8 things to know about valuing physician practices

Physician practice acquisition and employment transactions are occurring at a feverish pace, and have been since 2009. Even after six years at this pace, significant consolidation is expected to continue with increasing numbers of physicians entering employment.

"Across the board, hospitals are trying to acquire everything they can get their hands on," Stuart A. Neiberg, MAcc, CPA, CFA, director with HealthCare Appraisers, said in a presentation at Becker's Healthcare's 13th Annual Spine, Orthopedic and Pain Management-Driven ASC Conference in Chicago.

According to Mr. Neiberg, changing reimbursement models under the Patient Protection and Affordable Care Act have driven these trends. Physicians are trying to align themselves with hospitals in any way they can, Mr. Neiberg said, which leads to valuation activity.

Here are eight things to know about physician practice transactions and valuation, according to Mr. Neiberg.

1. Physician employment continues to rise with acquisition activity. Along with significant consolidation comes significant physician employment, especially in certain specialties. "Five years ago, cardiology took a nosedive," Mr. Neiberg said. "It was the first wave of physician practice acquisitions. Now, buyers are moving to acquire primary care physicians and large multi-specialty physician practices." With most acquisitions, some sort of employment aspect is included. Hospitals do not want to buy a group and not have providers service the patients, according to Mr. Neiberg.

2. Most deals are structured as an asset deal with the subsequent employment of physicians and the buyer acquiring. "The hospital or health system wants to limit liability going forward; they want to buy assets and dissolve equity," Mr. Neiberg said. Asset deals include inventory, tangible assets and identified intangible assets, such as physicians, other clinicians, the EMR, well-known trade names or non-compete provisions, for example.

3. Practice acquisition is not just for hospitals and health systems. Now we are seeing acquisition activity pick up with payers and managed care administrators seeking to expand their networks, according to Mr. Neiberg.

4. Fair market value is the applicable standard of value for hospital acquisitions. Insurance companies are not necessarily subject to FMV standards, according to Mr. Neiberg. If they manage DHS funds like Medicare, they could be subject to FMV litigation, but commercial insurance and concierge pans do not.

5. Fair market value is slightly different in healthcare than in standard valuation. According to Mr. Neiberg, the healthcare definition of FMV is "the price at which property would change hands between a hypothetical, willing and able buyer and a hypothetical, willing and able seller, acting at arm's length in an open and unrestricted market, when neither is under compulsion to buy or sell." The deal must occur between two parties "who are not otherwise in a position to generate business for the other party."

6. There are three main valuation approaches: The income approach, the market approach and the asset, or cost, approach. The income approach is a way of determining value based on anticipated economic benefits. It essentially puts a single value on the expected future cash flows to the buyer. The market approach determines value by comparing businesses to similar entities that have been sold. It tends to offer little insight due to the difficulty of comparing unique businesses. The cost approach assigns value to a business based on the value of the assets net of liabilities, or how much the business would cost to recreate. It restates the entity's balance sheet, including its specific identifiable intangible assets.

6. Valuators are polarized on practice valuation approaches. Practice valuation can be a binary topic. Some valuators think practice valuation is based on the cash flows physician practices generate. However, "they do not generate tremendous cash flow because physicians take out a lot for compensation," said Mr. Neiberg. Meanwhile, other valuators exclusively look at practices by identifying its intangible assets and what it would cost to build from the base up. The central argument revolves around whether intangible value can exist in the absence of an income stream, which fully supports the intangible value. "Positions on either end are incorrect," Mr. Neiberg said. "We try to employ the approach of being in the middle."

7. There are right and wrong ways to generate intangible value in physician practices. According to Mr. Neiberg, good ways to generate intangible value include leveraging employed physicians or mid-level providers, providing ancillary services and performing allowed surgical procedures in office to receive site-of-service differential. Abiding by FMV, intangible value is not created by giving physicians credit for revenue enhancements or expense reductions generally unavailable in absence of a transaction.

8. Ancillary services within physician practices can potentially be considered stand-alone businesses. This occurs frequently in the valuation process of orthopedic practices. Ancillary services can be valued as stand alone businesses depending on whether an upfront investment would be required that might make a hypothetical buyer not want to invest, according to Mr. Neiberg. "Most orthopedic carve outs get sniff-test approved," he said. They are often valued with the income method. MRI carve-outs can generate a profitable revenue stream for example, whereas an ultrasound group in an OB/GYN practice might not. "It's not sniff-test approved; you don't see ultrasound-only facilities. They are usually part of larger imaging facilities," Mr. Neiberg said.


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