Thus, the post-acquisition physician(s) compensation must be accounted for in the business value. The same monetary benefit cannot materialize itself in both the purchase price of the medical practice (via a lower compensation assumption) and in the post-acquisition physician compensation (via an actual compensation offer greater than that included in the practice valuation). The compensation level of the physician(s) is important because financial relationships between hospitals and health systems and physicians must be at fair market value to meet certain regulatory requirements (i.e., the Stark Law and Anti-Kickback Statutes). However, to appropriately determine the fair market value of physician compensation during the valuation of a medical practice, generally normalization adjustments must be performed by the appraiser.
Normalization adjustments are made to reflect an expense structure any hypothetical willing buyer with a controlling interest would anticipate. Specifically, certain normalization adjustments should be made to eliminate one-time gains or losses, non-recurring income or expense items, expenses of non-operating assets, and other unusual items, etc. When owning a practice, physicians are accustomed to receiving compensation of all remaining earnings after payment of expenses. If expenses have not been appropriately normalized, leftover earnings could be under- or overstated. If expenses are overstated, compensation is also potentially understated. As such, in determining post-acquisition compensation, it is crucial to evaluate a medical practice’s incurred operating costs.
Normalization adjustments to operating expenses are important, but such adjustments to physician compensation often have the greatest potential to affect a medical practice’s value. Each physician’s compensation should be adjusted to fair market value (it is worth noting that this discussion is primarily relevant when a hospital is acquiring a practice). It is quite possible, due to limitations caused by expense management, that the current physician compensation is lower than fair market value and, as such, could appropriately be adjusted upward. This adjustment to physician compensation can be directly included in valuation projections, translating into a reduction in forecasted profits for the medical practice, and thus, a reduction in the value of the “business enterprise value” of the practice. However, it is also possible that a physician’s current compensation is higher than fair market value, and, as such, will need to be adjusted downward. In this scenario, all other factors remaining constant, an increase in the medical practice value will occur. When valuing the practice, normalization adjustments to compensation should reflect a post-transaction compensation that is consistent with fair market value, regardless of whether compensation, or the “business enterprise value” of the practice, will be higher or lower. As stated previously herein, providers must be compensated at fair market value to remain in compliance with the Stark Law and Anti-Kickback Statutes.
Accordingly, physicians should have a thorough understanding of the inverse relationship between post-acquisition compensation and the value of their medical practice to ensure compliance in transactions between hospitals and health systems.
Kathryn A. Culver, Manager – Healthcare Consulting, PYA
Kathryn Culver is a consulting manager within the valuation service line at PYA, P.C. She performs fair market valuations for physician practice groups, hospitals, and health systems, and evaluates compensation agreements between health facilities and physicians. In addition, Kathryn is a Certified Public Accountant and has a strong foundation in accounting and finance. She has presented for several organizations on topics such as healthcare valuation, practice valuation, and physician compensation planning and has authored articles in various healthcare industry publications.
The views, opinions and positions expressed within these guest posts are those of the author alone and do not represent those of Becker’s Hospital Review/Becker’s Healthcare. The accuracy, completeness and validity of any statements made within this article are not guaranteed. We accept no liability for any errors, omissions or representations. The copyright of this content belongs to the author and any liability with regards to infringement of intellectual property rights remains with them.
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