Physician Practice Acquisitions by Hospitals

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Tennessee Society of CPAs 2010 Healthcare Conference

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  • So what does this mean in the context of a physician practice? In summary, it means that fair market value is the amount determined from the perspective of a pool of potential investors in an arm’s-length transaction based solely on the underlying financial merits of the practice. Accordingly, the assumptions used to value the practice must be void of any potential synergies or other benefits that a particular buyer (i.e., hospital) might be able to achieve post acquisition, such as higher volume or reimbursement rates. Consideration of such synergies would generally change the standard of value from fair market value to investment value . This is often a challenging issue for physicians to grasp and accept because such synergies often do exist.
  • Physician Practice Acquisitions by Hospitals

    1. 1. Physician Practice Acquisitions by Hospitals Presented by W. James Lloyd, CPA/ABV, ASA Tennessee Society of CPAs 2010 Healthcare Conference November 30, 2010
    2. 2. Speaker Biography – W. James Lloyd <ul><li>W. James (Jim) Lloyd is a shareholder and valuation services practice leader at Pershing Yoakley & Associates, P.C. Jim has valued hundreds of businesses and related intangible assets spanning a broad range of industries including healthcare, banking, manufacturing, real estate, and wholesale distribution among others. In addition to being a Certified Public Accountant, Mr. Lloyd has earned multiple professional credentials relevant to business valuation and dispute services including the Accredited in Business Valuation (ABV) credential from the American Institute of CPAs, Accredited Senior Appraiser (ASA) credential from the American Society of Appraisers, and the Certified Fraud Examiner (CFE) credential from the Association of Certified Fraud Examiners. </li></ul><ul><li>Jim is a frequent speaker at various national and regional conferences on valuation and litigation related topics and holds leadership roles with several professional organizations including the American Institute of CPAs and the American Society of Appraisers. </li></ul><ul><li>Expert testimony experience includes federal and various state and local courts and arbitration proceedings across the United States. </li></ul>Page
    3. 3. Agenda Page
    4. 4. Common Types of Physician Alignment Strategies Page
    5. 5. Physician Practice Acquisitions - “Buy and Employ” Transactions Page
    6. 6. Transaction Drivers Lifestyle preference and practice patterns Increasing specialization/aging Decreasing supply… Increasing pressure… Healthcare reform Operating costs Page
    7. 7. “ Buy and Employ” Transactions <ul><li>Typical Transaction: </li></ul><ul><ul><li>Hospital buys the practice at FMV </li></ul></ul><ul><ul><ul><li>Usually structured as an asset purchase </li></ul></ul></ul><ul><ul><ul><li>Cash and AR normally excluded </li></ul></ul></ul><ul><ul><li>Physicians employed by the hospital – generally under some type of productivity based compensation arrangement </li></ul></ul>Page “ Buy and Employ” Transactions
    8. 8. Buy and Employ Transactions – Key Issues <ul><ul><li>Key Issues: </li></ul></ul><ul><ul><ul><li>Fair market value of the practice </li></ul></ul></ul><ul><ul><ul><li>Fair market value of the compensation arrangement </li></ul></ul></ul><ul><ul><ul><li>Commercial reasonableness </li></ul></ul></ul><ul><ul><ul><li>Buyer’s side due diligence </li></ul></ul></ul><ul><ul><ul><li>Accounting for the transaction </li></ul></ul></ul>Page “ Buy and Employ” Transactions
    9. 9. Navigating the Regulatory Environment Page IRS Stark Anti- Kickback
    10. 10. Compliance Issues Regarding Hospital-Physician Financial Relationships Fair Market Value ________________________________________________________________________ Cents ________________________________________________________________________ Scope : Range of Dollars Only Key Question : “How Much”? Commercial Reasonableness ________________________________________________________________________ Sense ________________________________________________________________________ Scope : Overall Arrangement Key Question : “Why”? Two Components Page
    11. 11. Commercial Reasonableness <ul><li>Department of Health and Human Services Definition 1 </li></ul><ul><ul><li>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.” </li></ul></ul><ul><li>Stark Definition 2 </li></ul><ul><ul><li>“ 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.” </li></ul></ul><ul><li>OIG Threshold </li></ul><ul><ul><li>Compensation arrangements with physicians should be “reasonable and necessary.” </li></ul></ul>1 63 Fed. Reg. 1700 (Jan. 9, 1998). 2 69 Fed. Reg. 16093 (March 26, 2004). 3 “OIG Compliance Program For Individual and Small Group Physician Practices,” Notice, 65 Fed. Reg. 59434 (Oct. 5, 2000); OIG Advisory Opinion No. 07-10, September 20, 2007, pg. 6, 10; “OIG Supplemental Compliance Program Guidance for Hospitals,” Notice, 70 Fed. Reg. 4858 (Jan. 31, 2005). Page
    12. 12. Factors in Determining CR Business Purpose Provider Analysis Facility Analysis Resource Analysis Independence & Oversight Commercial Reasonableness Determination Page
    13. 13. Fair Market Value <ul><li>IRS Definition 1 </li></ul><ul><ul><li>Fair market value (“FMV”) is defined as the amount at which property would change hands between a willing seller and a willing buyer when neither is under compulsion and both have reasonable knowledge of the relevant facts </li></ul></ul><ul><li>OIG/Stark Definition 2 </li></ul><ul><ul><li>The value in arm’s-length transactions, consistent with the general market value </li></ul></ul><ul><ul><li>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 </li></ul></ul>1 Estate Tax Reg. 20.2031.1-1(b); Revenue Ruling 59-60, 1959-1, C.B. 237. 2 Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations. Page
    14. 14. FMV of the Practice – Key Concepts Page
    15. 15. Methods Typically Used to Value Physician Practices Page
    16. 16. Which Method is Appropriate? <ul><li>If the practice has intangible value (such as goodwill), an income approach should be used </li></ul><ul><li>If the practice does not have intangible value, the NAV method should be used </li></ul>It Depends… Page
    17. 17. Enterprise Value vs. Intangible Value <ul><li>The sum total of the tangible and intangible assets can not exceed the total enterprise value! </li></ul><ul><li>Example: </li></ul><ul><ul><li>If the enterprise value = $2 million (e.g. determined from DCF Method) </li></ul></ul><ul><ul><li>And the tangible assets (e.g. net working capital and fixed assets) = $1,200,000 </li></ul></ul><ul><ul><li>Then, intangible asset value can not exceed $800,000 </li></ul></ul>Page
    18. 18. Assessing Intangible Value The existence of intangible value primarily comes down to cash flow Physician groups that generate positive cash flow (above the physician’s “normalized” compensation based on professional productivity) will normally have some level of intangible value Practices that do not produce such positive cash flow, generally will not have intangible value Page
    19. 19. Certain practices are more likely to have intangible value <ul><li>Large multi-specialty practices with mid-level providers and significant ancillary revenue are more likely to have intangible value </li></ul><ul><ul><li>Reason: they generate revenue above and beyond the professional fees produced by the physician’s personal efforts. </li></ul></ul><ul><li>Small highly specialized practices (e.g. general surgeons) are less likely to have intangible value because all revenue is professional fees generated by the physicians personal efforts </li></ul>Page
    20. 20. Inappropriate Methods/Approaches Page
    21. 21. 1992 Mac Thornton “no goodwill” letter <ul><li>The OIG has expressed anti-kickback concerns over hospitals paying any intangible value for physician practices. </li></ul><ul><li>See: letter from D. McCarty Thornton(Associate General Counsel, Inspector General Division) to T.J. Sullivan (Office of the Associate Chief Counsel, IRS) dated December 22, 1992 regarding the OIG’s views concerning AKS and physician practice acquisition transactions. http://oig.hhs.gov/fraud/docs/safeharborregulations/acquisition122292.htm . </li></ul>Page
    22. 22. Financial Analysis and Due Diligence <ul><li>Before choosing and applying one or more valuation methods, the practice should be analyzed to assess its operations and earnings capacity </li></ul><ul><li>Appropriate buyer’s side due diligence should be performed to identify risk factors and opportunities for improvement </li></ul>Page
    23. 23. Buyer’s Side Due Diligence Page
    24. 24. Balance Sheet Analysis Page
    25. 25. Balance Sheet Analysis <ul><ul><li>Key issues: </li></ul></ul><ul><ul><ul><li>Do the assets actually exist? </li></ul></ul></ul><ul><ul><ul><li>Are the assets still being used in the practice? </li></ul></ul></ul><ul><ul><ul><li>Condition of the equipment – upgrades and service agreements </li></ul></ul></ul>Page <ul><ul><li>Often have very little “book value” and/or resale value </li></ul></ul><ul><ul><li>However, will have “in-use” value as long as being used in the practice </li></ul></ul>Fixed Assets
    26. 26. Balance Sheet Analysis Page
    27. 27. Revenue Analysis <ul><li>Net revenue per procedure </li></ul><ul><ul><li>Trends (year-to-year comparisons) </li></ul></ul><ul><ul><li>Benchmark (e.g. against Medicare rates for reasonableness) </li></ul></ul>Net revenue per provider (assess risk) <ul><li>Ancillary revenue </li></ul><ul><ul><li>should normally be analyzed separately (technical vs. professional revenue and expenses) </li></ul></ul>Page
    28. 28. Operating Expenses <ul><li>Year-to-year and benchmark comparisons </li></ul><ul><li>Physician labor costs </li></ul><ul><li>Non-physician labor costs </li></ul><ul><li>Facilities </li></ul><ul><li>Medical supplies </li></ul><ul><li>Other </li></ul>Physician compensation should be “normalized” based on productivity (collections or wRVUs) Physician compensation used to value the practice should be reflective of the expected post-transaction compensation Page
    29. 29. Accounting for the Transaction Hospitals acquiring physician practices must account for the transaction under the “acquisition” method. Accordingly, the transaction price (including debt assumed) must be allocated among the identifiable assets acquired from the transaction. Goodwill is recorded as the difference between the transaction price and the identifiable assets. Page
    30. 30. ASC 805, Business Combinations (SFAS 141R) Page
    31. 31. Key Terms and Definitions <ul><li>Identifiable Intangible Asset – </li></ul><ul><li>An intangible asset is considered identifiable if it either: </li></ul><ul><ul><li>Is separable, that is, capable of being separated or divided from the entity individually or together with a related contract, identifiable asset, or liability, regardless of whether the entity intends to do so; or </li></ul></ul><ul><ul><li>Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights or obligations. </li></ul></ul><ul><ul><li>Source: ASC 805-20-25-1 through 25-10. </li></ul></ul>Page
    32. 32. Categories of Intangible Assets (Separable From Goodwill) <ul><li>Marketing related intangible assets </li></ul><ul><ul><li>Trademarks, trade names, service marks, etc </li></ul></ul><ul><li>Customer related intangible assets </li></ul><ul><ul><li>Customer lists, production backlog </li></ul></ul><ul><li>Artistic related intangible assets </li></ul><ul><li>Contract related intangible assets </li></ul><ul><li>Technology-based intangible assets </li></ul>Page
    33. 33. Key Terms and Definitions <ul><li>Fair Value Standard of Value </li></ul><ul><li>Defined as: “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” </li></ul><ul><ul><li>Accordingly, the price is based upon a hypothetical transaction for the subject asset or liability at the measurement date, considered from the perspective of a market participate that holds the asset or owes the liability </li></ul></ul><ul><ul><li>Source: ASC 820-10-20 (formerly SFAS 157, paragraph 5) </li></ul></ul>Page
    34. 34. Key Terms and Definitions <ul><li>Market Participants Are buyers and sellers in the principal (or most advantageous) market for the asset or liability that have all the following characteristics: </li></ul><ul><ul><li>Independent of the reporting entity (non-related party) </li></ul></ul><ul><ul><li>Knowledgeable, having a reasonable understanding about the asset or liability and the transaction based on all available information, and </li></ul></ul><ul><ul><li>Willing and able to transact for the asset or liability </li></ul></ul><ul><ul><li>Source: ASC 820-10-20 (formerly SFAS 157, paragraph 10) </li></ul></ul>Page
    35. 35. Key Terms and Definitions <ul><li>Exit Price Fair value represents the price that would be received from selling the asset or paid to transfer the liability, which is an “exit” price concept. </li></ul><ul><li>In contrast, the transaction price is referred to as an “entry” price. </li></ul><ul><li>The exit price does not always equal the transaction price. </li></ul><ul><li>Source: ASC 820-10-30-2 (formerly SFAS 157, paragraph 7) </li></ul>Page
    36. 36. Key Terms and Definitions <ul><li>Principal (or most advantageous) Market Fair value assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. </li></ul><ul><li>The principal (or most advantageous) market (and therefore, the market participants) should be considered from the perspective of the reporting entity. </li></ul><ul><li>Source: ASC 820-10-35-5 (formerly SFAS 157, paragraph 8) </li></ul>Page
    37. 37. Key Terms and Definitions <ul><li>Highest and Best Use Fair value assumes the highest and best use for the asset by market participants, considering the use of the asset that is physically possible, legally permissible, and financially feasible at the measurement date. </li></ul><ul><ul><li>Note: the “legally permissible” provision is particularly significant for healthcare entities and will most likely result in fair value = fair market value in many cases. </li></ul></ul><ul><li>Source: ASC 820-10-35-12 (formerly SFAS 157, paragraphs 12 – 13) </li></ul>Page
    38. 38. Applicability to Physician Practices <ul><li>Identifiable intangible assets encountered in connection with physician practice acquisitions are normally contractual in nature, such as: </li></ul><ul><ul><li>Non-competition agreements </li></ul></ul><ul><ul><li>Clinical trial contracts </li></ul></ul><ul><ul><li>Favorable lease agreements </li></ul></ul><ul><ul><li>CONs (depending upon the type of practice) </li></ul></ul><ul><li>Does not include workforce in place (considered part of goodwill) </li></ul>Page
    39. 39. Applicability to Physician Practices – Con’t <ul><li>For physician practices with significant ancillary revenue, should free standing or hospital based reimbursement rates be used for purposes of measuring the fair value of the purchased intangible assets? </li></ul>Page
    40. 40. Questions? <ul><li>Contact Information: </li></ul><ul><li>W. James Lloyd, CPA/ABV, ASA </li></ul><ul><li>Shareholder | PYA </li></ul><ul><li>[email_address] | 865-673-0844 </li></ul><ul><li>www.pyapc.com </li></ul>Page

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