Jessica ChangAmid the ongoing implementation of healthcare reform measures and the healthcare industry’s transition from fee-for-service to fee-for-value, which has increased pressure on providers to deliver high-quality care at lower costs, hospitals and health systems have been compelled to step up their alignment strategies with physicians and medical groups. Acquisition of physician practices remains one of the most common alignment strategies.

Being acquired by a hospital or health system can be attractive to physician groups because it allows the physicians to focus on their clinical work and not be encumbered by the business, regulatory, and administrative demands required to run a practice. Hospitals and health systems are able to leverage their existing resources and infrastructure to provide medical practices with the administrative support needed, including revenue cycle management, electronic health records implementation and maintenance, human resource management, employee benefits, and other administrative responsibilities.

With the proliferation of such physician practice acquisitions, however, comes an increase in regulatory scrutiny, especially for not-for-profit buyers that must adhere to the fair market value (FMV) standard of value as promulgated within the Stark Law, the federal Anti-Kickback Statute, and IRS regulations. A comprehensive business valuation under the FMV standard of value takes into consideration three methodologies: asset approach, income approach, and market approach. When valuing physician practices, the applicable methodologies are dependent upon many factors, including specialty, geography, risk profile, payer mix, and availability of reliable data.

Asset Approach

Historically, transactions have often been based on the asset approach, which accounts for a practice’s tangible and potentially intangible assets in use. The valued assets typically consist of furniture, fixtures and equipment, medical records, inventory, and prepaid expenses. Most often the other assets and liabilities are retained by the seller. This approach is considered to be very reliable because it is based primarily on tangible assets and therefore involves less subjectivity.

Income Approach

The income approach considers future cash flows of a physician practice and often is deemed an appropriate method as it attempts to measure potential ROI in the practice. Because this approach is based on projected performance, factors regarding projected cash flows must be considered, including the following.

Volume projections. Questions to ask when projecting volume should address considerations such as the rate of population growth in the practice’s service area, the potential market share capture, and whether there is capacity to increase the practice’s volume.

Revenue projections. When projecting revenue from the proactive, the hospital or health system should consider the payer environment in the market—for example, whether it is highly capitated or still primarily fee-for-service.

Expected physician compensation. Considerations here include whether there is a compensation plan in place for the owner physicians after the transaction and, if so, whether the compensation plan would have to be incorporated into the projections. Another consideration is whether current compensation is commensurate with physician productivity. If not, adjustments would have to be made to align compensation to projected productivity.

Normalized adjustments. With respect to this factor, hospitals and health systems should consider whether there is seasonality in the year-to-date period that may need to be adjusted prior to developing the projections. A further consideration is whether there are any specific expenses included in the financials that are discretionary to the physician(s), or unrelated to the operations of the practice, that should be removed.

Market Approach

Although activity has been in the upswing, most acquisitions are private transactions that do not publicly disclose purchase prices and financial data. With the market approach, market multiples of EBITDA and revenue are calculated based on relevant transactions and adjusted based on performance, size, growth, and profitability to the targeted practice. Other potential factors include risk associated with the practice specialty, physician age, and demographics. Because many of the market transactions involve for-profit buyers, as well as largely diversified companies that may represent “strategic value,” it is often difficult to correlate market activity as truly comparable for transactions under the FMV standard of value.

All three valuation approaches should be considered in a comprehensive physician practice acquisition. The objective always should be to use the most applicable approach(es) to reach a value determination for the practice that will stand up to any potential regulatory scrutiny.


Jessica Chang, ASA, is a senior consultant, The Camden Group, Los Angeles.

Publication Date: Wednesday, July 30, 2014