Consultative Valuation: Preventive Medicine for Deal Development

You’ve been working with a physician group for months, putting together a deal to acquire their practice. Finally, everyone is happy. Now the lawyers say there are regulatory questions; the acquisition price may not comply with fair market value requirements. No one wants to have a deal unravel in the final stages due to fair market value findings. Too often, whatever trust and respect may have been cultivated between hospital and physicians unravels at the same time. Nor does anyone want to face regulator-mandated changes in a deal months or years after it is consummated. Fortunately, both of these risks can be avoided, through a process DGA calls “consultative valuation.” Consultative valuation makes fair market value assessment an integral part of the deal development process. It assures that only structures and prices that will pass the fair market value test will be considered. Regulatory compliance is built in, so the FMV opinion on a consummated deal will always be both positive and solid. The transaction process will go more easily, the ultimate fair market opinion process will proceed more smoothly and be less costly, and the trust and respect between the hospital and its medical staff will be preserved.

MEETING FAIR MARKET VALUE RULES WHILE STRUCTURING A DEAL THAT WORKS

Whether the deal you are structuring is an equity-based freestanding provider joint venture, a departmental service agreement (under arrangement or provider based) or asset leasing, what’s top-of-mind for the hospital is usually strategic goals, feasibility and physician relationships. The physicians are typically focused on maintaining an income stream and optimizing their financial position. Neither is focused on FMV considerations or likely to have had extensive experience with them. Consultative valuation can assure that deals are structured and priced appropriately, avoiding the myriad of hazards that interfere with regulatory acceptance. For example, an objective valuation consultant will assure that:

Fundamental value calculations are correctly done: Your organization doesn’t frequently perform capitalized earnings or discounted cash flow analyses, cost or asset valuation techniques or market comparables. Errors in technique can lead to inappropriate offers to the physicians; consultative valuation prevents this.
Tax effects are treated properly: The “hypothetical buyer” required by valuation principles is usually a taxable entity. When that is overlooked by non-profit hospitals, earnings potential and therefore acquisition price, may be set a great deal higher than it should be.
Earnings streams are treated correctly: A hospital has certain advantages over the “hypothetical buyer.” Often, its licensure means it will get greater reimbursement for a service than the physicians it is buying a business from. If that is factored into the buying price, however, the deal will not survive regulatory scrutiny.
Repricing is handled right: Appropriately re-pricing outpatient provider program revenue streams to account for differences in licensure requires considerable experience with healthcare (especially Medicare) payment regulations. An inadequate re-pricing analysis means an erroneous valuation conclusion.
Capital costs are dealt with appropriately: In everyone’s enthusiasm for a deal, sometimes the need to replace equipment is not taken into account. Even if major equipment continues to function, it may need to be replaced to meet competitive standards. A valuation consultation will assure that replacement needs are factored into lease or acquisition agreements in ways that are acceptable from financial, regulatory and sometimes even logistical viewpoints.
Payments for physician services are properly handled: Hospitals may combine a business purchase or equipment leasing agreement with service contracts for physicians. Regulations on management agreements are strict, and payments that meet FMV requirements may be a long way from physician aspirations. A valuation consultant can offer alternative approaches to addressing physician goals, as well as familiarizing physicians with regulatory constraints.

KEYS TO SUCCESS IN CONSULTATIVE VALUATION

Consultative valuation requires the involvement of professionals who have expertise in both fair market valuation and hospital/physician relationships. Professionals engaged in the dual roles of valuation and deal structuring must establish and preserve an objective position to be effective. The valuation/structuring consultant should be introduced to and accepted by all participants from the outset. To maintain objectivity, two-sided communication is critical. Effective communications mechanisms such as appointed physician liaisons or working groups who have free access to the valuation/ structuring professional are essential. Even at the early stage of ascertaining objectives, it is common to encounter fair market valuation challenges. The response is to evaluate, educate and revise objectives—if possible. Sometimes one side or the other is not willing to revise its objectives sufficiently to fit within a fair market value framework. If that is the case, the early involvement of the valuation/structuring consultant has saved everyone the time and expense of fully developing a deal that would not meet regulatory scrutiny. The negotiation process is delicate. When orchestrated solely by hospital and physician participants, the risks of one or more “unruly elements” evolving into a deal killer (or worse) is considerable. The ongoing participation of a valuation expert provides a layer of protection for both sides. When properly implemented, consultative valuation results in a productive negotiation, a problem-free and considerably less costly fair market opinion process, and a more successful transaction.