Issues When Valuing Healthcare Transactions

Medical practice sale pitfalls

There are several issues to be keenly aware of when valuing a medical practice, including sources used to evaluate the efficiency of a practice and the need to determine what a benchmark is for the doctor in the practice. It is imperative to do a common sizing calculation when comparing a practice’s performance with national practice data for the medical specialty.

Valuing Healthcare

At the 2013 NACVA and CTI  Annual Consultants’ Conference,  Jeff Moffatt, CPA, ABV, CVA, CITP, and Steve Ratliff of Blue & Co. of Indianapolis, Indiana, presented the topic of “Valuing Healthcare Transactions and Agreements” with a special emphasis on the hospital acquiring an individual or group medical practice. According to Blue & Co.’s research, one of the more interesting statistics  was that hospitals are expected to acquire physician practices at at a rate of 70 percent faster than prior years.  This leads to one of the challenges facing most healthcare practice valuation analysts:  How does a valuation professional support a value for a medical practice when it is being acquired by a hospital?

Valuation of a medical practice can be based on fair market value or commercially reasonable value.  This leads to an appraiser needing to consider significant analyses of the practice’s expenses  to determine which expenses, though never used or marginally need, have been run through the books.  Additionally, we have seen that many practices have very shoddy bookkeeping regarding expenses, but excellent billing and collections because these services are offloaded to a commercial processing entity for a fee.  This leads to one of the major questions to consider when valuing the practice:  What is normal or commercially reasonable compensation for the doctor(s) who will be joining another group or a hospital? 

Physician compensation is a benchmarking exercise where an appraiser needs to look at historical compensation such as a W-2, 1099, or K-1, plus any voluntary deductions such as 401(k), 403(b), or Section 125 Tax Savings  and Medical Savings Plans to determine what has been the usual compensation for a doctor in a practice with any specific specialty.  Make sure that you do not count as compensation any employer-matching funds such as the above-listed retirement plans and a Keogh Plan.  When looking for benchmark salary data, be sure to examine salary.com, Medical Group Management Association (MGMA) surveys, American Medical Group Association (AMGA), Hospital and Healthcare Compensation Service (HHCS) and Sullivan, Cotter and Associates (Sullivan).

After determining the compensation of the doctor(s) in a practice, the business valuation professional needs to examine the medical revenue detailed by office visits, consultations and procedures, treatments, surgery (volume of services) and the complexity of services provided.  This data will be available from the practice’s billing data  based on current procedure terminology (CPT) codes that are issued by the American Medical Association.  These are broken into three groups that have five digit indicators—e.g., Medicine 9xxxx, Surgery 1xxxx – 6xxxx and Radiology 7xxxx.  

CPT reports are on a per-physician basis and need to be combined to determine a total practices performance.  Benchmarking coding patterns based on CPT codes serve to indicate a level of efficiency and frequently identify coding errors that lead to rejected billing for services performed.  It is important to learn what the normal benchmark for similar physician practices is.  This data is available from the Office of the Inspector General (OIG).

One factor that needs to be examined is the percentage of recovery that is received from the insurance company billed, Medicare and Medicaid.  There also needs to be consideration in the source of payer trends during the past three years.  As the population  ages,  we often see the net collected revenue declining and yet, the number of patient interactions increasing.  Only by doing this analysis will an appraiser be able to identify doctor productivity as opposed to declining reimbursements for the various services being performed as the mix of payers changes.

There are several normalizing or adjustment areas when valuing a medical practice.  These include: 

• accounts receivable
• fair market value of fixed assets
• one-time events that may be extraordinary or unusual
• non-operating assets and liabilities
• discretionary items such as related party transactions (especially rent)
• personal vs. business expenses
• non-operating expenses. 

It is imperative to develop a comparative, common-sized income statement to the benchmark standard for the specific medical service in which the practice performs.  MGMA data can be very helpful in identifying an expense category that will require additional, in-depth research to determine what makes the specific practice different from the common-sized MGMA data.

While this topic is in a high state of flux as this article is being printed, one event is certain; appraisers will need to be much more vigilant in developing a practice’s valuation.  Hospitals have been extremely active in the acquisition of medical practice groups that utilize many days of hospitalization for their particular service specialty.  Beware of transactions where the offer appears to be too good, as there may be many strings that may not be evident which make the opportunity very limiting to the doctor(s).

See also the referenced data presented at the 2013 NACVA/CTI Annual Consultants Conference:  http://thectiblog.com/2013/02/valuing-healthcare-transactions-and-agreements/

[author][author_image timthumb=’on’]https://quickreadbuzz.com/wp-content/uploads/2012/11/logo_CTI_small.png[/author_image]  [author_info]Edward T. Wandtke, CPA, CVA, MBA, is President of Wandtke & Associates, a Westerville, Ohio firm that provides brokerage, management consulting, and valuation services for service companies, intellectual property, and intangible assets The firm’s experience has spans a wide range of industries. Edward can be reached at ed.wandtke@wandtke.com. [/author_info] [/author]