physician practice acquisitions by hospitals
DESCRIPTION
Tennessee Society of CPAs 2010 Healthcare ConferenceTRANSCRIPT
Physician Practice Acquisitions by Hospitals
Presented by W. James Lloyd, CPA/ABV, ASA
Tennessee Society of CPAs2010 Healthcare Conference
November 30, 2010
Prepared for TSCPA – 2010 Healthcare ConferenceNovember 30, 2010
Speaker Biography – W. James Lloyd
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.
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.
Expert testimony experience includes federal and various state and local courts and arbitration proceedings across the United States.
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Agenda
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Common Types of Physician Alignment Strategies
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Physician Practice Acquisitions - “Buy and Employ” Transactions
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Transaction Drivers
Lifestyle preference and practice
patterns
Increasing specialization/aging
Decreasing supply…
Increasing pressure…
Healthcare reform
Operating costs
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“Buy and Employ” Transactions
• Typical Transaction:
– Hospital buys the practice at FMV
• Usually structured as an asset purchase
• Cash and AR normally excluded
– Physicians employed by the hospital – generally under some type of productivity based compensation arrangement
“Buy and Employ”
Transactions
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Buy and Employ Transactions – Key Issues
“Buy and Employ”
Transactions
• Key Issues:
Fair market value of the practice
Fair market value of the compensation arrangement
Commercial reasonableness
Buyer’s side due diligence
Accounting for the transaction
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Navigating the Regulatory Environment
IRS Stark
Anti-Kickback
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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
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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.”
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. 0710, September 20, 2007, pg. 6, 10; “OIG Supplemental Compliance Program Guidance for Hospitals,” Notice, 70 Fed. Reg. 4858 (Jan. 31, 2005).
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Factors in Determining CR
Business Purpose
Provider Analysis
Facility Analysis
Resource Analysis
Independence & Oversight
Commercial
Reasonableness
Determination
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Fair Market Value
• IRS Definition1
– 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
• OIG/Stark Definition2
– The value in arm’slength transactions, consistent with the general market value
– The price that an asset would bring as the result of bona fide bargaining between wellinformed 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 wellinformed 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
1Estate Tax Reg. 20.2031.11(b); Revenue Ruling 5960, 19591, C.B. 237.2Federal Register / Vol. 69, No. 59 / Friday, March 26, 2004 / Rules and Regulations.
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FMV of the Practice – Key Concepts
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Methods Typically Used to Value Physician Practices
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Which Method is Appropriate?
• If the practice has intangible value (such as goodwill), an income approach should be used
• If the practice does not have intangible value, the NAV method should be used
It Depends…
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Enterprise Value vs. Intangible Value
• The sum total of the tangible and intangible assets can not exceed the total enterprise value!
• Example:
– If the enterprise value = $2 million (e.g. determined from DCF Method)
– And the tangible assets (e.g. net working capital and fixed assets) = $1,200,000
– Then, intangible asset value can not exceed $800,000
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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
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Certain practices are more likely to have intangible value
Large multispecialty practices with midlevel providers and significant ancillary revenue are more likely to have intangible value
Reason: they generate revenue above and beyond the professional fees produced by the physician’s personal efforts.
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
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Inappropriate Methods/Approaches
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1992 Mac Thornton “no goodwill” letter
• The OIG has expressed antikickback concerns over hospitals paying any intangible value for physician practices.
• 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.
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Financial Analysis and Due Diligence
• Before choosing and applying one or more valuation methods, the practice should be analyzed to assess its operations and earnings capacity
• Appropriate buyer’s side due diligence should be performed to identify risk factors and opportunities for improvement
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Buyer’s Side Due Diligence
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Balance Sheet Analysis
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Balance Sheet Analysis
Key issues:
• Do the assets actually exist?
• Are the assets still being used in the practice?
• Condition of the equipment – upgrades and service agreements
• Often have very little “book value” and/or resale value
• However, will have “inuse” value as long as being used in the practice
Fixed Assets
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Balance Sheet Analysis
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Revenue Analysis
Net revenue per procedure
Trends (yeartoyear comparisons)
Benchmark (e.g. against Medicare
rates for reasonableness)
Net revenue per provider (assess
risk)
Ancillary revenue
should normally be analyzed separately
(technical vs. professional revenue and expenses)
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Operating Expenses
Yeartoyear and benchmark
comparisons
•Physician labor costs•Nonphysician labor costs•Facilities •Medical supplies•Other
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
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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.
Accounting for the Transaction
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ASC 805, Business Combinations (SFAS 141R)
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Key Terms and Definitions
Identifiable Intangible Asset –
•An intangible asset is considered identifiable if it either:
– 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
– 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.
Source: ASC 80520251 through 2510.
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Categories of Intangible Assets (Separable From Goodwill)
• Marketing related intangible assets
– Trademarks, trade names, service marks, etc
• Customer related intangible assets
– Customer lists, production backlog
• Artistic related intangible assets
• Contract related intangible assets
• Technologybased intangible assets
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Key Terms and Definitions
Fair Value Standard of Value
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.”
– 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
Source: ASC 8201020 (formerly SFAS 157, paragraph 5)
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Key Terms and Definitions
Market Participants
Are buyers and sellers in the principal (or most advantageous) market for the asset or liability that have all the following characteristics:
– Independent of the reporting entity (nonrelated party)
– Knowledgeable, having a reasonable understanding about the asset or liability and the transaction based on all available information, and
– Willing and able to transact for the asset or liability
Source: ASC 8201020 (formerly SFAS 157, paragraph 10)
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Key Terms and Definitions
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.
•In contrast, the transaction price is referred to as an “entry” price.
•The exit price does not always equal the transaction price.Source: ASC 82010302 (formerly SFAS 157, paragraph 7)
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Key Terms and Definitions
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.
•The principal (or most advantageous) market (and therefore, the market participants) should be considered from the perspective of the reporting entity.Source: ASC 82010355 (formerly SFAS 157, paragraph 8)
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Key Terms and Definitions
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.
– 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.
Source: ASC 820103512 (formerly SFAS 157, paragraphs 12 – 13)
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Applicability to Physician Practices
• Identifiable intangible assets encountered in connection with physician practice acquisitions are normally contractual in nature, such as:
– Noncompetition agreements
– Clinical trial contracts
– Favorable lease agreements
– CONs (depending upon the type of practice)
• Does not include workforce in place (considered part of goodwill)
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Applicability to Physician Practices – Con’t
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?
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Questions?
Contact Information:
W. James Lloyd, CPA/ABV, ASA
Shareholder | PYA
[email protected] | 865-673-0844
www.pyapc.com
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