The document discusses key considerations for medical practice valuation, including regulatory issues related to fair market value standards, the Stark Law, Anti-Kickback statutes, and tax laws. It covers various valuation approaches like asset, market, and income approaches. Specific methods covered include guideline public company method, precedent transactions method, and discounted cash flow method. The document emphasizes the importance of accounting for healthcare industry risks and regulations when conducting practice valuations.

1. Medical Practice Valuation
James P. Sacher, CPA
October 10, 2012

2. STANDARD OF VALUE
• What is the Standard of Value?
– Professional standards
– Stark Law

3. FAIR MARKET VALUE
“the price at which property would change
hands between a willing buyer and a willing
seller, when the former is not under any
compulsion to buy, the latter is not under
any compulsion to sell, and both parties
have reasonable knowledge of the relevant
facts” [Rev. Rul. 59-60, 1959-1 CB 237]

4. REGULATORY ISSUES
• Regulatory Issues
– Stark Law
– Anti-Kickback statues
– Tax laws

5. REGULATORY ISSUES
• Regulatory Issues
– Stark Law
• Financial relationship
• With an entity
• Designated health services
– Anti-Kickback statues
– Tax laws

6. REGULATORY ISSUES
• Regulatory Issues
– Stark Law
– Anti-Kickback statues
• Knowingly and willfully
• Intent to induce referral
• Solicited, offered or paid remuneration
– Tax laws

7. REGULATORY ISSUES
• Regulatory Issues
– Stark Law
– Anti-Kickback statues
– Tax laws
• Private Inurement – individual can‟t receive
organization‟s funds except at FMV
• Private Benefit
• Excess Benefit

8. REGULATORY ISSUES
• Regulatory Issues
– Stark Law
– Anti-Kickback statues
– Tax laws
• Private Inurement
• Private Benefit – tax exempt organized to serve the
public interest not private; no bright line test
• Excess Benefit

9. REGULATORY ISSUES
• Regulatory Issues
– Stark Law
– Anti-Kickback statues
– Tax laws
• Private Inurement
• Private Benefit
• Excess Benefit – transaction priced at higher than
market value with a disqualified person

10. STARK LAW DEFINITION
“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
well-informed 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. 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.” [42 C.F.R. 411.351]

11. STARK LAW DEFINITION
“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 well-informed 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.
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.” [42 C.F.R. 411.351]

12. STARK LAW DEFINITION
“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 well-informed 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.
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.” [42 C.F.R. 411.351]

13. APPROACHES
• Approaches to Valuation
– Asset based or cost approach
– Market approach
– Income approach

14. ASSET OR COST
• A standard balance sheet approach
• Convert historical balance sheet into
economic balance sheet
• Value both tangible and intangible assets
• Quantify liabilities
• Could be very time consuming

15. MARKET APPROACH
• Comparables
– Identification comparable transactions

16. MARKET APPROACH
• Comparables – Guideline companies
– P/E ratio
– MVIC to sales
– MVIC to EBIT
– MVIC to EBITDA

17. MARKET APPROACH
• Comparables
– But what is comparable?

18. MARKET APPROACH
• Comparables
– But what is comparable?
– Caracci, et al. v. Comm., 98 AFTR 2d2006-
5264 (456 f.3D 444) Key questions raised:
• What is required for market comparability
• What is reasonable knowledge of relevant facts
• What should be valued, assets or market value of
invested capital

19. CAUTIONS
• Cautions
– Level of payment for service varies radically from state to state
and even market to market
– Urban markets are dominated by a few health insurers who hold
significant influence over the fees paid to providers
– Very few insurers have national market coverage and those that
do have significant market share in only a few states
– Payor mix is critical
– Inconsistent with Stark regs.
– Requires in-depth analysis of revenues and future prospects
– Reality check

20. INCOME APPROACH
• Values the expected cash flows in the
future discounted by an appropriate cost
of capital rate
– Expected cash flow
– Risk of cash flow

21. INCOME APPROACH
Expected cash flow
EBIT x (1- tax rate)
+ Depreciation and amortization
+ Deferred taxes
- Capital expenditures
- Changes in working capital .
= Free cash flow

22. EBITDA
• EBIT
– Trying to get to cash flows independent of the
capital structure
– Cash flow is an after-tax concept
– Must be “normalized” to remove the effects of
private company discretionary spending

23. NORMALIZED EARNINGS
• Determining Normalized Earnings
– Services, charges, collections
• A sound valuation must make some determination
as to the appropriateness of the billing and coding
practices
– Reasonable compensation
• Benchmark data
• Compensation should reflect that of a non-owner
• Consider all compensation
– Other discretionary spending

24. MORE ON COMPENSATION
• Post Transaction Compensation
– Charles A. Derby v. Commissioner, TC
Memo 2008-45
– Determination of cash flow must be
reflective of post-transaction compensation

25. PROJECTED CASH FLOW
• Capitalization of Cash Flows
– Current operations are indicative of future
operations
• Discounted Cash Flows
– Future operations are expected to be
substantially different from current operations

26. CAPITALIZATION RATE
• Build Up Method
– Risk free rate of return
– Conversion of fixed income to equity security
– Industry and company specific risk factors
– Less a growth rate (remember it‟s healthcare)
This is really a discount rate minus a growth rate

27. DISCOUNT RATE
• Weighted Average Cost of Capital
– Reflects the anticipated capital structure

28. COMPUTING THE VALUE
Capitalization of Cash Discounted Cash Flows:
Flows:
Projected earnings stream
Average historical until stabilized
earnings (simple or (remember, it‟s
weighted) healthcare)
Capitalization rate Compute terminal value
Value for last year
Present value each year
by discount rate
Sum = Value

29. OTHER CONSIDERATIONS
• How to allocate purchase price
• Non-compete agreements
• Medical records
• Goodwill

30. ASSET ALLOCATION
• How to divide the purchase price?
• Sum of the parts must equal the whole
• Identify assets, including intangible assets
and those that don‟t appear on the books
• Start with most liquid assets first
• Work towards most illiquid
• Residual is goodwill

31. NON-COMPETE
• Non-Competition Agreements
– Complete valuation of business
– Estimate probability of competition in each
year of forecast
– Prepare alternative valuation assuming seller
competes; estimate profits attributable to seller
– Compute present value
– Present value of probability adjusted
difference is value of covenant

32. MEDICAL RECORDS
• Rarely show up as an asset on the balance
sheet
• Considerable value
• How to value?
• Further complication – EHR

33. GOODWILL
• Practice Goodwill vs. Personal Goodwill
• Practice goodwill
• Personal goodwill
• Leading case – Martin Ice Cream Co. v.
Commissioner [110 T.C. 189 (1998)]
• Why is this important
• Interesting caveat – who owns personal
goodwill?

34. SUMMARY
• Most healthcare related transactions must
be at fair market value
• Appraisers must be qualified and familiar
with healthcare issues and markets
• Sanctions are onerous
• Constant change requires appraisers to
understand healthcare and monitor change

35. QUESTIONS
James P. Sacher, CPA
Skoda Minotti | CPAs, Business & Financial
Advisors | Delivering on the Promise.
6685 Beta Drive
Mayfield Village, Ohio 44143
Phone - (440) 449-6800
Fax - (440) 646-1615
Email - jsacher@skodaminotti.com
Web site: www.skodaminotti.com