Physician practices are increasingly undergoing consolidation

What Data Valuators Need from Physician Practices—and Why!

Physician practices are increasingly undergoing consolidation. Often that means being acquired by a hospital, and a prerequisite of being acquired is having a valuation performed by an independent, third-party valuator. Here’s information on the sort of data that valuators need (and that physician practices should be collecting today), an explanation of why valuators need that information, and how they use it.

For several years, the healthcare industry has been in the latest round of acquisition of physician entities. A typical scenario includes the sale of a physician practice to a hospital with post- acquisition employment of practice physicians. To complete the transaction, a valuation of the practice is conducted by an independent, third-party valuator familiar with the requirements and limitations of various regulatory rules. Completing the valuation includes the request, receipt, and analysis of data from the practice. The volume and nature of the information request can seem lengthy, but each item serves a specific purpose. This article provides an overview of the types of information requested, how valuators use this information, and suggestions for working with valuators.

Value
Value can be defined as estimated or assigned worth. Value can be calculated by the equation of Value = Benefit/Risk. The benefit is an economic income stream (i.e., revenue resulting in net cash flow) generated by the practice. Risk is multifaceted and accounts for business, economic, and financial factors. As a result of federal laws involving healthcare transactions, identifying the source and nature of revenue is of critical importance. The often cited definition of fair market value as defined by the Stark Law is: 1

“Fair market value means 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.”

The Stark Law also requires that an arrangement be commercially reasonable (i.e., in the absence of referrals, the arrangement would make sense). A referral is a specified term and is defined by the Centers for Medicare and Medicaid Services by selected CPT (Current Procedural Terminology) codes.2 As stated in the definition above, fair market value cannot be based in any manner that takes into account the volume or value of anticipated or actual referrals.

A thorough analysis of the physician practice is necessary to determine and support fair market value. This requires significant information be provided to the valuator.

Background Information
Information requested can include the legal name of the practice, date of inception, foundational documents, locations, office hours, the number of physicians and mid-level providers, their schedules, and types of services provided.

Some of this information is required to meet valuation standards (e.g., legal name of the practice, date of inception, etc.) while other items are needed for analysis related to provider productivity, identification of referrals, and post transaction compensation. A solo physician operating without mid-level providers or diagnostic imaging equipment is a less complex practice than a multi-specialty practice, which includes mid-level providers, lab, and radiology services. Identifying the number of providers and the types of services provided in the practice are key in calculating a future benefit stream that does not does take into account the volume or value of referrals.

Financial Information
Financial information requested can include internally prepared financial information and accountant prepared financial statements both for several previous years and a year-to-date period. The valuator will also request at least the two most recent tax returns for the practice. Total revenue as filed on income tax returns should match or reconcile to revenue and expenses on internal financial statements.

Productivity Reports
In order to understand the nature and source of practice revenue, the valuator will request several reports related to practice productivity for two or more previous full years and year-to-date information. This can include by year:

CPT code reports by provider including modifiers, volumes, and collections Total collections by provider Total collections by payer As part of the analysis, the valuator will compare total collections by provider with CPT code production reports. If there is a variance, a common explanation may be that the practice simply missed submitting production information for all providers to the valuator. Some level of variance is expected due to timing between dates of service for billed CPT codes and recognition of cash received for services provided prior to the billed dates of service. However, if the variance is significant, it could mean that production reports do not accurately represent the work performed by providers or that collection reports include payments for services other those billed by CPT code.

The valuator will also compare collections from CPT code reports and total collections by provider with financial statements. Variances between production and collections reports and financial statements are most often the result of revenue for other services being provided by the practice or its physicians (i.e., call pay, medical directorships, research, etc.). Understanding the nature of revenue streams is critical to complying with regulatory requirements.

Leases
A valuator will typically request copies of all leases to which the practice is a party. These typically include medical equipment, office equipment, and office space. For medical equipment, the practice should also provide any related software update and repair and maintenance contracts. If the equipment is under a capital lease, an amortization schedule or payoff amount as of the date of valuation will allow determination of the outstanding debt. For office space, the practice should provide current leases for all locations and identify any location where the real estate is owned by a party related to an individual associated with the practice. Information the practice may have obtained regarding current lease rates in the market is also beneficial. The valuator will compare lease rates with fair market value rates for similar office space. Variances between contractual lease rates due to a lease contracted by related parties and fair market value rates will be reflected in adjusted cash flows of the practice.

Staffing
The valuator will request a staff roster for the practice. This should include an employee’s name, job title or position description, salary or hourly compensation rate, hours worked per year, hire date and termination date (if applicable). The practice should identify any personnel related to practice owners or other providers.

The valuator will compare total expenses calculated from the staff roster with historical expenses. The practice should be prepared to explain changes between the staff roster provided and the historical levels of expense. The practice should also volunteer any unique training or skill sets of key employees.

Non-Operating and One Time Costs
The valuator will request identification of any one-time or non-operating costs included in practice financials. These can range from payments for automobiles to purchases of new computers throughout the practice. These expenses may be adjusted by the valuator to a normalized level with the difference between reported and normalized levels reflected in the practice cash flows.

Closing Thoughts
Valuators will issue an opinion or conclusion of value. This opinion or conclusion is based on information provided by the entities involved in the transaction, industry research and experience of the valuator. Representatives from the practice should become engaged in the valuation process. The more accurate the information received and more consistent the facts provided, the more accurate and supportable the conclusion or opinion of value will be.

Richard Romero is a Director with CBIZ Healthcare Valuation in Franklin, TN and can be reached at 615.732.6266 or richard.romero@cbiz.com.

Ryan Harvey is a Consultant with CBIZ Healthcare Valuation in Atlanta, GA and can be reached at rharvey@cbiz.com.

1: Stark Regulation 42.C.F.R. Section 411.35
2: www.cms.gov/PhysicianSelfReferral/40_List_of_Codes.asp