Source: http://quickreadbuzz.com/2014/12/17/valuing-astc-under-hypothetical-conditions/
Timestamp: 2019-04-25 03:55:35+00:00

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In this article, Robert Cimasi and Matthew Wagner provide a roadmap of the valuation and legal issues valuation professionals confront valuing a medical practice that also provides ancillary and technical component (ASTC) services. The fact that the ASTC services are often integrated with the professional services of a practice does not restrict the ASTC service line from having value separate and aside from that of the practice enterprise. The authors share their views on how to value the hypothetical “carve-out” ASTC, including what approaches to consider.
The use of a hypothetical condition, under the concept of the highest and best use, is illustrated below, using the example of the determination of fair market value of a cardiology physician practice that has an in-office diagnostic imaging ancillary service line.
The standard of value most often utilized in performing healthcare valuation engagements is that of fair market value, which has a distinct and separate meaning in healthcare, in contrast to its definition in the context of valuation in other industries.
The standard of fair market value is defined as the most probable price that the subject interest should bring if exposed for sale on the open market, but exclusive of any element of value arising from the accomplishment or expectation of the sale. This standard of value assumes an anticipated hypothetical transaction, in which the buyer and seller are each acting prudently with a reasonable equivalence of knowledge, and that the price is not affected by any undue stimulus or coercion.
The Internal Revenue Code (IRC) and accompanying Treasury Regulations, IRS revenue rulings, and other IRS pronouncements, which provide guidance pertaining to determining fair market value for transactions involving tax-exempt organizations, e.g.:the general rule for the valuation of property, including the right to use property, is fair market value (i.e., the price at which property or the right to use property would change hands between a willing buyer and 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).
In addition to the threshold of fair market value, transactions in the healthcare industry are also scrutinized as to whether they meet the regulatory threshold referred to as commercial reasonableness.
An arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty, even if there were no potential DHS referrals.
Each financial and contractual connection between hospitals and physicians should be scrutinized to ensure that goods or services changing hands are being provided at fair market value, and at a level no more than necessary for the business purposes of the arrangement.
While the standard of value for healthcare related valuation engagements is typically set forth by legal and regulatory edicts, determining the premise of value for an engagement should be based on the most probable transactional facts and circumstances for the subject property interest within the context of the current transactional marketplace as of the valuation date. For example, when valuing a physician practice, once adjustments are made to reflect the economic operating expense burden related to the fair market value physician compensation necessary to support the forecasted productivity and revenue stream, there is often insufficient net cash flow to support the value of the invested capital of the enterprise in its entirety. This results in no economic return to capitalize into enterprise value.
In those instances, the highest and best use of the assets of the practice enterprise may not be reflected in a transaction utilizing the typically employed premise of value in use as a going concern, but rather, might more appropriately be reflected under the premise of value-in-exchange, i.e.: (1) as an orderly disposition of an assemblage of assets; (2) as an orderly disposition of assets, without assemblage; or, (3) as a forced liquidation.
Assume the cardiology practice referred to above is being valued, one potential asset of a cardiology practice may be the ancillary services and technical component (ASTC) service line, unit of the practice is comprised of diagnostic imaging tests that are performed by providers of the subject practice, in contrast to the core professional services of the business. This ASTC service line may be valued as a stand-alone enterprise, under the premise of value in use as a going concern, utilizing a hypothetical condition (as defined below).
The fact that the ASTC services are often integrated with the professional services of a practice does not restrict the ASTC service line from having value separate and aside from that of the practice enterprise within which it is apart. The transactional marketplace provides many examples of service lines, or business units, within large corporations that are commonly valued separately and sold as though they were independent, stand-alone entities. However, in healthcare, the appraisal of a service line that is integrated into a physician practice needs to address two controlling issues: (1) under professional valuation standards, the disclosure of the use of a hypothetical condition is required to value an existing ASTC service line that is integrated with a physician professional practice, as a hypothetical, stand-alone, enterprise; and (2) significant attention must be paid to ensure that the transaction does not run afoul of the specific regulatory restrictions pertaining to the valuation of healthcare enterprises (as briefly mentioned above, and as further discussed below).
The hypothetical, stand-alone, ASTC enterprise (also referred to as a “carve out” ASTC enterprise) is typically valued using two approaches, i.e., the Market Approach and the Income Approach. The Market Approach relies on: (1) recent sales of similar ASTC related businesses with homogenous badges of comparability to the subject ASTC enterprise; and/or, (2) guideline publicly traded ASTC related businesses with homogenous badges of comparability to the subject ASTC enterprise, to ascertain an indication of value.
The Income Approach utilizes some form of discounted future net economic benefit generated by the subject “carve out” ASTC enterprise to derive an indication of value. Note that, the Cost Approach is typically not utilized to value “carve out” ASTC enterprises, since the purpose of splitting out the ASTC enterprise from the practice in its entirety is premised on the assumption that the ASTC enterprise generates sufficient net cash flow, that when capitalized, produces an indication of value in an amount which is higher than the sum of the individual ASTC-related tangible and intangible assets, indicating that the highest and best use of the “carve out” ASTC enterprise can be found under the premise of value in use as a going concern, in contrast to the premise of value in exchange, i.e.: (1) as an orderly disposition of an assemblage of assets; (2) as an orderly disposition of assets, without assemblage; or, (3) as a forced liquidation.
When using an Income Approach to value a “carve out” ASTC enterprise, the net economic benefit related to the ownership of the ASTC enterprise must be isolated from the net economic benefit associated with the ownership of the residual professional practice. This ability to isolate the ASTC enterprise net economic benefit is part of the hypothetical condition relied upon under professional valuation standards, (further discussed below).
Determining the most probable economic capital expense burden that would be incurred to produce the technical only ASTC revenue stream. Since much of the tangible personal property (TPP) of a physician practice is utilized by both the ASTC service line and the residual professional practice (e.g., billing computers, desks, etc.), the forecast of capital expenditures (and the corresponding depreciation projections) for the ASTC service line, should include amounts necessary to reflect the most probable level of economic capital expense necessary to support the revenue stream of the ASTC service line, which can be derived from normative industry benchmark survey data. This is especially the case when the initial allocation of TPP to the ASTC service line includes only those items that are exclusively utilized in the provision of ASTC related services (e.g., nuclear camera, echo machine, etc.).
Once the net economic benefit of the subject “carve out” ASTC enterprise has been isolated, the final steps in using an Income Approach are: (a) to develop an appropriate risk adjusted required rate of return to apply to that future net economic benefit stream; and, (b) to determine the types and amounts of any further premiums or discounts (e.g., control premiums, discount for lack of marketability, etc.).
The anticipated hypothetical transaction would be conducted in compliance with the Anti-Kickback Statute, making it illegal to knowingly pay or receive any remuneration in return for referrals.
In summary, a hypothetical condition forms the basis of performing certain valuation engagements in conformance with professional valuation standards. If appropriately applied, these conditions will provide additional guidance regarding the specific facts and circumstances related to the subject property interest to the intended users of the valuation report. In the healthcare industry, this is particularly useful given the ongoing reform efforts, dynamic transactional arena, and the concentration and ambiguity of regulatory scrutiny on the underlying transactions that form the basis for the valuation engagements.
Robert James Cimasi, MHA, ASA, FRICS, MCBA, CVA, CM&AA, serves as Chief Executive Officer of Health Capital Consultants (HCC), a nationally recognized healthcare financial and economic consulting firm headquartered in St. Louis, Missouri, serving clients in 49 states since 1993. Mr. Cimasi has over 30 years of experience in serving clients, with a professional focus on the financial and economic aspects of healthcare service sector entities including: valuation consulting and capital formation services; healthcare industry transactions including joint ventures, mergers, acquisitions, and divestitures; litigation support & expert testimony; and, certificate-of-need and other regulatory and policy planning consulting. Mr. Cimasi can be reached at (414) 994-7641 or at RCimasi@healthcapital.com.
Matthew J. Wagner, MBA, CFA, is senior vice president of Health Capital Consultants), where he focuses on the areas of valuation and financial analysis. Mr. Wagner has provided valuation services regarding various healthcare related enterprises, assets and services, including, but not limited to, physician practices, acute care service lines, diagnostic imaging service lines, ambulatory surgery centers, long-term care enterprises, provider-owned insurance plans, equity purchase options, physician clinical compensation, and healthcare equipment leases. Mr. Wagner can be reached at (314) 994-7641.
 The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) authorized the Appraisal Subcommittee (ASC) of the Appraisal Foundation, which is made up of representatives of the leading U.S. government agencies and non-governmental organizations empowered to oversee the U.S. mortgage and banking system, to develop USPAP. Source : History of the Foundation, The Appraisal Foundation, 2014, https://netforum.avectra.com/eWeb/DynamicPage.aspx?Site=TAF&WebCode=History (Accessed 10/20/2014).
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 Investment Value may be defined as: “…the specific value of an investment to a particular investor or class of investors based on individual investment requirements; distinguished from market value, which is impersonal and detached.” Source : “Investment Value.” In The Dictionary of Real Estate Appraisal, 152. 4th ed. Washington, DC: Appraisal Institute, 2002.
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 42 U.S.C.A. §1395nn(a) (2006); Social Security Act §1877(a) (2006).
 42 U.S.C.A. §1395nn(h)(3) (2006); Social Security Act §1877(h)(3) (2006).
 “Excess Benefit Transaction,” Treasury Regulation §53.4958-4(b)(i) (2002).
 “Medicare and Medicaid Programs; Physicians’ Referrals to Health Care Entities With Which They Have Financial Relationships,” 63 Fed Reg. 1700 (Jan. 9, 1998).
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