As the acquisition of physician practices has once again become a hot topic, hospitals may be considering payment for certain intangible assets. For regulatory purposes, these transactions must remain consistent with the fair market value (FMV) standard under the Stark Law and Anti-Kickback Statute.
The issue of paying for intangible assets as a component of a physician practice, when the practice is not projected to generate financial return to the buyer, has become a subject of intense debate. Valuators and legal counsel cannot seem to agree on when paying for intangible assets not supported by cash flow is appropriate. Additionally, with recent updates to the Stark Law, potential acquirers find themselves shouldering even more compliance responsibility.
According to the Stark II regulations: "... While good faith reliance on a proper valuation may be relevant to a party's intent, it does not establish the ultimate issue of accuracy of the valuation figure itself..."
Neither a health system nor a practice should rely on a valuation report without a thorough review of the various inputs considered. Specifically, finance executives should consider these points when reviewing the work of a valuation expert, prior to completing any transaction:
The valuation opinion must consider post-transaction compensation paid to the physicians. When physicians sell a practice to a hospital or health system, the physicians are generally expected to remain employees of the health system for a defined period of time, or indefinitely. Through an employment relationship, physicians may earn higher levels of compensation than they had earned historically as owners of their practices. Derby et al v. Commissioner, a United States Tax Court case decided in mid 2008, demonstrated that the projections used in a valuation must consider the actual compensation paid, post transaction. Simply adjusting compensation to the median level ignores a known variable that is crucial for an accurate valuation opinion. It should be noted that while post transaction compensation must be considered, such compensation should also be consistent with fair market value.
With consideration given to post-transaction physician compensation, the practice should generate profitability on a stand-alone basis. The perspective of a hypothetical purchaser is required under valuation theory in determining fair market value. Under this standard, synergies or changes that are attributable to a specific buyer (e.g. higher hospital or facility based reimbursement) should likely not be considered.
No incremental value associated with identifiable intangible assets should be included in the value of the practice, unless those assets can generate cash flow on a standalone basis. An Internal Revenue Service (IRS) text entitled "Valuation of Medical Practices" indicates that the value of the practice should be based on the cash flows that are capable of being generated by the practice (i.e., the Income Approach to valuation). According to the IRS, only when this value exceeds the value of the practice's fixed assets should value be allocated to intangibles.
In the context of acquisitions of physician practices by hospitals, profitability is what the practice can generate, absent any synergies from a specific buyer and with consideration given to actual post-transaction physician compensation.
Most valuators in the healthcare industry would agree that physician practices have value in excess of tangible asset value to a health system in its local market. The regulatory environment prevents hospitals from purchasing physician practices at amounts in excess of their value on a standalone basis.
While this topic remains a much debated issue in the market, most of the authoritative writings on the subject take the position that intangible value cannot exist absent the support of the Income Approach. The finance executive must be very aware of the circumstances where an appraiser may be taking a different view on this subject.
Whether or not intangible value exists under a cost approach should be a point evaluated based on the facts and circumstances of the particular valuation and very well supported by documentation from the appraiser. This documentation should be well-understood and commonly accepted by knowledgeable healthcare legal counsel, given the Stark and other regulatory implications that could be triggered by relying on an opinion that is inconsistent with generally held valuation practice.
Kyle W. Rudduck, is a consultant in valuation services for Sinaiko Healthcare Consulting, a division of Altegra Health. Curtis H. Bernstein and Thomas J. Cuccia are directors of valuation services for Sinaiko Healthcare Consulting.