MGMA 2007 National Conference

Transcription

1 Valuing Medical Practices and Healthcare Businesses MGMA 2007 National Conference Christopher J. Evans, DHA, FACHE, CMPE President & CEO, Health Capital Advisors, Inc. 204 Lakeway Drive Lewisville, NC

2 Session Overview Why I m here to enhance your learning and to talk about your hot topics in valuation Session goals - Participants will learn: Fundamental premises surrounding valuation Key issues in how value is influenced by market conditions Understand factors and outcomes to consider in structuring business asset or membership interest transactions 2

3 Fundamental Issues in Valuation Your Hot Topics Key Messages to remember about value and valuation Facts and Circumstances SHOW ME THE MONEY TANSTAAFL there ain t no such thing as a free lunch If you remember nothing else about this session, remember these three things 3

4 Fundamental Issues in Valuation Purpose of the valuation (use drives the scope of work; outcome is a supportable opinion of value) Interest to be valued (assets or stock) Level of value (control or minority & marketability) Standard of value (Fair Market Value typically) Premise of value (going concern, liquidation) Date of valuation (and what might be known) USPAP and business valuation standards Regulatory issues 4

5 Fundamental Issues in Valuation Principal regulatory issues in healthcare Ethics in Patient Referrals Act ( Stark ) State Stark laws Medicare Fraud and Abuse Antikickback Statute 501(c)(3) of the Internal Revenue Code for taxexempt organizations Corporate practice of medicine laws Restrictive covenants (non-competes) and liquidated damages provisions Commercial reasonableness 5

6 Fundamental Issues in Valuation The Basic Eight factors of Revenue Ruling 59-60, which form the foundation for most valuations 1. History of the enterprise 2. Earnings capacity and outlook for future earnings 3. Dividends and dividend-paying capacity 4. Book value of the stock and financial condition of the business 6

7 Fundamental Issues in Valuation The Basic Eight continued 5. The existence of goodwill and its causes 6. The size of the block(s) of stock under consideration 7. The nature of the industry and of the local, regional, national, or international economy in which it operates 8. To the extent possible, comparisons with similar companies whose shares are freely traded on an exchange or over the counter, or with similar, but non- publicly traded companies 7

8 Fundamental Issues in Valuation Valuation is a Range Concept Start-Up Growing Cash Cow Declining Interactive Time Lines Internal Stock Market Economy Industry Conditions External VALUE = f(purpose, Internal Time, External Time) Divorce (Spouse) Greed Low $ Sale of Minority Block Estate Tax Minority Marketable Minority Block Valuation Purpose Valuation Conclusion Reasonable Range of Conclusions Estate Tax Control Value Sale of Business High $ Divorce (Owner) Wishful Thinking 8

9 Fundamental Issues in Valuation In business, words are words, explanations are explanations, promises are promises, but only performance is reality. Harold Geneen ITT 9

10 Fundamental Issues in Valuation Valuation Approaches and Methods Cost Approach Book, market, liquidation, replacement values Income Approach Direct capitalization, discounting Market Approach Market multiples/aggregated data Prior transactions Guideline company method 10

11 Fundamental Issues in Valuation Proper use of approaches: Consider them all Business profitable - all approaches Business unprofitable - cost approach History versus future All value is the expectation of future benefit Focus framework should be 10% assessing past performance, 70% assessing projected performance, and 20% reconciling the differences 11

12 Fundamental Issues in Valuation Tangible Assets Going Concern- Related Intangible Assets Cost Approach Build-Up Method Value of furniture, fixtures, equipment Accounts receivable Supplies on hand Real property Autos Assembled workforce Policies & procedures Administrative data Use an equipment appraiser!!!! Facts & Circumstances Specific 12

13 Fundamental Issues in Valuation Income Approach Capitalization/Discounting Methods SHOW ME THE MONEY + TANSTAAFL Typically adjusted ( normalized ) net cash flow over 3-5 years plus terminal value Unusual or one-time expenses Owner discretionary expenses Additional income and expenses Risk rate development for cost of equity 13

14 Fundamental Issues in Valuation Market Approach Comparable companies Market multiples/aggregated data Prior transactions Guideline company method However, the market approach may well be not applicable Difficulty locating recent comparables Past comps with different market conditions The market approach is almost always only a sanity check for the income approach. 14

15 Fundamental Issues in Valuation What is Goodwill and is it Dead? Intangible goodwill may be considered the enterprise value in excess of the value of the tangible and going concern-related intangible assets it is alive and well in profitable businesses It always manifests itself in earnings and must be demonstrated by the income approach It cannot be calculated outside of the income approach (e.g., using a survey) It can be influenced by post-sale compensation arrangements 15

16 Market Influence in Valuation The Disparate Universe of Buyers in Healthcare $$$ Hospital Network 1 Hospital Network 2 PPM 1 Strategic Buyers Hospital A Hospital B $$ Practice A Practice D HMO 2 Practice B HMO 1 Practice E Willing Buyer - Willing Seller $ Physician A Practice F Low Ball Buyers 16

17 Market Influence in Valuation The presence of (multiple) strategic buyers does not guarantee that FMV = or even approaches strategic value The upper end of FMV is based on commercial reasonableness (e.g., payback within 7 years from debt free net income) Risk is increasing, not decreasing Capital market movements Payment reform the future is not good LT income growth for most businesses is <3% while expenses grow at 5% - 9%! 17

18 Market Influence in Valuation Untimely physician death example (key issues) Date of valuation vs. date of death Universe of buyers Patient retention Provider coverage Practice losing money example (key issues) Is it a going concern or not? Is there justification to pay for any intangibles? Commercial reasonableness 18

19 Market Influence in Valuation Paying the doctor to go away? Is a cost decrement to the hospital a basis for value? Can we give him his practice back for free? No restrictive covenant can void goodwill Buyer needs to have reasonable safety from competition Liquidated damages might mitigate the loss 19

20 Structuring Transactions Strategic decisions still drive buyers in acquisitions Unreasonably high prices are almost gone Risk rates dramatically higher than 5 years ago WACC currently around 19% for very strong investments, 25%+ for many medical groups Pay attention to issues of control 20

21 Structuring Transactions Proforma everything paying particular attention to compensation and capital needs Recognize that valuation forecasts/projections are not operational, but should be the basis Use health law attorneys only If it looks too good to be true, it probably is Think return of investment no more than 7 years Recheck your proforma: No surprises! 21

22 Hot Topics and Questions Hot topics Questions Appendix Bonus items 22

23 Thank You and Best Wishes Chris 23

24 Definitions Fair market value (FMV) the price at which property or the right to use property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy, sell or transfer property or the right to use property, and both having reasonable knowledge of relevant facts [IRC Section (b) (i)]. 24

25 Definitions Fair market value (FMV) Fair market value means the value in arm s length transactions, consistent with the general market value. General market value means the price than 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, when the price or compensation has not been determined in any manner that takes into account the volume or value of anticipated or actual referrals. (Federal Register, Vol. 69, No. 59, March 26, 2004, page 16128) (aka Stark II) 25

26 Definitions Control The power to direct the management and policies of a business enterprise. Minority Interest An ownership interest less than 50% of the voting interest in a business enterprise. 26

27 Definitions Marketability The ability to quickly convert property to cash at minimal cost. Stock Shares of corporate capital. Asset Tangible or intangible property of a business enterprise. Liability Debts owed by a business enterprise. Equity The owner s interest in property after deduction of all liabilities 27

28 Regulatory Overview Healthcare is a highly-regulated industry Fraud & abuse, private benefit/inurement, anti-referral prohibitions, antitrust Sanctions for non-compliance with the law are great Loss of Medicare provider status, loss of taxexemption status, astronomical financial penalties, incarceration 28

29 Medicare/Medicaid Fraud Investigations Medicare based on trust Claims increasingly audited Fraud requires Knowing Reckless disregard Intentional ignorance 29

30 Principal Industry Legal Issues Affecting Business Valuation Ethics in Patient Referrals Act ( Stark ) State Stark laws Medicare Fraud and Abuse Antikickback Statute 501(c)(3) of the Internal Revenue Code for tax-exempt organizations Corporate Practice of Medicine Laws 30

31 Stark Laws Ethics in Patient Referral Act - Elements: Physician Makes referral For designated health services payable by Medicare To an entity (i.e., hospital) With which physician (or immediate family member) has a financial relationship No protection outside of enumerated exceptions 31

32 Stark Laws Financial relationship Ownership or investment interest Covers hospital-physician joint ventures Compensation arrangement Includes management services contracts and all other contracts with physicians Includes hospital payments to physicians Includes recruitment assistance 32

33 Stark Laws Designated Health Services Clinical lab Physical therapy Occupational therapy Radiology and diagnostic services Radiation therapy DME Home health Outpatient prescription drugs Inpatient and outpatient hospital services Parental and enteral nutrients, supplies, etc. Prosthetics 33

34 Stark Laws FAIR MARKET VALUE All transactions and considerations must be based on fair market value and the result of arms length dealing on commercially reasonable and available terms The value or volume of referrals cannot be considered The FMV consideration is one of the most difficult to address 34

35 Stark Laws 3 Questions Does the physician (or a family member) have a financial relationship to the entity? Will the physician make referrals to the entity for designated health services that are paid by Medicare or Medicaid? Does an Exception apply? 35

36 Medicare Anti-kickback Law Covers the giving or receiving of anything of value to induce Medicare/Medicaid referrals Violation if only one material purpose is to induce referrals Violation = felony, possible loss of provider status, false claim liability OIG looking for disguised payments for referrals Protection available outside safe harbors 36

37 IRS Section 501 (c)(3) Compliance Covers tax-exempt organizations Exempt organization must serve public rather than private interests Activities must further tax-exempt purposes Net earnings of tax-exempt organization shall not inure to private persons ( private inurement ) 37

38 IRS Section 501 (c)(3) Compliance Consequences of private inurement: Loss of tax-exempt status (institutional) Intermediate sanctions (board and managers) Relationship between hospital and physicians must further tax-exempt purposes of hospital Private benefit to physicians must be incidental 38

39 IRS Section 501 (c)(3) Compliance Terms must be arms length and commercially reasonable Revenue sharing can amount to private inurement 39

40 IRS Section 501 (c)(3) Compliance In health care context, examine contracts for employment, services, and supplies, equipment and real estate leases, physician practice acquisitions, joint ventures, and compensation arrangements 40

41 Why is Compliance Important? Reduces risk of legal violations Reduces risk of whistle blower (qui tam) suits Reduces risk of financial liability Reduces risk of unfavorable publicity Promotes integrity among employees 41

42 Corporate Practice of Medicine Laws In some jurisdictions, only physicians (or other licensed professionals) may practice medicine through professional services entities Focus is on maintaining the independence of the health care professional Enforcement may be strict or not 42

43 Corporate Practice of Medicine Laws From the valuation perspective, the following areas may be of concern Employment relationships Personal services agreements Operation of medical and related professional practices Joint venture relationships Potential universe of buyers issues 43

44 Emerging Business Strategies and Relationships Industry consolidation through: Acquisitions Mergers Divestitures Partnerships Equity & Non-equity arrangements Joint Ventures 44

45 Current Uses of External Opinions Acquisition and divestiture Employment/compensation agreements Joint venture agreements Operating agreements Hospital conversions (NFP to FP) 45

46 Current Trends in Transactions Essential elements: Justification for action Documentation of independent valuation, business review or fairness opinion No double counting (avoid conferring excess benefit) 46

47 Impact of Fair Market Value FMV is not intrinsic value, nor investment value, nor strategic value The regulators know this Some buyers and sellers do not seem to care 47

48 Increasingly Typical Valuation Engagements FMV of provider compensation Employed physicians, medical directors, consultants, physician assistants, nurse practitioners, midwives Joint venture relationships Valuation of partnership contributions for new ventures, dissolution of old ventures Valuation for disintegration 48

49 Increasingly Typical Valuation Engagements Medical practices - minority interests Restrictive and network agreements Right of first refusal to purchase Option to purchase Network participation Exclusive or non-exclusive Non-solicitation provisions 49

50 Increasingly Typical Valuation Engagements Valuing invested capital of failed ventures What defines failed when one partner chooses to continue? Valuing contracts for service when intangibles exist Identifying and valuing assets in strategic acquisitions 50

51 Case Study 1 For Sale: Assets of hospital, FFE, real property, physician network of practices Engagement: FMV of physician network How is the value of the network s referrals to the hospital included? How is the value of the in-place provider network to support managed care contracts considered? Result: Value of physician network is a fractional asset valuation of the whole entity - value is based on network alone - hospital-referred income and other benefits must be valued on the hospital s valuation 51

52 Case Study 2 For Sale: Assets of a physician practice opened 3 years ago under a physician recruitment guarantee. Practice has $300,000 in cumulative start-up losses, partially because it depreciated its purchases rapidly. Engagement: FMV of practice assets for sale to physicians How do you handle the start-up losses? If all losses were reclassified as equity, would the physicians receive an excess benefit? Result: Health law attorneys will interpret this in various manners. Attorneys will seek to convey that the deal will result in no excess benefit being conferred 52

53 Case Study 3 For Sale: Assets of a 2 year old clinical ancillary services business with losses over $400,000 including third party debt. Two partners each own 50%. Projections estimate break-even in 12 months; one partner wants out now. Engagement: FMV of business assets to transfer via partnership agreement to one partner to yield 100% and control. Is this a going concern? What about release of debt guaranty? Result: Transfer of the 50% interest for release of guaranty and pro rata share of other payables 53

54 Summary A rapidly changing and consolidating industry Many opportunities for experienced appraisers Pick areas suited to your expertise Seek assistance - spread the risk CYA - Cover Your Assets 54

55 Drivers of Change in Healthcare Business Arrangements Financial Competition Medical staff relationships Managed care penetration Payer relationships and position Personnel General management 55

56 Factors Driving Business Practices in Healthcare Financial Overhead escalation and control Decreasing reimbursement - form and amount Lack of capital for growth Inability to see the need to invest in their business - little or no strategic financial management 56

57 Factors Driving Business Practices in Healthcare Competition Increasing competition between providers Network development steering patients to specific delivery systems Pure play competitors entering markets and diluting patient base Outreach activities capturing market share 57

58 Factors Driving Business Practices in Healthcare Medical staff relationships Cooperative or competitive between hospital and medical staff Frequent poor communications Sources of income and diversification Short term vs. long term thinking 58

59 Factors Driving Business Practices in Healthcare Managed care penetration Stage and form of managed care penetration Discounted fee for service, capitation, direct contracting Competition, market share, and contract access Capturing the premium dollar 59

60 Factors Driving Business Practices in Healthcare Payer relationships and position Complement of payers in market Carnivore, omnivore Health plan equity position or not Data analysis and data capabilities 60

61 Factors Driving Business Practices in Healthcare Personnel Availability and quality of staff Compensation Investment in staff - training and retention issues Use of staff and cost minimization - benchmarking 61

62 Factors Driving Business Practices in Healthcare General management Old paradigm mind set Short term leadership horizon Broad governance issues and strategic direction of the organization Failure to follow-through 62

63 Hospital - Physician Equity Opportunities Joint ventures Ancillary services - PT, OT, therapies Surgical and other diagnostic centers Skilled nursing and assisted living facilities Medical office buildings Condominiumization of hospital services - boutique model of delivery 63

64 Hospital - Physician Equity Opportunities Wellness, behavioral health, urgent care, occupational medicine, hospice and dialysis centers Creation of new delivery and contracting systems - PHOs, IPAs (though not a lot of recent activity) Privatization of health departments 64

65 Hospital - Physician Equity Opportunities Methods for acquiring & selling equity Cash buy-in / pay-out Earn out method - certain circumstances Deferred compensation / buy-in Buy-sell agreements Recruitment agreements 65

66 Hospital - Physician Equity Opportunities Valuation/Fairness/Documentation Standard and premise of value FMV, fair value, intrinsic value, strategic value, value in liquidation Purpose and function of valuation Complete or limited valuation 66

67 Hospital - Physician Equity Opportunities Valuation issues cont. What is being valued: assets, stock, contract, capital contribution, etc. Universe of buyers Control or minority interest Marketability issues Actual or hypothetical 67

68 Hospital - Physician Equity Opportunities Valuation issues cont. Purchase - cash, stock or terms Timing of valuation 68

69 Hospital - Physician Equity Opportunities Operating issues Nature of the agreement (e.g., JV, operating, management, etc.) Operating agreement provisions Control, succession and reporting mechanisms Management composition 69

70 Hospital - Physician Equity Opportunities Operating agreement, cont. Capital account contributions, events and provisions (failure to make additional contributions) Distributable cash Partner liabilities Tax exempt status issues Dissolution of company & buy-sell 70

71 Hospital - Physician Equity Opportunities Transaction issues Timing of transaction - current valuation (e.g., within 3 months of closing date w/ updated balance sheet) Terms and fairness - FMV Normally judged from the viewpoint of one side only in a deal (the other side has to concern itself with fairness from its viewpoint) 71

72 Hospital - Physician Equity Opportunities Transaction issues, cont. A fairness opinion is no guarantee that the proposed deal is the best possible deal Price is an important consideration Not all prices are comparable How should a stock deal compare with an allcash deal? 72

73 Hospital - Physician Equity Opportunities Transaction issues, cont. Not all stocks have equivalent attractiveness Liquidity is a concern Historical performance and the outlook for future performance Some stocks have more potential for rapid appreciation than others 73