PYA Presents Intro to Healthcare Valuation

Healthcare Valuation 101
AICPA National Health Care Industry Conference
November 13, 2013

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Speaker Biography –
W. James Lloyd, CPA/ABV, ASA, CFE

American Institute of CPAs

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AICPA National Healthcare Industry Conference
Valuation 101
Agenda and Timeline


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Introduction


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Fair Market Value
• Revenue Ruling 59-60
• International Glossary of Business Valuation Terms
• Stark Law definition of FMV:
- Assets
- Service agreements
- Equipment leases
- Space rental

CMS commentary on FMV compensation
Federal Anti-Kickback safe harbors:
• Space rental
• Equipment rental

IRS definition of reasonable compensation


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Healthcare Laws and
Case Law Update


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Anti-Kickback statute and regulations:
• Section 1128B of the Social Security Act prohibits the offering,
paying, soliciting or receiving of any remuneration to induce or to
reward referrals of items or services payable by federal
healthcare programs, including Medicare and Medicaid. [42
U.S.C. §1320a-7b(b)]
• Covers referrals for any item or service that might be paid for by
Medicare or any other federal healthcare program
• Provides for criminal liability to both sides of an illegal
transaction, even where only one purpose of the remuneration
offered, paid, received, etc., is to obtain money in exchange for
referrals or to induce referrals


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United States v. Kats and United States v. Greber
interpreted the Anti-Kickback statute as being
violated if only one purpose of the remuneration is
to pay for a referral of goods or services, or to
encourage or induce referrals, even if another
purpose of the payment is to compensate the
individual for professional services or the payment
serves another legitimate purpose. [871 F.2d 105
(9th Cir. 1989); 760 F.2d 68 (3d Cir. 1985), cert.
denied, 474 U.S. 988 (1985)]


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Section 6402(f) of the Patient Protection and
Affordable Care Act (“PPACA”) added the following
two sub-sections to the Anti-Kickback statute:
• Claims for items and services provided to federal healthcare
program beneficiaries that violate the Anti-Kickback statute
constitute false or fraudulent claims for purposes of the Civil
False Claims Act [42 U.S.C. §1320(a)-7b(g)]
• A person does not need actual knowledge of the Anti-Kickback
statute or specific intent to violate the Anti-Kickback statute [42
U.S.C. §1320(a)-7b(h)]


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Key Anti-Kickback Statue (“AKS”) safe harbors:
[42 CFR §1001.952]
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Investment interests
Space rental
Equipment rental
Personal service and management contracts
Sale of a practice
Employees
Practitioner recruitment
Obstetrical malpractice insurance subsidies
Investments in group practices
Ambulatory surgical centers


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Emphasis of FMV in AKS safe harbors:
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Investment interests
Space rental
Equipment rental
Personal service and management contracts
Increased coverage, reduced cost-sharing amounts, or reduced
premium amounts offered by health plans
• Ambulatory surgical centers (pre-operational services)
• Price reductions offered by contractors with substantial financial
risk to managed care organizations
• Ambulance replenishing


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Examples of additional AKS compliance guidance:
• 1992 Letter from D. McCarty Thornton (“Thornton Letter”)
• Selected OIG Advisory Opinions
- Advisory Opinion 07-05
- Advisory Opinion 07-10, 09-05, 12-15
- Advisory Opinion 12-22
- Advisory Opinion 09-09, footnote 5
• OIG Special Fraud Alerts
- February 24, 2000: Rental of office space
• OIG Special Advisory Bulletin
- June 2001: Practices of Business Consultants
- “A valuation consultant promising or assuring a client that its
appraisal of a physician‟s practice will yield a “fair market
value” that satisfies the client‟s need for a particular
valuation, regardless of the actual value of the practice.”

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Stark Law
• Stark statute
- The federal physician self-referral prohibition (“Stark Law”)
prohibits a physician from referring Medicare patients for
designated health services (“DHS”) to an entity with which
the physician, or the physician‟s immediate family member,
has a financial relationship, unless the relationship meets the
specific requirements of a Stark exception. [42 U.S.C.
§1395nn]
- Prohibits the entity from submitting a claim (or causing a
claim to be submitted) to Medicare
- “Financial relationships” include both ownership and
compensation relationships.
- Strict liability statute – no intent to violate necessary


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Designated Health Services (“DHS”):
[42 CFR §411.355]
• Clinical laboratory services
• Physical therapy, occupational therapy, and outpatient speechlanguage pathology services
• Radiology and certain other imaging services
• Radiation therapy services and supplies
• Durable medical equipment and supplies
• Parenteral and enteral nutrients, equipment, and supplies
• Prosthetics, orthotics, and prosthetic devices, and supplies
• Home health services
• Outpatient prescription drugs
• Inpatient and outpatient hospital services


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Common Stark exceptions:
• General exceptions to both ownership and compensation:
[42 CFR §411.355]
- Physician services
- In-office ancillary services
- Academic medical centers
• Exceptions related to ownership or investment interests:
[42 CFR §§ 411.352 and 411.356]
- Physician-owned hospitals
- ACA prohibitions
- Grandfathered hospitals and expansion prohibitions


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Common Stark exceptions, cont’d:
• Exceptions related to compensation arrangements:
[42 CFR §411.357]
- Rental of office space
- Rental of equipment
- Bona fide employment
- Personal service arrangements
- Physician recruitment
- Isolated transactions
- Fair market value compensation
- Indirect compensation arrangements
- Obstetrical malpractice insurance subsidies
- Retention payments in underserved areas


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CMS Advisory Opinions
• Social Security Act requires that CMS issue written advisory
opinions on the Stark Law
• These opinions provide guidance on whether a physician's
referrals for DHS payable by Medicare to an entity with a
financial relationship are prohibited under Stark.
• Advisory opinions available to the general public at
www.cms.gov
• Provides a binding opinion on the application of Section 1877 to
specific factual situations


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Key Stark compliance concepts:
• Fair market value
- Academic Medical Center exception
- Rental of office space
- Rental of equipment
- Bona fide employment relationships
- Personal service arrangements
- Isolated transactions
- Group practice arrangements with a hospital
- Payments by a physician
- Fair market value compensation
- Indirect compensation arrangements


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Key Stark compliance concepts: cont’d
• The Stark regulations define fair market value as “the value in
arm‟s length transactions, consistent with the general market
value;” and general market value is defined as “the price that an
asset would bring as the result of bona fide bargaining between
well-informed buyer and sellers who are not otherwise in a
position to generate business for the other party, or
compensation that would be included in a service agreement, as
the result of bona fide bargaining between well-informed parties
to the agreement who are not otherwise in a position to generate
business for the other party, on the date of the acquisition of the
asset or at the time of the service agreement.” [42 CFR 411.351]


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Key distinction in the FMV definitions:
• The Stark definition prohibits consideration of the parties‟
positions to generate business for one another.
• Taking into account the ability to generate referrals can result in
FMV outside the healthcare industry, but is a fatal valuation error
under Stark.


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Key Stark compliance concepts, cont’d:
• Set in advance: [42 CFR §411.354(d)]
- Formula set forth in sufficient detail
- Objectively verifiable
- Not changed during the course of the agreement based on
referrals or other business generated
- Unit-based compensation must be FMV and does not vary
based on referrals of DHS
- CMS favorably considers percentage-based formulas for
personally performed services


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• Volume or value of referrals:
- Referral is defined as a request by a physician for, or
ordering of, or the certifying or recertifying of the need for,
any designated health service for which payment may be
made under Medicare Part B, including a request for a
consultation with another physician and any test or
procedure ordered by or to be performed by (or under the
supervision of) that other physician, but not including any
designated health service personally performed or provided
by the referring physician. [42 CFR §411.351]
- CMS favorably considers percentage-based formulas for
personally performed services


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• Commercial Reasonableness:
- The bona fide employment relationship exception, the fair
market value compensation exception, and the indirect
compensation arrangement exception all require that the
arrangement be “commercially reasonable.” The personal
services arrangement exception requires that the services
be “reasonable and necessary for legitimate business
purposes of the arrangement.” [42 C.F.R. §§ 411.357(c)(3),
(d)(1)(iii),(l)(4) and (p)(2)]
- The Stark regulations explain commercial reasonableness
as: “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 of similar scope and specialty, even if there were
no potential designated health services referrals.” [69 Fed.
Reg. 16093 (March 26, 2004)]

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Federal False Claims Act: [31 U.S.C. §3729]
• Any person who knowingly presents, or causes to be presented,
a false or fraudulent claim for payment or approval; knowingly
makes, uses, or causes to be made or used, a false record or
statement material to a false or fraudulent claim; conspires to
commit a violation
• Liability to the United States Government is a civil penalty of not
less than $5,000 and not more than $10,000, plus 3 times the
amount of damages, which the Government sustains because of
the act of that person [31 U.S.C. §3729(a)(7)]
• “Bootstrapped” by prosecutors to AKS and Stark claims


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Civil Monetary Penalties Law (“CMPL”):
[42 U.S.C. § 1320a-7a]
• Many types of CMPLs are set forth in the Social Security
Act, including CMPLs related to the following:
- Improperly filed claims
- Payments to induce reduction or limitation of services
- Authorization by Attorney General


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Emergency Medical Treatment and Active Labor Act
(“EMTALA”)[42 U.S.C. §1395dd]:
• Patients needing emergency care must be given a screening
examination.
• The ER must treat the patient until the patient is stabilized.
• If the hospital cannot treat the patient, it must transfer the patient
to a facility that can.
• Impact on ER staffing and on-call arrangements
- Hospital must maintain list of physicians who are on-call to
provide stabilizing treatment for patients with emergency
medical conditions
- Statute and regs are silent as to which medical specialties
must be represented by on-call physicians
- Lack of guidance for hospitals to use in resolving the issue of
physician emergency on-call coverage


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Tax Issues
• Federally tax-exempt organizations:
- Tax-exempt organizations under I.R.C. § 501 (c)(3) that
contract with physicians for services, must ensure that those
arrangements do not result in private inurement or convey
more than an insubstantial private benefit to avoid
jeopardizing tax-exempt status or risking an excise tax due
to an excess benefit transaction.


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Tax Issues, cont’d:
• Excess benefit transactions:
- Section 4958 imposes excise taxes on “disqualified persons”
and “organization managers” in connection with “excess
benefit transactions” between organizations exempt under
Section 501(c)(3) and “disqualified” persons.
- A disqualified person is a person with substantial influence
over an organization.
- If a physician is determined to be a disqualified person,
compensation paid must equal the value of services
provided.
- The value of services is “the amount that would ordinarily be
paid for like services by like enterprises (whether taxable or
tax-exempt) under like circumstances.”
- The regulations also note that a cap on compensation is a
relevant factor in determining the reasonableness of
compensation.

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Tax Issues, cont’d:
• Private inurement:
- An exempt organization must be operated exclusively for
charitable purposes, and no part of the organization‟s net
earnings may inure to the benefit of any private shareholder
or individual.
- Any amount of inurement may result in the Internal Revenue
Service‟s (“IRS”) revocation of an organization‟s tax-exempt
status.
• Rebuttable presumption of reasonableness:
- Treasury regulations provide for straightforward procedures
for insuring compliance with IRC Section 4958 intermediate
sanctions rules on reasonable compensation.


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Healthcare reform laws:
• Fraud and Abuse Revisions:
- Whole Hospital/Rural Provider Exception Revisions [PPACA
§6001]
- Stark Self-Referral Disclosure Protocol [PPACA § 6409]
- Anti-Kickback Statute – Enhanced Medicare and Medicaid
Program Integrity Provisions [PPACA § 6402]
• New Healthcare Delivery Models and Demonstration/Pilot
Programs
- Accountable Care Organizations
- Impact of quality-related payment and delivery system
reforms


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State Laws
• Certificate of Need Laws (“CON”):
- CON laws limit expansion of healthcare facilities and to
serve as barrier to market competition.
- Some state laws provide exemptions for relocations, capital
expenditures subject to threshold, change of ownership, and
acquisitions.
- Because of restrictions on establishing certain types of
healthcare facilities or offering of certain types of healthcare
services, CON laws may have significant value. [See 50
State Survey of Certificate of Need and Licensure: Nursing
Homes, Assisted Living, Home Health, and
Hospice, American Health Lawyers Association (2009)]


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State Laws, cont’d:
• State Anti-Kickback laws:
- Applicability to state Medicaid services
- Limitations of violations, duty to report, specific behavior
- Availability of safe harbor protection
• State Stark Laws:
- Applicable to specific payer or unlimited by payer type
- Applicable to broad “practitioner”
• State corporate practice of medicine laws
• State non-profit and charity laws


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Terminology and
Definitions


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Accountable Care Organization (ACO)
• The goal of an ACO should be to reduce, or at least control the
growth of, healthcare costs while maintaining or improving the
quality of care patients receive.
• ACOs need to have at least eight components:
- Complete and timely information about patients and the
services they are receiving
- Technology and skills for population management and
coordination of care
- Adequate resources for patient education and selfmanagement support
- A culture of team work among the staff of the practice
- Coordinated relationships with specialists and other
providers


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Accountable Care Organization (ACO), cont’d
• ACOs need to have at least eight components: cont‟d
- Coordinated relationships with specialists and other
providers
- The ability to measure and report on the quality of care
- Infrastructure and skills for management of financial risk
- A commitment by the organization‟s leadership to improving
value as a top priority, and a system of operational
accountability to drive improved performance


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Ambulatory Surgery Center (ASC)
• A freestanding entity that is specifically licensed to provide
surgery services performed on a same-day outpatient basis.
• A freestanding ambulatory surgery center does not employ
physicians.


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Ancillary Services
• Refer to healthcare services provided exclusive of room and
board
• Three categories
- Diagnostic
- Therapeutic
- Custodial
• Examples include:
- Supplies and laboratory tests provided under home care,
audiology, durable medical equipment (DME), ambulatory
surgical centers (ASC), home infusion, hospice care, skilled
nursing facility (SNF), cardiac testing, mobile lithotripsy,
fitness center, and radiology


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Anti-kickback Statute
• Federal statute
- Section 1128B of the Social Security Act is an intent-based
statute that prohibits the knowing and willful
offering, paying, soliciting or receiving of any remuneration to
induce or to reward referrals of items or services payable by
federal healthcare programs, including Medicare and
Medicaid. [42 U.S.C. § 1320a-7b(b)]


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Capitation
• A provider-reimbursement mechanism where a provider
organization receives a fixed, previously negotiated periodic
payment per member covered by the health plan in exchange
for delivering specified healthcare services to the members for a
specified length of time regardless of how many or how few
services are actually required or rendered.
• Per member per month (PMPM) is the commonplace calculation
unit for such capitation payments.


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Centers for Medicare & Medicaid Services (CMS)
• CMS is an agency within the US Department of Health & Human
Services responsible for administration of several key federal
healthcare programs, which include the following:
- Medicare
- Medicaid
- Children‟s Health Insurance Program (CHIP)
- Health Insurance Portability and Accountability Act (HIPAA)
- Clinical Laboratory Improvement Amendments (CLIA)
• CMS has also been charged with several key tasks for
advancing health IT, including implementation of electronic
health record incentive programs.


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Certificate of Need (CON)
• Originated to regulate the number of beds in hospitals and
nursing homes, and to prevent overbuying of expensive medical
equipment.
• Mandatory regulation through health planning agencies
determined the most urgent healthcare needs, contributed to
solutions for these needs, and attempted to manage the
fluctuations in prices often caused by a competitive market.
• The idea was that new or improved facilities or equipment would
be approved based only on a genuine need in a community.


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Collections Ratio
• The total amount of collections divided by the total amount of
charges posted by the practice.


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Contractual Adjustments
• Difference between charges and amounts received or due from
third party payers under contractual agreements.


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Conversion Factor
• A numerical figure, determined by the Health Care Financing
Administration, which is multiplied by the total RVU for a service
to determine its reimbursement amount


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Current Procedural Terminology (CPT)
• Uniform numbers assigned to every task and service a medical
practitioner may provide to a patient including
medical, surgical, and diagnostic services.
• CPT codes are used by insurers to determine the amount of
reimbursement that a practitioner will receive by an insurer.
• CPT codes are developed, maintained, and copyrighted by the
American Medical Association.


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Designated Health Services
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Clinical laboratory services
Physical therapy services
Occupational therapy services
Radiology
Radiation therapy services and supplies
DME and supplies
Parenteral and enteral nutrients, equipment and supplies
Prosthetics, orthotics and prosthetic devices
Home health services and supplies
Outpatient prescription drugs
Inpatient and outpatient hospital services


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Encounter
• A documented, face-to-face contact between a patient and a
provider who exercises independent judgment in providing
services to the patient


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Evaluation & Management (E&M)
• Includes a set of CPT codes ranging from 99201 to 99499
• Involves physician-patient encounters in either an office setting
or hospital setting


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Fee-for-Service
• Fee-for-service equivalent gross charges at the practice‟s
established undiscounted rates for all services provided to
patients under a commercial contract, or under a
Medicare/TEFRA, Medicaid, or similar state healthcare contract


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Healthcare Common Procedure Coding System
(HCPCS)
• HCPCS Level II coding system is a comprehensive,
standardized system that classifies similar products that are
medical in nature into categories for the purpose of efficient
claims processing.
• Used by Medicare and monitored by CMS


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Managed Care
• A system in which the provider of care is incentivized to
establish mechanisms to contain costs, control utilization, and
deliver services in the most appropriate settings.
• 3 Key Factors:
- Controlling the utilization of medical services
- Shifting financial risk to the provider
- Reducing the use of resources in rendering treatments to
patients
• 3 Types of Managed Care Plans:
- Health Maintenance Organizations
- Preferred Provider Organizations
- Point of Service


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Medical Group Management Association (MGMA)
• The MGMA survey reports national and regional physician
compensation and productivity data for 2,846 group
practices, primarily single specialty practices, representing
59,375 physicians and non-physician providers.


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Medicare Part B
• Helps cover medically-necessary services like doctors‟
services, outpatient care, home health services, and other
medical services to people who are age 65 or older
• Also covers some preventative services


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Medicare Physician Fee Schedule (MPFS)
• Physician Fee Schedule utilized by Medicare Part B, which lists
more than 7,400 unique covered services and their payment
rates
• Covered services include office visits, surgical
procedures, anesthesia services, and a range of other
diagnostic and therapeutic services


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Modifier
• Provides the means to report or indicate that a service or
procedure has been performed and has been altered by some
specific circumstance but not changed in its definition or code
• Enables health care professionals to effectively respond to
payment policy requirements established by other entities


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Payer Mix
• Refers to the entities other than the patient that finance or
reimburse the cost of health services.
• In most cases, this term refers to insurance carriers, other thirdparty payers, or health plan sponsors.


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Per-click
• Unit-of-service (per-click) payments in space and equipment
leases
• Prohibits payments to physician-lessor for DHS referred to
lessee by physician
• CMS is soliciting comments on prohibitions related to
arrangements involving DHS entities and physician-lessees


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Preferred Provider Organizations (PPO)
• A healthcare delivery system where providers contract with the
PPO at various reimbursement levels in return for patient
steerage into their practices and/or timely payment
• PPOs differ from other healthcare delivery systems in the way
they are financed, including providing more choice, benefit
flexibility, and enrollee access to providers and medical services
both in and out-of-network.


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Primary Care
• Primary Care specialties include the following:
- Family Practice: General
- Family Practice: Sports medicine
- Family Practice: Urgent care
- Family Practice: with Obstetrics
- Family Practice: without Obstetrics
- Geriatrics
- Internal Medicine: General
- Internal Medicine: Urgent care
- Pediatrics: Adolescent medicine
- Pediatrics: General
- Pediatrics: Sports medicine


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Procedural Coding
• A mechanism for identifying and defining physicians‟ and
hospitals‟ services
• Coding provides universal definitions and recognition of
diagnoses, procedures, and levels of care.


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Reimbursement
• The healthcare term that refers to the compensation or
repayment for healthcare services.
• Reimbursement is being repaid or compensated for expenses
already incurred or, as in the case of healthcare, for services
that have already been provided.
• Reimbursement of claims for healthcare services depends on
the assignment of CPT codes.


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Relative Value Unit
• The standardized method of analyzing resources involved in the
provision of services or procedures
• Nonmonetary, relative units of measure that indicate the value of
healthcare services and the relative difference in resources
consumed when providing different procedures and services
• Relative value units (RVUs) capture 3 components of patient
care:
- Physician Work RVU – the relative level of time, skill,
training, and intensity to provide a given service
- Practice Expense RVU – addresses the costs of maintaining
a practice including rent, equipment, supplies and nonphysician staff costs
- Malpractice RVU – generally the smallest component of the
RVU values and represents payment for the professional
liability expenses

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Resource Based Relative Value Scale (RBRVS)
• RBRVS is utilized to ensure fair and accurate valuation for all
physician services.
• The American Medical Association established a committee to
make annual recommendation regarding new and revised
physician services to CMS and performs broad reviews of the
RBRVS every five years.


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Stark Law
• The federal physician self-referral prohibition (“Stark Law”)
prohibits a physician from referring Medicare patients for
designated health services (“DHS”) to an entity with which the
physician, or the physician‟s immediate family member, has a
financial relationship, unless the relationship meets the specific
requirements of a Stark exception. [42 U.S.C. § 1395nn]


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Sustainable Growth Rate
• A component of the formula CMS uses to calculate physician
payments for providing services to Medicare patients


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Uncompensated Care
• Healthcare services by providers that don't get reimbursed,
usually because people don't have insurance and cannot afford
to pay for the cost of care


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Types of Healthcare
Transactions Being
Valued


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Valuation Opportunities
FMV Business Organization Acquisitions
• Hospital acquisitions of medical practices

FMV in Joint Venture Transactions
• Hospital and Physician
• Physician to Physician
• Hospital to Hospital

FMV Related to Facilities Lease Arrangements


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Valuation Opportunities, cont’d
FMV compensation involving Equipment Rental
Arrangements
FMV compensation in Personnel Employment
Leasing Arrangements
FMV compensation Medical Directorships
FMV On-Call Compensation
FMV and Hospital Physician Recruitment Programs


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FMV hospital/physician co-management
arrangements
FMV physician practice buy-in
FMV physician practice buy-out
FMV physician practice in divorce litigation
• Personal v. Enterprise Goodwill

FMV practice mergers


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Tax valuations
- Gifts
- Family limited partnerships
- Transfers

Litigation/Dispute Matters


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Introduction of Case
Study


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Hypothetical Case Study Scenario
Large orthopaedic practice located in a highly
competitive metropolitan market
• Approximately 20 physicians across several sub-specialties
• Multi-locations in close proximity to several hospitals
• Significant ancillary services including physical therapy
DME, imaging, and an ASC

Ancillary services = approximately 50% of
revenue
• Significant impact on pre-acquisition physician
compensation

Hospital is negotiating to acquire the practice
and employ the physicians

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Hypothetical Case Study, cont’d
Hospital utilized two outside appraisal firms
• One to value the business
• Another to evaluate the fair market value compensation for the
physicians‟ post-transaction employment arrangements

Proposed transaction terms:
• $20M upfront cash for the business
• 25% increase in the physicians‟ post-transaction compensation

Significant pressure to get the transaction closed
• Including from the Hospital‟s CEO


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Hypothetical Case Study, cont’d
Business appraiser bifurcated the practice and
valued the professional and ancillary service lines
separately
• Ancillary service lines valued based on discounted cash flow
method
• Remainder (professional component) valued based on net asset
value method
• The two value indications were then summed to determine the
$20M purchase price

Bifurcated approach resulted in a higher value
because no physician compensation expense in the
ancillary cash flows


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Hypothetical Case Study
Hospital’s general council requests an independent
commercial reasonableness assessment and
opinion before signing off on the deal.
Questions
• Is it commercially reasonable for the hospital to pay $20M
upfront for the practice utilizing a bifurcated valuation approach
for the ancillaries--especially when the non-bifurcated cash
flows would have produced a much smaller value?
• Is it commercially reasonable for the physicians‟ post-transaction
compensation to increase by 25% when their historical
compensation was significantly impacted from the ancillary
services they anticipate selling to the hospital for $20M?


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Healthcare Business
Valuation Approaches
and Methodology


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Valuation Approaches
There are three general approaches for valuing any
business/asset, which are:
• Asset (“cost”) Approach
• Income Approach
• Market Approach


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Asset Approach
Derives an indication of value based on the
anticipated cost to replace, replicate, or recreate the
asset
Generally used for non-operating-type entities
and/or businesses that generate no/nominal cash
flow
Net Asset Value Method


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Net Asset Value (“NAV”) Method
Provides an indication of value based on the entity’s
underlying assets and liabilities
Assets and liabilities are adjusted to their respective
current values, and then the liabilities are subtracted
Result = the entity’s net equity (i.e. “net asset”)
value
Often requires third party appraisals of the tangible
assets
Commonly used for businesses that lack positive
cash flow (e.g. physician practices with no excess
cash flow after subtracting the physicians’ fair
market value compensation

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Income Approach
Derives an indication of value based on the entity’s
earning power (i.e. ability to generate income/cash
flow for the owners).
Generally most applicable for operating entities with
positive earnings and growth prospects.
Primary methods include:
• Discounted Cash Flow Method
• Capitalized Income Method


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Discounted Cash Flow (“DCF”) Method
Provides an indication of value based on the entity’s
ability to generate positive net cash flow
• Net cash flow = the excess above all necessary operating costs,
working capital requirements, and capital expenditures
• Amount available for distribution to the owner(s)

Cash flows must be projected for a discrete period
of time and then discounted to present value
utilizing a risk-adjusted discount rate
Terminal period cash flows are capitalized.


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Capitalized Income Method
Uses a single period measure of net cash flow as a
proxy for future periods
Value determined by capitalizing the single-period
cash flow stream with a capitalization rate
• Capitalization rate = Discount rate – long term growth rate
• Assumes future cash flows will grow at the long-term growth rate

Primarily used for mature/low growth businesses
Often difficult to use for healthcare entities
• The past is not always a reliable indication of the future!


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Market Approach
Derives an indication of value based on market
transaction data involving similar businesses
Often difficult to use for small/medium-sized
healthcare entities due to substantial differences
across markets and other factors
Primary methods include:
• Guideline Public Company (“GPC”) Method
• Merger and Acquisition Transaction (“M&A”) Method


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Guideline Public Company Method
Utilizes valuation multiples developed from
guideline publicly traded companies
Guideline companies must be “sufficiently similar”
to the subject entity but not necessarily the same.
Common multiples include: price/earnings
(P/E), price/sales, price/beds, price/book value, etc.
Generally difficult to use for most small/mediumsized businesses


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Merger & Acquisition Transaction Method
Provides an indication of value by utilizing valuation
multiples developed from similar entities that have
been bought/sold
Requires reliable transaction data involving similar
businesses
Valuation multiples must be closely correlated to the
transaction price.
Irving Levin & Associates – good resource for
healthcare transaction data


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Valuation Adjustments


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Valuation Adjustments
Valuation adjustments are sometimes necessary to
“adjust” the preliminary value indication to fit the
particular facts and circumstances.
Common examples include:
•
•
•
•

Control premiums
Discounts for lack of control
Discounts for lack of marketability/liquidity
Adjustments for tax benefits associated with certain passthrough entities


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Control Premiums
Control premiums are positive adjustments to the
preliminary value indication.
Generally applicable when minority-level cash flows
are used to value a controlling interest
Increases the otherwise minority level indication of
value to a control level of value


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Discounts for Lack of Control (“DLOC”)
Controlling ownership interests are generally worth
more, on a per-share/unit basis, than minority
interests in the same business.
Empirical “control premium” studies are often used
to develop benchmark DLOC adjustments (the
inverse of a premium = discount).
Must consider the actual facts and circumstances
• Why would an investor likely pay a premium for control of the
subject entity?
• Governing documents and rights of ownership


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Discounts for Lack of Marketability
Everything else being equal, investments that can
be easily and quickly converted into cash are worth
more than investments that are illiquid.
Discounts for lack of marketability/liquidity are used
to adjust the value indication to a “cash equivalent”
basis.
Very facts-and-circumstances driven
Methodologies often controversial


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Pass-Through Tax-Benefit Adjustments
When valuing pass-through entities such as
LLCs, S-corporations, and
partnerships, adjustments may be necessary to
account for the more favorable tax benefits
associated with the ability to receive non-taxable
distributions as compared to taxable dividends
from C-corporations.
In theory – a hypothetical buyer would be willing to
pay more for an interest if the distributions were
non-taxable as compared to taxable.
Generally only applies to minority interests in passthrough entities

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Valuation Reports


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Types of Valuation Reports
There are several ways in which appraisers can
communicate their findings/conclusions including:
• Formal (i.e. full scope) reports
• Summary/restricted use reports
• Oral reports

The deliverable (i.e. how the appraiser
communicates his/her conclusions) should be
based on the particular facts and circumstances of
the engagement and needs of the client.


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Types of Reports, cont’d
Formal reports are very detailed (i.e. long) and
generally take a lot of time to prepare.
Restricted Use/Summary reports are summarized
versions of formal reports.
• These reports generally do not include the same level of detail
that would normally be in a formal report.

Oral reports are just oral communications of the
appraiser’s analysis and conclusions.
• Generally supplemented with supporting schedules


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In General - What Should Be Included in
Written Valuation Reports?
Client should be clearly identified
Intended purpose of the valuation should be clearly
explained
“As of” date should be identified
Standard of value should be stated and defined
Scope of services
• Full appraisal
• Calculation of value


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What Should Be Included in Written Valuation
Reports?
Overview of the business
Financial and operational analysis
Industry and economic factors/analysis
Valuation methodologies utilized and why including
discussion of key assumptions
Reconciliation of the various value indications and
conclusion
Certification
Assumptions and Limiting Conditions


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What Should Not Be In The Report
Excessive boilerplate
• Unnecessary language that does not add value to the analysis
or conclusion
• For example, ten pages of meaningless national economic
statistics as compared to only two pages of financial and
operational analysis regarding the subject business

Inappropriate and/or unnecessary analysis, such as:
• Inaccurate benchmark comparisons (e.g. cardiology practices to
family medicine, or large hospitals to critical access facilities)
• Meaningless ratios (e.g. debt to equity or inventory turnover
ratios for a small physician practice)


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Valuation of Healthcare
Compensation
Arrangements


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Valuation of physician compensation arrangements
•
•
•
•
•

Broad valuation approaches
Valuation methodology applicable to each approach
Applicability to types of compensation arrangements
Synthesis and reconciliation of methods
Compensation-specific issues in healthcare
- Stacked arrangements
- Result of arms-length negotiations between parties in a
position to refer healthcare beneficiaries does not create a
market or FMV


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Methodology applicable to cost-based approach
• Build-up methodology
- Build-up of components of value
- Individual components may be valued under cost, income,
and/or market approaches
• Avoided cost methodology
- Cost-to-replace
- Cost-to-recreate
- In other words, a make-or-buy analysis
• Prior rejected offers
• Opportunity cost restrictions


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Methodology applicable to income-based approach
• Professional fee income methods
- Applicable to certain personal service arrangements
- Limited to personally performed services
• Technical fee income methods
- Bears potential Stark risk, depending on the nature of the
analysis
- Applicable in limited circumstances
• Other income methods
- Lease arrangements
- Other arrangements may include income sources as proxy
for value
- Payer quality bonuses


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Methodology applicable to market-based approach
• Survey methods
- Published survey methods
- Ad hoc survey method
- Adaptations of survey methods for specific uses
- Conversion of annual survey results to hourly rates
- Decisions on levels of survey data


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Methodology applicable to market-based approach,
cont’d
• Scoring, algorithms or judgmental methods
- Factors applicable to physician responsibilities or duties,
including complexity and organizational implications
- Skill, experience, credentials, leadership and training
- Demand, unmet need and supply issues in the physician
specialty
- Productivity and/or profitability
- In on-call arrangements, degree of patient acuity; rotation,
frequency and intensity of call; restrictions on physician


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Methodology applicable to market-based
approach, cont’d
• Production-based methods
- Measures of productivity
- Published survey metrics
- Collections, net of TC and PE
- Encounters
- Work RVUs
- Ratio metrics
- Other metrics
- Interpolation of market data or matching techniques
- Application to multiple surveys
- Synthesis of results across surveys and production metrics


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approach, cont’d
• Guideline contracts method
- Healthcare contracts
- Same specialty or type of arrangement
- Different arrangements inside the healthcare industry
- Contracts outside the healthcare industry
• May represent only part of the equation, built up with others to
arrive at aggregate FMV for the entire arrangement


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cont’d
• Weaknesses of market data
- Lack of understanding or misinterpretation
- Misapplication
- Errors in data gathering and reporting
- Data not compatible (i.e., inclusion/exclusion of mid-level
providers, technical component services, modifiers)
- Misunderstanding of statistical data (i.e., use of upper
quartile/decile compensation-to-production ratios)
- Automatic tendency to gross up for inflation when
inappropriate


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cont’d
- Data tainted by referral relationships
- Small respondent sample sizes
- Variations in data
- Geographic
- Urban, rural
- Payer
- Outdated information
- Cherry-picking
- Survey respondent error


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approach, cont’d
• Mitigating factors
- Use of multiple surveys or market sources
- Weighting to account for weaknesses in market method
results
- Use of multiple, market-based methods
- Use of other approaches in addition to market-based
approach


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cont’d
• Other common errors
- Failure to recognize differences between W-2 earnings and
independent contractor payments and miscalculation of
gross-up payroll taxes, benefits and other costs (e.g.,
malpractice premiums)
- Assumption of equality between administrative and clinical
compensation values


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Commercial
Reasonableness:
What is it and How to
Assess it?


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Commercial Reasonableness
Department of Health and Human Services Definition1
• An arrangement which appears to be “a sensible, prudent business
agreement, from the perspective of the particular parties involved, even
in the absence of any potential referrals”

Stark Definition2
• “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 of similar scope and specialty, even if there were
no potential designated health services (“DHS”) referrals.”

OIG Threshold
• Compensation arrangements with physicians should be “reasonable
and necessary.”


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Several AKS harbors include references to
commercial reasonableness:
•
•
•
•

Space rental
Equipment rental
Personal services and management contracts
Sale of practices

Several Stark exceptions require commercial
reasonableness
•
•
•
•
•

Office space rental
Equipment rental
Bona fide employment
Group practice arrangements with hospitals
Personal service arrangements


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Disparity between FMV and commercial
reasonableness:
• A transaction can be neither FMV nor commercially reasonable
• A transaction can be FMV but not commercially reasonable
• An otherwise reasonable transaction can be caused to fail the
commercial reasonableness standard by excessive
remuneration

Parties to commercial reasonableness
• Legal Counsel – Legal counsel ensures services provided under
an arrangement do not overlap with existing agreements and
are structured properly with respect to regulatory standards, as
well as ensure agreed-upon compensation is within the range of
fair market value of a valuation opinion or internal
documentation.


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Parties to commercial reasonableness, cont’d
• Client – Ideally, the organization proposing an arrangement
should conduct a thorough investigation of commercial
reasonableness before legal counsel is involved. As a key role,
the organization should base its opinion of commercial
reasonableness on the opinion of personnel most acquainted
with the operational needs, financial alternatives, and clinical
requirements of the underlying arrangement.
• Valuator – A valuator‟s primary role in assessing commercial
reasonableness is to determine fair market value compensation
under the stated arrangement. Additionally, experienced
valuators may be able to provide helpful insight of industry and
market practices to assist in an opinion of commercial
reasonableness.


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Key Factors in Evaluating CR


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Sample questions for determining commercial
reasonableness
• Is the proposed arrangement for services reasonably necessary
for the organization‟s business operation? If so, why?
• Does the organization already provide the services proposed
under the arrangement?
• Does the arrangement advance the financial and/or strategic
goals of the organization?
• Will the proposed arrangement advance patient care, patient
satisfaction, and overall community benefit?
• Is the proposed compensation under the arrangement
consistent with fair market value?
• Can a financial return be expected for services performed under
the arrangement absent of referrals from the physician party to
the arrangement? If so, what? If not, why?


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Questions


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PYA Presents Intro to Healthcare Valuation

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