Valuation of a Medical
Practice
Reed Tinsley, CPA, CVA,
CFP, CHBC
Need for a Valuation
• Practice Sale
• To another physician
• Acquisition by a hospital
• Acquisition by other entity
• Retirement/Withdrawal
• Buy/sell agreements
• Buy out value based on FMV
• Appraisal vs. formula methodology
Need for a Valuation
• Divorce
• Refer to all related state law
• Refer to all related state case law
• Merger
• Distribution of initial equity interests
• Distribution of sales proceeds
Need for a Valuation
• New Owner Buy-In
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•
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If buy-in will be based on FMV
Formula approach?
Structuring the buy-in
Tax reporting issues
• Litigation
Key Point #1
The "strength" of the practice's
income stream and what it
produces for the owner(s) is what
creates true value in a medical
practice.
Key Point #2
The key to a successful valuation is
deciding whether or not the
practice's future income stream will
mirror its present income stream.
Regulatory Issues
Impacting the Valuation
Process
Regulatory Issues
• Medicare Fraud and Abuse
• Known as the "anti-kickback law"
• Prohibits payments, offers, or
inducements of any remuneration for
referrals
• Issue: If acquisition price exceeds FMV,
transaction may be considered a
remuneration for referrals
• Generally applies to hospital acquisition
transactions
Regulatory Issues
• Stark II self referral law
• Prohibits physicians from making
referrals for designated health services,
• If a financial relationship exists between
the physician and the entity to which he
or she is referring
• Stark definition of FMV
Defining Fair Market Value
Stark II regulations states, as follows:
“Fair market value means the value in arm’s length transactions,
consistent with the general market value. “General market value’’
means 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, or the compensation that would be included in a service
agreement as the result of bona fide bargaining between wellinformed parties to the agreement who are not otherwise in a
position to generate business for the other party, on the date of
acquisition of the asset or at the time of the service agreement.
Defining Fair Market Value
Stark II regulations states, as follows:
Usually, the fair market price is the price at which bona fide sales
have been consummated for assets of like type, quality, and
quantity in a particular market at the time of acquisition, or the
compensation that has been included in bona fide service
agreements with comparable terms at the time of the agreement,
where the price or compensation has not been determined in any
manner that takes into account the volume or value of
anticipated or actual referrals.” (Federal Register, Vol. 69, No.
59, March 26, 2004, page 16128)
Valuation Note: This may restrict and prevent the use of certain
market comps
Defining Commercial
Reasonableness
Stark I regulations states, as follows:
• “With respect to determining what is “commercially reasonable,” any
reasonable method of valuation is acceptable, and the determination should
be based upon the specific business in which the parties are involved, not
business in general. In addition, we strongly suggest that the parties
maintain good documentation supporting valuation.” (Federal Register, Vol.
66, No. 3, January 4, 2001, page 919)
Also, Stark II regulations state the following:
• “An arrangement will be considered “commercially reasonable” in the
absence 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 (or family member or group practice) of similar scope and
specialty, even if there were no potential DHS referrals.” (Federal Register,
Vol. 69, No. 59, March 26, 2004, page 16093)
• Valuation Note: Just because a transaction may be “fair market value” does
not necessarily make it “commercially reasonable”
Regulatory Issues
• Private Inurement
• Applies to tax exempt hospitals - section 501
(c) (3)
• Defined: No part of a hospital's net earnings
may inure to the benefit of any private
individual
• Issue: Sales price in excess of FMV
KEY Factors
Impacting the
Valuation of a Medical
Practice
Key Factors
• Revenue and Cost
• Revenues
• Increasing or declining?
• Where did the revenues come from?
• Ongoing revenues?
• If owner(s) stays
• If owner(s) leaves
• One-time revenues?
Key Factors
• Revenue and Cost
• Revenues (continued)
• Revenue adjustments: Teaching, subsidies, Drug
studies, medical directorship, special service
revenues
• Impact of CPT coding
• New doctors ramping up their productivity
Key Factors
• Revenue and Cost
• Costs
• Comparable to similar practices
• Adjust to reasonable cost structure if
necessary
• Look for excess doctor-related costs that are in
reality disguised compensation
• Make using normalization adjustments
Key Factors
• Costs to pay attention to:
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•
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Salary costs
Physician direct expenses (Travel, CME)
Expiring leases
One-time costs
Adding costs as projected revenues
grows
Key Factors
• Medical Specialty
• Impacts future reimbursement patterns
• Review recent and anticipated changes
to coding and charge payment
• Impacts
• Adjustment for “reimbursement risk”
• Impact on discounted future cash flow
method – future revenues
Key Factors
• Referral Sources
• Applies to medical specialists
• Issue: Will these referrals continue into
the future uninterrupted?
• Obtain and analyze referring doctor report
• Analyze ages of the referring doctors
• Identify recent changes to referral patterns
• Impacts discount/capitalization rate or
future revenue stream
Key Factors
• Payer Mix
• Has direct impact on revenue stream
• Impacts what the practice is paid for the
services it renders
• Identify recent changes to practice payer
mix
• Ex. Growth in managed care and Medicare
• Anticipate future changes in payer mix
• Impacts reimbursement risk & revenue
projection
Key Factors
• Service Mix
• Identify how the practice generates its
revenues
• Obtain and analyze CPT Frequency Report
• Issue: Will these same services continue if
there is a change in practice ownership?
• Impacts future income stream
determination and related risks
Key Factors
• Patient Demographics
• Identify demographics of practice patients
• Issue: Will these demographics change in
the near future
• Move to a different a payer class which pays
more or less
• Ex. Patients moving into the Medicare program
• Impacts discount/capitalization rate
• Might impact revenue growth projection
Key Factors
• Future Changes to Reimbursement
• Has direct impact on income stream
• Issue: Continued payer changes in
reimbursement rates
• Medicare
• Managed Care
• Impacts discount/capitalization rate
• Impacts future earnings projection
Key Factors
• Practice Transition
• Issue: Will the current owner(s) be
available to assist in the transition to the
new owner?
• If yes, can expect to maintain revenues
• If no, anticipate a drop in patient volumes
or referrals
• Generally want a transition period of 6
mo.
Key Factors
• Competition
• Issue: Are there, or will there be,
competitors that will, or can, take
patients away from the practice now and
in the future?
• Is a practice “risky” if it doesn’t have
competition?
Review Data
Gathering
Checklist
Business tax returns for year 2010 - 2012
1. Detailed tax depreciation schedule for year 2012
2. If available from tax preparer, future depreciation report
If you use Quickbooks, please prepare and email a "Portable" backup file
(Please provide QB version and any related login information)
For years 2010, 2011 and 2012, please list all non-operating, non-recurring expenses paid in each year
If you do not use Quickbooks:
1. Financial statements for years 2010 -2012 on the cash basis of accounting; most recent 20__ financial statements
2. Most recent 20__ YTD comparative financial statements on the cash basis of accounting
3. YTD general ledger for years 2011, 2012, and YTD 2013
4. Current aging of vendor accounts payable
5. If available, total payments to individual vendors for years 2011 and 2012
Charges, collections, and adjustments for 2010, 2011 2012 and YTD 2013
1. For the Practice
2. By Individual Provider, including extenders
Listing of gross charges and collections by specific payer for 2011, 2012 and YTD 2013
Current summary aging of accounts receivable
1. Total for the practice
2. By Individual payer class
Current summary of accounts receivable – credit balances only
Current Daily Patient Visits by Individual Provider (if applicable to specialty)
1. Office
2. Inpatient (hospital visits)
Listing of all current practice employees, their current annual salaries and their job duties
1. Also provide list of employees and their 2012 W-2 wages
2. If available, employee organizational chart
Current practice fee schedule
CPT frequency report of the year 2010, 2011, 2012, and YTD 2013
1. For the practice
2. by Individual Provider, including extenders
Summary of all lease agreements (lease term, lease amount, remaining term on lease)
Fixed asset inventory (Please list all assets in each room of the office)
Most recent business property tax appraisal invoice
Summary of all current notes payable (original principal, interest rate, term of note, final payment
date)
List of top 8 managed care payers and current reimbursement rate received from each
(Also include reimbursement for the practice's top 20 CPT codes)
Provide narrative of reimbursement trends for the practice over the last 3 years
Copy of any prior valuation reports
Work RVUs by provider for year 2010, 2011, 2012 and YTD 2013 (if report available from billing
software)
Summary description of the practice (when started, services offered, etc)
Provide breakdown of age distribution of the patient base (ex. Ages 30-40: 35%)
List all expected capital expenditures in the next 5 years (ex. Computers, equipment, leasehold
improv)
Expected revenue growth in the next 5 years
1. Explain why you think revenue targets can be reached
2. Describe all internal and external factors that may impact your revenue stream in the next 5
years
Referring Doctor Report for years 2010, 2011, 2012 and YTD 2013 (if practice relies on physician
referrals for patient base)
Copy of partnership or shareholder agreement
Copy of any agreements with hospital
Discount and
Capitalization Rates
Capitalization Rate
• To "capitalize" means to convert the
income stream into an indication of
value by dividing or multiplying the
selected definition of the stream by
some factor, called a capitalization rate
• Is derived from the discount rate
Discount Rate
• A discount rate represents the total
expected rate of return (stated as a
percentage) that a buyer (or investor)
would demand on the purchase price of an
ownership interest in an asset (such as U.S.
Treasury bills) given the level of risk
inherent in that ownership interest
• Discount rate is used to derive present
value factors which are used to discount a
future benefit stream to a present value
Discount Rate
• Often calculated as the sum of (a) the "safe
rate," (b) equity risk premium, (c) risk
premium for size, and (d) a premium for
the amount of risk involved in the
investment
• Safe rate is intended to represent the
annual rate of return currently available
from investments offering maximum
security (and thus the lowest risk), and the
highest degree of liquidity
Discount Rate
• The equity risk premium is the extra return earned by an
average equity investor in excess of long-term Treasury
securities
• There is obviously more risk associated with a smaller
business than a major S&P 500 company; thus, everything
else being equal, investors in a smaller business will
demand a higher rate of return; this is the risk premium
for size
• The risk premium should take into account the (a) the risk
that the predicated amount of future income from the
investment will not actually be realized, and (b) risk of
future loss, through unforeseen circumstances, of part of
all of the principal amount invested
Target the Following Practice
Risks
• Competition risk
• Number of competitors is growing
• Reimbursement risk
• Evidence of changes to current
reimbursement rates and related future trends
• Market risk
• Evidence of changes to payer classes
• Ability to recruit physicians to practice
Concept of Practice
"Earnings"
Practice revenues
Less adjustments
Adjusted revenues
Practice overhead
Less adjustments
Adjusted overhead
Adjusted net income
Add: Owner compensation
Subtract: Replacement compensation
Equals: “Earnings”
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Earnings Surveys For
Replacement Compensation
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MGMA Physician Compensation Survey
MGMA Cost and Productivity Report
American Medical Group Practice Association
Modern Healthcare's Physician Compensation
Report
• Issue: Post-acquisition compensation – how to
handle
Valuation Methods
• Income Approach
• Capitalization of earnings
• Discounted future cash flow (income
approach)
• Asset Approach
• Workforce in Place?
• Market Approach
• Guideline Company
• Comparable Sales
Methodology Issues
• Discounted Cash Flow
• How to model future years
• Detail out revenues and expenses with
adjustments
• Summary approach
• Growth rate to use
• Anticipating capital expenditures
Methodology Issues
• Discounted Cash Flow (continued)
• How to calculate working capital needs
• Terminal year growth rate?
• How is real estate handled?
• Market Approach
• Is there really one for medical practices?
Questions
Answers
Reed Tinsley, CPA, CVA, CFP,
CHBC
Houston, Texas 77070
Direct Line: 281-379-5988
Direct Fax: 281-605-5701
www.rtacpa.com
Blog: http://rtacpa.blogs.com/