Concerns Raised on the Valuation of Surgery Centers (Advisory Opinion 09-9)

This advisory opinion relates to the start up of two simultaneous ASCs, one by a surgeon owned LLC and one by a hospital. The plan, as indicated in the advisory opinion, is to merge the two ASCs as they become operational and to value the two ASCs based on the then tangible value of the assets of the ASCs. The two ASCs were being developed simultaneously to attempt to avoid certificate of need concerns. It is also likely that there were other ulterior reasons for the approach that are not apparent in the opinion. For example, it is often the case that if a hospital merges its ASC into an existing surgery center or otherwise contributes a line of business into a surgery center, that line of business must be valued for purposes of determining the hospital's contribution. Surgeons often object to this. Here, it is likely that the physicians were greatly concerned that that would have a high value and that they would argue that they were paying for cases they actually generated at the hospital. The parties, in putting together this advisory opinion transaction, seemingly developed a situation where both developed an ASC at the same time and then merged them together. This helped reduced the risk that someone would take the position that the hospital's service line had to be valued as part of the contribution. It also put the two parties on the same grounds and made it easy to ask the OIG for an advisory opinion for both ASCs to be valued at tangible asset value.

The OIG in the opinion goes on to state some possible concerns with valuations of surgery centers performed based on a cash flow basis approach. This is contradictory to all principles of valuation which rely upon a cash flow analysis or an income approach as one of three cornerstone methods of valuing businesses. In essence, the three standard valuation approaches include replacement or cost approach, a market approach and an income approach (which is often based on a cash flow analysis). Most professionals and the Internal Revenue Service would argue that the income approach for this kind of cash flow is usually the most appropriate method by which to value an ongoing healthy business. Here are certain of the OIG's comments from Advisory Opinion 09-9:

"Our conclusion might be different if the valuation of the respective contributions of the investors included intangible assets. For example, given the circumstances of the Proposed Arrangement, we might be concerned if the valuation were based on a cash flow analysis of the Surgeon ASC as a going concern. Because the Surgeon Investors are referral for the Surgeon ASC, a cash flow-based valuation of that business potentially would include the value of the Surgeon Investors' referrals over the time that their ASC was in existence prior to the merger with the Hospital ASC. The result might be that the Surgeon Investors would receive a greater return on their capital investment than the Hospital, which could reflect the value of their referrals to the Surgeon ASC. (In these circumstances, the Hospital ASC, being newly developed at the time of the proposed merger, may have little or no cash flow record, but we might be similarly concerned with a valuation based on a cash flow analysis of a hospital-owned ASC for which the hospital could influence referrals). We do not assert that a cash flow-based valuation or other valuation involving intangible assets would necessarily result in a violation of the anti-kickback statute; the existence of a violation depends upon all the facts and circumstance of a particular case."

The OIG in its opinion does not say that using a cash flow analysis itself would violate the Fraud and Abuse Statute. It says instead, "We do not assert that a cash flow-based valuation or the valuation of the intangible assets would necessary result in a violation of anti- kickback statute; the existence of a violation depends upon all the facts and circumstances of a particular case."

This is an opinion where we perceive that the OIG may not have fully understood the driving rationale behind putting this type of planned merger together. In missing the understanding of what was really going on, they inadvertently made negative inferences with respect to one of the core methods of valuing a business. This provides some concern because the overwhelming number of transactional valuations in all sectors, including healthcare sectors, are based on some level of income approach or discounted cash flow analysis.

Contact Mr. Becker at (312) 750-6016 or at

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