appraisers

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Fair Market Value (R.R. 59-60)

• The typical standard of value is classically
  defined by Revenue Ruling 59-60
• The price at which property would change hands
  between a willing buyer and willing seller,
  neither party being under any compulsion to buy
  or sell, and both having reasonable knowledge of
  all relevant facts, with equity to both.

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Fair Market Value (Stark)

• the value in an arms length transactions,
  consistent with the general market value.
  General market value means the price that an
  asset would bring, as the result of a bona fide
  bargaining between well-informed buyers and
  sellers who are not otherwise in a position to
  generate business for the other party. (Stark
  regulations at 42 CFR 351)

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Fair Market Value (Stark)

• the definition of fair market value in the
  statute and regulation is qualified in ways that
  do not necessarily comport with the usage of the
  term in standard valuation techniques and
  methodologies. (Phase II 69 FR 16107 March
  26, 2004)
• Bradford Decision court acknowledges fair market
  value differences between Stark and traditional
  entity valuation standard of value

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Facts and Circumstances

• Ultimately, fair market value is determined
  based on facts and circumstances. The
  appropriate method will depend on the nature of
  the transaction, its location, and other
  factors. (Federal Register, Vol. 72, No. 171,
  CMS, 42 CFR Parts 411 and 424)
• The sum of regulations affecting R.R. 59-60 is
  what is called healthcare fair market value

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Implications of Healthcare FMV

• Avoid investment value
• No consideration of downstream referrals
• No consideration of hospital rates
• No consideration of specific economies of scale
• Limitations on use of opportunity cost
• Deal must make sense between purely arms-length
  players

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Commercial Reasonableness

• An arrangement will be considered commercially
  reasonable in the absences of referrals if the
  arrangement would make commercial sense if
  entered into by a reasonable entity of similar
  type and size and a reasonable physician of
  similar scope and specialty, even if there were
  no potential DHS referrals. (CMS definition in
  Stark interim final rule, phase II)

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Commercial Reasonableness v. FMV

• How are they different?
• Commercial reasonableness looks to the details of
  a specific transaction in a broader context than
  the payment calculated under the fair market
  value standard.
• What does this mean for appraisers?
• Check with counsel for how to apply!
• Limited guidance exists about how to apply the
  definition and where responsibilities lies for
  consideration and compliance.

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Tips on Applying Healthcare FMV

• Working closely with qualified counsel will help
  ensure you are making assumptions and using data
  consistent with the legal opinion
• To the extent possible, both parties should sign
  off jointly on major assumptions
• Trade offs in quality, timeliness, and
  believability will dictate whether or not an
  appraisal can be delivered

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Physician Practice Common Deal Terms

• 5 year term, (fixed compensation for 2-3 yrs.)
• 0 - 25 increase in pre-sale compensation
• Fixed assets separately appraised
• Nominal amount of intangible value
• Working capital excluded (Cash, A/R, A/P)
• Personal debts excluded
• Non-compete agreements to rival hospitals

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Asset Sale v. Stock Sale

• Buyers prefer asset sales (primarily for
  liability purposes), while sellers prefer stock
  sales (primarily for tax purposes)
• The practice value should reconcile under either
  approach. We begin with a stock sale assumption
  and then make adjustments to arrive at an asset
  sale value
• This reconciliation is useful for the parties

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Simultaneous Transactions

• Appraisers must have knowledge of the financial
  terms of any other simultaneous transactions as
  it affects the future cash flows of the selling
  entity
• It is not enough to assume a market-level of
  physician compensation if there is knowledge at
  the time of the transaction as to the actual
  future level to be paid

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Intangible Assets

• Appraisers must carefully consider any value
  assigned to intangible assets in determining fair
  market value
• This is probably the single highest risk factor
  in performing physician practice appraisal
• The standard of value dictates the assumptions
  allowed under a calculation of value, and in
  turn, impacts the valuation of intangibles

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Overview of Valuation Approaches

• Asset the sum of its individual, identifiable
  assets.
• Income the risk-adjusted present value of
  expected future cash flows.
• Market the applied relationship between
  practice value and revenue or cash flow from
  actual transactions in the marketplace.

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Valuation Approach Utility Debate

• Income Approach v. Asset Approach
• The two methods tend not to reconcile in
  physician practice valuation.
• That is, a cost to replace methodology (asset
  approach) typically provides a value in excess of
  a discounted cash flow methodology (income
  approach) when expected future compensation is
  scheduled to increase.

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Evaluating the Income Approach

• Pros
• Well known, trusted appraisal methodology for
  small businesses
• Inherently considers the future compensation in
  the practice price
• Cons
• Assumptions can be manipulated
• Intangible value is not specifically identified
• Methodology inherently captures referrals
• Approach pre-supposes that cash flow is the sole
  reason for investment

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Evaluating the Asset Approach

• Pros
• Indicated value is not tied to referrals in any
  way
• Specifically identifies the value of each
  intangible asset
• Cons
• Assumptions can be manipulated
• Does not account for future benefits/costs
  associated with transaction terms
• Does not require cash flow support the value of
  an intangible
• Does not supply any attribution of intangible
  return between corporate goodwill and individual
  goodwill

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Validity of Asset Approach

• 1996 IRS CPE Text on Practice Valuation
• a well trained, organized, and efficient work
  force is a valuable asset in any business The
  use of the cost approach is based on the premise
  that for a potential buyer to re-create the
  particular practice it has to hire and train a
  similar workforce that hiring/training process
  has identifiable costs for recruitment,
  orientation, training and lost salary that form
  the basis of the valuation process.
• Medical Practices have going concern value. The
  buyer of an existing practice purchases a turnkey
  operation and receives immediate value from the
  assembled workforce and other assets needed to
  operate the business.

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Validity of Asset Approach

• Tough questions of the asset approach
• Does workforce in place have the legal standing
  to be transferred?
• i.e., does an employment contract exist?
• Is there history to support the claim of a cost
  to replace?
• i.e., has historical employee turnover been
  considered?
• Is paying for an avoided cost to create a
  commercially reasonable action?

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Typical Intangible Assets Considered

• Workforce in Place
• Medical Records / EMR
• Trade name
• Know-how / Clinical Protocols
• Customer Lists
• Phone Numbers

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Impact of Linked Future Compensation

• Increased compensation is a form of purchase
  price consideration (Derby v. Commissioner)
• Determining the compensation offset
• In a DCF, the cash flow can be adjusted to
  reflect the higher compensation or a direct
  purchase price offset can be computed
• If the practice value is based on a Cost
  approach, the compensation offset must be done
  through a secondary calculation

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Hospital Losses

• Per Physician Losses (MGMA)
• Primary Care (Family Medicine)
• Range - 25,000 to (238,000)
• Median - (78,000)
• Hospital Revenue - 1.7M
• Medicine Specialists (Cardiology)
• Range - 103,000 to (248,000)
• Median - breakeven
• Hospital Revenue - 1.3M
• Surgical Specialists (Neurosurgery)
• Range - 73,000 to (921,000)
• Median (453,000)
• Hospital Revenue - 2.8M

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Business Valuation Key Considerations

• Future Compensation
• Key Personnel Contracts
• Support for Intangible Value
• Cost Replacement v. Goodwill

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Comparison of Approaches
Valuation Approach Physician Practice Ancillary Business Management Company Hospital
Asset Yes Yes Yes Yes
Income Typically, No Yes Yes Yes
Market No Yes No Yes
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Case Study 1 - Facts

• Hospital to acquire and employ 10 physician
  family practice (FP).
• Hospital has a not for profit tax status.
• Hospital believes employment will expand patient
  access and improve care coordination.
• FP average physician compensation is 180K
• FP will consider employment, but only if
  compensation is at least 200K.

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Case Study 1 FP Financial Summary
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Case Study 1 FP Benchmark
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Case Study 1 Asset Approach
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Case Study 1 Income Approach
The following simplified calculation shows the a
scenario analysis of average compensation paid
out relative to MGMA survey data
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Physician Compensation Red Flag
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MGMA Guidance

• When implementing a production-based
  compensation plan, practice managers must
  determine how to reward their highest producing
  physicians while reigning in compensation.
• Managers should also understand that increased
  compensation takes the form in increases in
  overall compensation not increases in
  compensation per unit of production.
• Source MGMA Physician Production and
  Compensation Survey, 2010 Report Based on 2009
  Data.

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MGMA Guidance - Graph
Source MGMA Physician Production and
Compensation Survey, 2010 Report Based on 2009
Data.
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Case Study 2 - Facts

• Hospital to acquire and employ 10 physician
  practice specializing in urology (Practice).
• Hospital believes employment will ensure
  long-term patient access, improve recruitment and
  enhance overall clinical integration.
• Practice is concerned by the potential for cuts
  to its professional fees and is willing to
  entertain offers for employment.

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Case Study 2 - Facts

• Practices total annual average physician
  compensation is 750K, consisting of

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Case Study 2 Practice Benchmark
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Case Study 2 Asset Approach
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Case Study 2 Income Approach
Professional Practice Business Segment Only
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Case Study 2 Income Approach
TC Business Segment Only (Radiation Therapy)
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Case Study 2 Value Reconciliation
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Case Study 2 Compensation

• How should one compare the 750K to survey data?

• The right answer, of course, depends on what is
  in the survey data.

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Regulatory Enforcement

• 4,100,000,000 recovered in 2010
• More scrutiny being applied to individuals and
  executives in terms of accountability
• Healthcare fraud recovery is becoming a political
  discussion point and funding source for various
  governments
• PPACA also designated funding for increased
  scrutiny on fraud, as well as tougher sentences

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Regulatory Enforcement

• 2011 enforcement included actions against 1,430
  defendants.
• There are believed to be hundreds of qui tam
  lawsuits under seal, awaiting judgment.
• New settlements and judgments seem to come out
  weekly.

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Questions Answers

Contact Information Randy Biernat, CPA/ABV BKD,
LLP Direct 317-383-4271 Email rbiernat_at_bkd.com