valuing physician practices

Valuing Physician PracticesDecember 6, 2016

Phone: 813.289.2588 [email protected] 5005 West Laurel Street Suite 204 Tampa, FL 33607 www.carnahangroup.com

Instructor Bio

Chris Carnahan has over 25 years of experience in healthcare and finance. He has held executive level positions in healthcare, technology, and manufacturing. Mr. Carnahan is the founder of Carnahan Group, Inc., and is responsible for the leadership, strategic direction, and financial matters of the firm. Mr. Carnahan has been involved in hundreds of medical staff demand analyses for not-for-profit and for-profit entities, including modeling demand and supply analysis for healthcare services within diverse communities. During his career, Mr. Carnahan has been involved in over 1,500 healthcare transactions, including physician compensation arrangements, acquisitions, fair market value opinions, asset appraisals, and provided expert testimony. Mr. Carnahan has presented numerous times to some of the largest healthcare systems in the world on the topics of community health needs assessments, medical staff demand analyses, valuations, and healthcare strategy. He is also an instructor for the National Association of Certified Valuators and Analysts (NACVA) in the area of healthcare valuations. In 2010, Mr. Carnahan received the Certificate of Achievement for an Instructor of Great Distinction by NACVA. Mr. Carnahan is a licensed Certified Public Accountant (CPA) in Florida, a Certified Valuation Analyst (CVA), accredited in Business Valuations (ABV), certified in Financial Forensics (CFF), a Master Analyst in Financial Forensics (MAFF), Chartered Global Management Accountant (CARNAHAN GROUPMA), and Small Business Administration (SBA). He is also a member of the American Institute of Certified Public Accountants (AICPA), a member of the National Association of Certified Valuators and Analysts (NACVA), a section member of the AICPA’s Valuation and Forensic Services.

Mr. Carnahan has presented and published articles on physician acquisitions and has testified as an expert witness in various venues and jurisdictions. In addition to Mr. Carnahan’s healthcare experience, in 2015 he established Carnahan Advisors, a forensics, accounting and litigation support firm for family law cases. His responsibilities include providing expert testimony and opinions, reviewing clients’ financial affidavits, analyzing equitable distribution and child support guidelines, and preparing court documents for clients and his employees, all in the area of financial matters.

Agenda

• FMV in Healthcare• Regulation • Current Trends and Marketplace• Medical Practice Valuation and Related Issues• Selecting the Right Approach• Income, Market, and Asset Approach• Physician Compensation • Issues in Valuing Physician Compensation

FMV in Healthcare

Why are FMV standards needed in Healthcare?• “To protect patients and the federal health care programs from

fraud and abuse by curtailing the corrupting influence of money on health care decisions.”

Governing bodies:• Office of the Inspector General (OIG)• Department of Health and Human Services (HHS)

Standards:• Anti-Kickback Statute• Stark law• IRS’s regulations

Stark Law

Stark law: generally prohibits physicians from making designated health service referrals to organizations with which those physicians (or an immediate family member) have a financial relationship, unless an exception under the law applies. This includes physician referrals to his/her own medical practice where the following circumstances are present:

• A physician delivers services through the medical practice;• The medical practice furnishes designated health services that

may be payable by Medicare making the medical practice a Designated Health Services (DHS) entity;

• The physician has a financial relationship with the medical practice; and

• The physician makes referrals to the medical practice for the furnishing of DHS.

In-Office Ancillary Exception

Physicians and medical practices rely on the Stark law’s in-office ancillary services exception and physician services exceptions to allow "within-practice" DHS referrals. Of these, the in-office ancillary services exception is used most frequently as it allows physicians in medical practices to:

• Make referrals for certain DHS within the medical practice;• Furnish those DHS to practice patients;• Bill Medicare and Medicaid for the services; and• Retain and use the revenues earned from providing the

services within the group for payment of practice expenses and physician compensation.

These exceptions are therefore of significant importance to a medical practice’s internal activities.

Anti-Kickback Statute

Criminal statute that prohibits the exchange (or offer to exchange), of anything of value, in an effort to induce (or reward) the referral of federal health care program business.

• Anyone who “knowingly and willfully offers, pays, solicits, or receives remuneration in order to induce business reimbursed under the Medicare or Medicaid programs.”

• Charges and payments are not based on value or volume of referrals or other business generated by the parties that is covered by Medicare or Medicaid.

• Issued by OIG, although originally enacted by SSA in 1972.

Anti-Kickback Statute, Cont’d

Safe harbor regulations: payment and business practices that, although potentially implicating the statute, are not treated as offenses under the statute:

• Investment interest: 40% rule• Space and equipment rental – FMV-based• Personal services and management contracts• Sale of practice• Referral services• Warranties• Discounts• Employees, etc.

Patient Protection and Affordable Care Act

Patient Protection and Affordable Care Act (PPACA) – healthcare reform legislation; passed by the 111th Congress and signed into law by President Barack Obama in March 2010. Key provisions:

• Extends coverage to millions uninsured people – provides affordable healthcare with no-cost preventive services;

• Implements measures to lower healthcare costs while improving efficiencies;

• Eliminates some of the previous industry practices, such as rescission of insurance policies and denial of coverage due to pre-existing conditions;

• Eliminates annual and lifetime limits on coverage and benefits• Make insurance companies responsible for keeping

administrative costs down; and• Shared responsibility for patients (avoiding minimum coverage

will result in penalties).

Current Trends in Healthcare

Physicians are concerned and evaluating whether to remain independent, align themselves with a major hospital or system, or sell their practice and become employed.

• Raising costs to run the practices – supplies, technology, employees

• Meaningful Use – incentives end and working capital is required

• Uncertainty around PPACA – payments, delivery system• Networks are becoming narrow – hospital alignment can help• Concerns regarding aging population, physician shortages• Volume-based reimbursement and productivity-based

compensation will be succeeded by value based/bundled payments

Physicians initiate majority of acquisitions.

Current Trends in Healthcare, Cont’d

Hospitals acquire mostly primary care practices, followed by cardiology, orthopedics, general surgery, endocrinology, gastroenterology, urology and oncology practices. What motivates hospitals?

• Increase service area and market share• Expand current capabilities in certain specialty areas• Meet community need• Insurance-driven motives• Increase efficiencies and alignment

Hospitals are not the only ones involved in M&A’s; recently insurance companies and managed-care organizations are getting involved.


January through May 2015: acquisition volume reached $241 billionShift toward:

• Vertical acquisitions (non-acute-care facilities – clinics, physician practices); 74% of total provider acquisitions volume and are expected to climb to 84% in 2018

• Digital acquisitions (buying companies focused on sensors, mobility, analytics/cloud capabilities) – projected to reach 8% in 2018

Hospital acquisitions are on the decline – 32% in 2006 to 21% in 2014. Expected to drop to 6% in 2018.


Management Services Organization (MSO) model – physician remains independent while MSO owns the assets and provides key management services (staff, billing and collections, accounting, equipment)Accountable Care Organizations (ACO) - groups of doctors, hospitals, and other health care providers, who come together voluntarily to give coordinated high quality care to their Medicare patients.

• The goal of coordinated care is to ensure that patients, especially the chronically ill, get the right care at the right time, while avoiding unnecessary duplication of services and preventing medical errors.

• When an ACO succeeds both in delivering high-quality care and spending health care dollars more wisely, it will share in the savings it achieves for the Medicare program.

Market Place Trends

2013 2014550

600

650

700

750

800

637

752

Healthcare M&A deals 2013 v. 2014

2013 201448

50

52

54

56

58

60

62

64

52.7

62

Value (billions)

2015 Health Care Services Acquisition Report

Integrated Issues after M&A

Although the intent of the merger is increasing quality of care while using efficiencies to decrease costs, quality often does not improve.

• Cost of care typically increases • Integration-often external, but not internal

• Random collection of hospital and physician groups• Lack of metrics to evaluate successful integration• Risk of violating anti-trust laws• Culture clash

Practice Ownership

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130%

10%

20%

30%

40%

50%

60% 57%55%

53% 52%50% 49%

47% 46%44% 43% 42% 41%

39%36%

Physician Owners

Becker’s Hospital Review Study

Practice Ownership, Cont’d

• 81% physicians overextended• 44% plan on reducing workload (part-time, retire, only accept

establish patients)

Solo practice Independent practice owner Employee of hospital/medical group

0%

10%

20%

30%

40%

50%

60%

70%

25%

49%44%

17%

35%

53%

62%

38%

200820122014

2014 Survey of America’s Physicians: Practice Patterns and Perspectives

Future of the Physicians

Continue practicing as they do now

Retire

Move to a different practice

Transition to a direct-pay practice

Join an accountable care organization

Merge with other private practices

Become a patient-centered medical home

Close their practice

Leave their practice to become hospital employed

Go into solo practice

Sell their practice and become an hospital employee

59.7%

16.9%

7.5%

7.4%

4.3%

4.0%

3.3%

3.2%

2.9%

2.4%

1.7%

Independent Physicians' Plans

Physicians Practice’s 2015 Great American Physician Survey

Top Mergers in 2015

Hospitals and Systems:• Care New England and Southcoast Health – creating

8-hospital system• Prime Healthcare paying $62 million to acquire Saint

Michael’s Medical Center in Newark, NJ• AtlantiCare joins the Geisinger Health System• Tenet Healthcare sells Central Carolina Hospital and

Frye Regional Medical Center to Duke LifePoint; five Atlanta market facilities to WellStar

• HCA takes over 14 urgent care centers in Las Vegas• Joint venture between Tenet Healthcare’s Brookwood

Medical Center and four (4) Baptist Health System hospitals in Alabama

• Baptist Health South Florida to merge with Bethesda Health by 2017

Top Mergers in 2015, Cont’d

Pharmacy:• Pfizer and Allergan are talking about merging to rival

Johnson & Johnson and Novartis. Pfizer already bought Hospira this year. Allergan merged with Actavis in March 2015

Drug stores:• Walgreens buying Rite Aid for $17 billion – leaving only CVS

and Walgreens on the market. Rite Aid bought EnvisionRx this year. CVS bought Omnicare

Insurance and finance market:• Currently UnitedHealth is the biggest one: Cigna-Anthem

merger may surpass UH• Aetna and Humana are planning on merging as well ($37

billion), which would leave only 3 big players• Capital One took over GE Capital healthcare finance unit

Medical Practice Valuation

General factors:• Competition and local market/demographics• Reimbursement rates• Current capacity• Capital and operating expenses• Regulation, CON, licensures, non-compete agreements• Current national/economic and industry outlook• Payor mix• Modalities mix if applicable• Commercial Reasonableness

Issues in Medical Practice Valuation

• Can’t take in consideration volume or value of referrals• What parts of the practice are part of the transaction?

• Full practice? • Or just ancillaries?

• Post-acquisition employment/compensation must be considered:• Under PSA• Under employment model• Derby vs. Commissioner

Selecting Valuation Approach

Valuations typically use:• Historical information (the Market Approach) and

projections (the Income Approach); • Both are forward-looking approaches to value

The multiples applied should also reflect expectations for the company in comparison with expectations for the market. However, overall over 95% transactions are done based on an Asset Approach.

Income Approach

Income Approach estimates the future cash flows based on historical financial information, with expectations for changes in reimbursement or volume included in the projections of future cash flows.

• While the true fair market value of the facility can be determined only by actual arm's length negotiations, absent such negotiations, the Income Approach is considered a reasonable and commonly used approach by appraisers of medical practices

Discounted Cash-Flow methodology: projected cash flows of the business, discounted back to present value at the discount rate.

• Cash flow equals net income plus depreciation and amortization, minus capital expenditures and incremental working capital

Income Approach, Cont’d

Other commonly used methodology - Capitalized Earnings Method• Evaluates the present value of the future economic benefits

that accrue to the investors in a business; however, these benefits, or future cash flows, are capitalized at a rate of return that is commensurate with the company’s risk

• This present value determines the fair market value of a business.

• The capitalization of earnings method determines value based on three factors: a risk adjusted rate of interest, typically the company’s cost of equity, a terminal growth rate and a normalized level of earnings.

• The normalized level of earnings is multiplied by the capitalization factor, defined as the inverse of the cost of equity less the terminal growth rate, resulting in the indication of value.


Cost of Equity: Ke = Rf + (β * RPm) + RPi + RPh + RPs + RPuRf = Rate of return on a risk-free securityβ = Industry BetaRPm = Risk premium for the marketRPi = Risk premium for the industryRPh = Risk premium for healthcare facilitiesRPs = Risk premium for small stocks over and above

RPm (small capitalization stock risk premium)RPu = Risk premium for unsystematic risk attributable to

the specific company (company specific risk premium)


Weighted Average Cost of Capital:• Calculate tax-adjusted cost of debt: pre-tax rate * (1 – income

tax rate)• Calculated cost of equity• Obtain current or projected/estimated capital structure between

equity and debtCalculate weighted average: (cost of debt * % capital structure) + (cost of equity * % capital structure)

• Commonly used for financed projects• Cost of financing the capital = price tag of the investment


General Assumptions: • Effective federal tax rate - the blended state and federal income

tax rate applicable to businesses operating in a particular state• Discount rate – most often equity cost of capital or WACC• Constant growth rate (for perpetuity) - the rate that operating

revenues and expenses are expected to grow after Year 5 of the projections and into perpetuity

• Capital expenditures annually/projected growth rate• Inflation rate – the estimated rate of inflation as reported by CPI• Pre-compensation earnings percentage


Revenue Assumptions: • Projected revenues based on volume, productivity, and

reimbursement/collectionsExpense Assumptions:

• Employee salaries, plus taxes, and benefits• Occupancy costs• Medical supplies• All other variable and fixed expenses (i.e. insurance, G&A, etc.)

• Provider compensation, taxes, and benefits – VERY IMPORTANT• Capital expenditures and depreciation/amortization• Working capital projections

Ancillary Services

Ancillary services: • Auxiliary or supplemental services used to support diagnosis and

treatment of a patient’s condition. Billed separately, but often directly related to the provision of professional services (technical component – TC) – meant to cover the use of physician’s/hospital’s equipment, supplies, and facilities when treating a patient.

• Some of the most common ancillary services include:• Diagnostic Laboratory• Nuclear Medicine (imaging)• Radiology (x-rays and imaging – CT, MRI, PET) • Radiation Oncology (cancer care)

Value of Ancillary Services

Determining the value of ancillary services:• Revenue considerations and trends• Cost inputs• Net earnings levels

How should the net earnings from ancillary services be treated in compensation and business valuation?

• Element of physician compensation?• Business owner compensation or return on investment?• Other positions?

Market Approach

Market Approach computes value by comparing the value of similar businesses that trade in the open market.• In the market approach, estimates of value are established using:

• Guideline publicly traded company method: an indication of value is developed by comparing the financial condition and operating performance of the company being appraised with those of other companies in the same or similar lines of business and/or thought to be subject to similar economic risks and environmental and political factors.

• Guideline transaction method: used to estimate the value of the subject company if sufficient information regarding sales of whole companies that are similar in nature to the company appraised can be compiled.

Market Approach, Cont’d

Market value is then adjusted for:• Qualitative and quantitative differences • MVIC/EBITDA most commonly used

The ideal application of the Transaction Method would be to obtain information regarding an exact contract relating to the sale of a practice between unrelated parties. Unfortunately, obtaining such information is typically quite difficult as these transactions are often private as most facilities are not willing to (or are legally bound not to) divulge information regarding their contracts.

Market Approach, Cont’d

Other issues to consider when using Market Approach:• Stark Regulation - the prices involved in M&A transactions are

generally at an investment level, which is specific to a particular buyer. If enough information is not available in the transaction to determine FMV, which considers the price to a “hypothetical” buyer, investment value cannot be ruled out. Consequently, discounting the “synergistic” premium is highly speculative and controversial

• The database transaction price may involve purchasing some other non-cash consideration. When the FMV standard is required, cash or cash-equivalent value is required. Appropriate adjustments have to be made to the transaction (obtain sufficient database descriptions of each individual transaction or sufficient numbers to apply a statistical measure).

Asset Approach

Asset/Cost Approach identifies the cost to replicate a business or to accumulate, and place in service, the assets necessary to operate a business.

• The Asset or underlying Cost Approach is based on the economic principal of substitution in that any willing buyer would be willing to pay no more for an asset than the price that would be necessary to obtain, such an asset elsewhere in the market place.

• Only used if Income and Market Approach both yield lower value - the indicative value usually presents a floor, or minimum value, but may still include intangible assets, such as certificates of need, etc.

Asset Approach, Cont’d

The Cost Approach is based on a comparison between the cost to develop the assets and the value of the existing assets. As a result, consideration of which premise of value to apply to the valuation should be applied. This decision is made upon the determination of the highest and best use of the asset subject to the valuation. • Premises of value for consideration include:

• Value in Continued Use, as Part of a Going Concern – assumes that the assets are sold in an assemblage of assets and as part of an income producing business enterprise.

• The premise of continued use contemplates the mutually synergistic relationships of (1) the company’s tangible assets to the intangible assets and (2) the company’s intangible assets to the tangible assets.


Value in Place, as part of a Mass Assemblage of Assets – assumes that the assets are sold as a mass assemblage and are capable of being, but are not operating, as an income producing business enterprise.

• The premise of value in place contemplates some of the mutual contributory value of (1) the company’s tangible assets to the intangible assets and (2) the company’s intangible assets to the tangible assets. However, a component of the value in place is that this premise may exclude some of the contributory value of intangible including trained and assembled workforce, going concern value and goodwill.


• Value in Exchange, in an Orderly Disposition – assumes that the assets are sold piecemeal, and not as part of a mass assemblage, and that the assets are given an adequate level of exposure in their normal secondary market. The premise of value in exchange does not contemplate any contributory value effect of the subject tangible assets on the intangible assets.

• Value in Exchange, Forced Liquidation – assumes that the assets are sold piecemeal and not part of a mass assemblage. Also assumes the assets are not allowed a normal level of exposure to their normal secondary market. Due to the forced liquidation market transaction, this premise assumes no contributory value from the subject tangible assets to the intangible assets, or vice versa.


Within the Cost Approach there are several related methods which include (1) reproduction cost and (2) replacement costs that should be considered. The costs below should include direct and indirect costs as well as any form of obsolescence.

• Reproduction Cost – Contemplates total cost construction of the exact replica of the subject assets using current prices.

• Replacement Cost – Contemplates the cost to recreate the functionality or utility of the subject assets.

Factors for asset approach: • Components of the transaction (tangible vs. intangible assets) • Lease (operating or capital) or direct buy-out, etc.• MSO model


Components of the transaction involve certain tangible and intangible assets:

• Fixed assets• Inventory/supplies• Accounts receivable• Assembled workforce• Medical charts (paper or electronic format)• Trade name• Phone number or website• Other intellectual property

Physician Compensation

Physician’s compensation:• Salary/draw – non-owner and owner physicians• Profit/distribution – owner physicians only; includes return on

tangible and intangible assets:• Net working capital• Fixed assets• Trained workforce• TC component for ancillary services (in excess of fixed asset

return)• Contract rights• Goodwill• Patient charts

Issues in Compensation Valuations

Compensation of physicians based on PSA or employment:• Can we apply the same structure? • Employed physician not permitted to be compensated for ancillaries• If compensating based on productivity, do we use wRVUs?

Collections? Or shifting towards quality incentives, value based or bundled payment models?

• Value or volume of referrals cannot be considered• Is this a part of acquisition? Compensation after transaction must be

applied to income approach: Debry vs. Commissioner

Issues in Compensation Valuations, Cont’d

Market survey data:• Should the data be adjusted? If so, how?

Per 2015 MGMA report, certain specialties showed total compensation well above the mean due to inclusion of ancillary services income.

• Compensation Level of Ancillary Revenue for all practices: non-invasive cardiology, ophthalmology, general orthopedic surgery + all subspecialties, ENT, pulmonary medicine, diagnostic radiology, and neurosurgery

• Compensation Level of Ancillary Revenue for physician-owned practices: invasive-interventional cardiology, non-invasive cardiology, hematology/oncology, ophthalmology, general orthopedic surgery + certain subspecialties, ENT, pulmonary medicine, pyschiatry, diagnostic radiology, and neurosurgery

Issues in Compensation Valuations, Cont’d

• Commercial Reasonableness – departure from strict FMV• Investment value in transactions• Tainted market values (i.e., lithotripsy)• Opportunity cost for physicians – not a viable methodology• Per-click arrangements• National versus local market rates

Questions?