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The Back Page: A Quick Primer on Medical Practice Valuation

Written by Richard N. Beveridge, MBA   
July 14, 2008
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  Richard N. Beveridge, MBA
Today’s uncertain healthcare environment has spurred a new wave of medical practice buy-outs, mergers and purchases. Cardiology practices, which were previously perceived as being impervious to purchase offers by hospitals, are now becoming targets for purchase.

Cardiology services represent a significant portion of the total reimbursement outlay for healthcare services. As a result, cardiology reimbursement has become a major focus of the federal government and other payers as they seek to contain healthcare costs.

Facing decreasing reimbursement, increasing malpractice premiums and increasing practice overhead and operating costs, many cardiologists are seeking employment relationships with hospitals. To employ the cardiologists often means hospitals will purchase their practices. To complete the practice purchase, a fair market value (FMV) for the practice must be determined through performing a practice valuation.

In performing practice valuations, specific IRS and other legislative statutes and policies must be incorporated in the valuation to include the following: 
  • ? ?An FMV for the practice must be determined. Fair market value is defined as “the price at which a property would change hands between a willing buyer and a willing seller, neither being under compulsion to buy or sell and each having reasonable knowledge of relevant facts.”1

  •  ?The Stark Law FMV definition includes additional considerations such as the transaction must be “arm’s length,” and “not based on the volume or value of actual or future Medicare/Medicaid designated health services (DHS) referrals to the entity or any related entity” and the “value must be commercially reasonable even if the acquired physicians were to make no future Medicare/Medicaid DHS referrals to the entity or related entities.” 

  •  ?The Federal Anti-Kickback Statute requires that the FMV exclude from considerations any amounts, reimbursable under a federal health program, that reflect past or future referral streams or other business generated between the parties. 
There are three main approaches and associated methodologies for determining the FMV of a medical practice in which these statutes must be applied:

Income Approach, using the discounted cash flow method, involves projecting the practice’s future available cash flows and, by applying an appropriate discount or rate of return, determining the present value of the revenue streams. Major concerns with this method involve the accuracy of the cash flow projections and the determination of an appropriate rate of return.  

Market Approach, using the comparative transaction method, analyzes the share or transaction prices for similar practices that have been sold or valued in the public market. A major problem with this method is the lack of data on comparable practices that have been bought or sold within a specific market. In addition, the reason for performing the practice valuation on a comparable practice may affect the overall value, e.g., divorce, new shareholder buy-in, or shareholder buy-out.   

Asset-Based Approach, using the asset accumulation method, assesses the practice-specific assets and liabilities to arrive at the FMV. The practice’s tangible and intangible assets are valued using the cost, income and market methodologies. Tangible assets such as equipment are appraised and the FMV determined that takes into account depreciation, replacement cost, and functional obsolescence. Intangible assets such as patient charts and an assembled and trained staff are appraised using approaches such as market and replacement cost methods. Practice liabilities such as accounts payable and accrued payroll taxes and pension plan contributions are subtracted from the value of the assets to arrive at the FMV.

The FMV range for the practice is determined from application of the above mentioned approaches. Often, two practice valuations are performed: one for each party to the negotiations. The actual price paid for the practice is determined through negotiations between the willing buyer and the willing seller who have access to the information developed through the practice valuations.

Mr. Beveridge is president of Richard Beveridge & Associates, Salt Lake City, Utah. rbeveridge@rbaconsult.com.
Last updated on July 14, 2008 at 8:50 am EST