The sale goes well beyond cashing the check. Make sure you understand these important aspects of the process.
Selling a successful practice and cashing in on a lifetime of hard work is what many practice owners envision. But there is far more to the transaction than just cashing the check and heading into a bountiful retirement. Taxes, regulations, and just establishing a fair price can all complicate the transaction.
Medical Economics spoke with Lori Robbins, JD, managing director, Washington National Tax, and Chris Ober, MBA, managing director, U.S. healthcare valuation, both with KPMG, an international accounting and advisory firm, about the challenges of selling a practice.
(Editor’s note: The transcript has been edited for clarity and brevity.)
Medical Economics: Why are there currently so many transactions for physician practices?
Lori Robbins: Physician practice sales are one of the biggest growth areas for health care transactions right now. We're on pace to reach over 300 deals this year, up from over 200 last year. And this continuing increase in deal volume is likely attributable to a few different things. For example, the pandemic created some financial pressures on medical practices since many patients were deferring care last year. As a result, some practices are looking to attract some capital investment, especially in areas like telehealth. We're seeing private equity buyers in the space of buying physician practices, and that can be for a variety of reasons ranging from expanding geographically to deepening their investments in specific medical specialties. And of course, you've got the hospital systems and the health plans that are continuing to buy physician practices looking to integrate that care into their health system and in some instances, preparing to diversify.
Medical Economics: How do the Stark laws influence the purchases of physician practices?
Chris Ober: Pretty significantly, actually. The Stark laws and anti-kickback statutes were put in place to prevent remuneration paid to physicians to refer patients to facilities within certain health systems, and that does not really consider what's in the best interest for the patient in general. They essentially require that any payments to physicians from health systems or any other buyers need to be within the context of a fair market value premise. And without really getting into the precise, long winded definition of fair market value, it really just suggests that what's being paid for physician practice is in line with the current productivity and current operations of that business without paying additional incentives to the physician practice for additional patient referrals going forward. The way that it really influences physician practice acquisitions is it does set up a guardrail for what can be paid for that practice. For example, if a health system really is interested in an aspiring cardiology practice, they can't just go and pay two or three times premium in order to secure that transaction because it needs to be within that fair market value. While there still may be competitive bidding for that practice, the range will be a little bit more minimized due to the fact that most of those health systems need to be within that framework-of-value guardrail. Where it does come into play is a lot of times physicians feel like they ought to be paid significantly more than what that fair market value range is, so that it does throw a kind of a kink into the negotiation.
But the one thing I would add is, can a health system actually pay a significant premium? And that begs the question, is a fair market value actually required? It isn't. But we've all seen some of the significant settlements and sanctions that have been applied to some health systems across the country historically for violation of those Stark and anti-kickback rules. So most of our clients do like to have a third party fair market value analysis performed, just in case there are governing bodies that come in and want to scrutinize some of their contracts or their acquisitions or practices that they've acquired. If they don't have the support, that what they're paying is in line with fair market value, or if there's any evidence that there are overpayments being deployed, then it leaves them kind of in a tough spot.
Medical Economics: How is a practice’s value determined? And what sort of documentation is necessary to establish it?
Ober: There are a few different ways that we generally look at physician practice acquisitions, and we'll generally start with an income approach, with a discounted cash flow method. And then we'll look at a market approach.
Basically, investors are interested in what the return on investment would be in terms of the cash flows being generated in the business going forward. And they're also interested in what other third-party buyers have paid for similar assets, what multiples of earnings and other types of multiples that they paid, which might inform them on their decision on what they might pay for this practice. The market approach really can consider two different things. You can look to the publicly traded market so you can look to the stock exchange and find publicly traded, similar companies and extract pricing multiples for what folks are investing in those businesses. Or you can look to private transactions. We have several databases that have information around physician practice acquisitions, and what multiples were paid for those transactions, whether it's controlled or minority. As you would imagine, we don't look to the guideline public company method as often because there aren't many physician practices that went public. But it's too early to really extract any data from those trades. So generally speaking, we don't look to the guideline company method, because you could pull hospitals, you could pull payers, and yes, they're in the healthcare space, but a physician practices an entirely different animal. It's not really a comparable metric. So we do look more to physician practice acquisitions to extract pricing multiples for those valuations from an income approach perspective for physician practices. A lot of times, we run into a situation where there isn't a lot of profitability left in the practice at the end of the day after salaries are paid out. Oftentimes, it's a challenge to run a discounted cash flow method if there isn't profitability in the business, because you end up getting a number that is not meaningful. To some extent, especially for the smaller practices, that tends to be the case, and especially if there aren't any ancillary services involved that might drive more cash flow. At the end of the day, if we're unable to use that approach, then we'll corroborate the market approach with basic cost approach, which is really going in and valuing the underlying assets of the business.We generally like to have two different value conclusions to corroborate together from a documentation standpoint. It's not as cumbersome as some of the financial reporting valuation work that we do in the health care space for purchase price allocations and goodwill impairment. In this case, what our general counsel and other regulatory bodies are satisfied with is a detailed set of exhibits and work papers, and then really a summary report could be 15 pages or so that just documents the methodologies used in the assumptions.
Medical Economics: For doctors running small practices, are there any special caveats they need to be aware of when it comes to valuation?
Ober: We touched on it a little bit on that last question. It's the smaller the practice, like primary care practices and other non-specialty type physician groups. Generally, if you think about the way that those entities operate, you may have two to three physicians that are running one, maybe two locations. And they're really just seeing patients, that's what they love to do. They see patients, they bill the insurance, they collect, and then they pay their expenses, and then what's left at the end of the day is generally their salaries. And so when you pull all of that out, that generally leaves little to no cash flow left in the business. Because unless they're planning on opening several locations where they have major capital investments that they're planning for some ancillaries—maybe that's X-ray machines or diagnostic equipment. But for primary care physicians, for example, there really isn't much investment need in it. But generally what's left in the business they're taking home as their salary, so when they are entering an acquisition opportunity, if they want to align with the health system or a private equity firm, they may have higher expectations of what their practice is worth, because maybe they created that practice, and have been running it for years and years, and very been very highly successful.
But when you take that discounted cash flow method out of the equation, and if there aren’t a lot of earnings in the business to apply a multiple to, then you're really applying a multiple to revenue number, which really is less meaningful in this industry. So you end up having to go to that alternative cost approach. You're looking at the cost. You're looking at the tangible and intangible assets within that practice. And now what you're really talking about is desks, chairs, tables, computers, filing cabinets, whatever it may be. Then what tends to happen is the fair market value conclusion usually comes in a little bit under where the physician’s expectations were. And so there's that initial sit down with the health system and the physician practice where there's not real alignment at first, and then the negotiation process gets them to somewhere within that reasonable fair market value range.
The other thing I might add is, when you're a primary breadwinner, I keep using primary physician practice, but really any physician practice in general that's just private and run by the physicians, can pay themselves whatever is left in the business. So, if they've historically been paid above what fair market value ranges for physicians of similar productivity and similar collections and so forth, based on the benchmarking data, then they may expect that when they align with that health system. That may be adjusted, because that needs to be within that fair market value boundary.
Medical Economics: Are specialty practices valued differently than a primary care practice would be.
Ober: Not really. It really is the same methodologies that would apply for those types of practices, but you're going to have several different expense structures. A primary care practice, you have your general operating expenses, your utilities, your salaries and wages, and those types of things. But when you get into oncology, maybe now you have drug costs. And it's just really in the expense structure. I think in terms of billing the insurance, you're billing under different codes, and so the collections will be different based on what specialty you're referring to, but you're still looking at net collections in terms of what CPT codes are being hit and what reimbursement rates are tied to those CPT codes and then getting to net collections. That operating expense structure will be a little bit different; you may see a lot more profitability in a radiology business or urology business than you would in maybe a primary care practice. But the methodologies would still apply across all specialties.
Medical Economics: Do the different payment models that practices uses, like capitation, or value-based care contracts, factor into the evaluation at all?
What I would say is in the first place, we've been talking about the volume-to-value shift for years and years, and it's a very slow moving animal. And it was put into place to cut costs in the health care infrastructure and to also provide better health outcomes. But what we've seen is historically, physicians don't like massive sweeping changes to their practice; they like to see their patients, they like stability in their practice. They've been a little bit reluctant to invest the large amounts of money in technology and other aspects that are necessary to comply with these bundled payments. There's also apprehension around whether or not anti-kickback laws prohibit some of those, those incentive payments that really align with-value based care. I know they did just have a final ruling on some Stark and anti-kickback revisions that loosen some of those restrictions to kind of foster better cooperation between payers and providers and push some of that risk to the provider side. But whether or not that will result in these alternative payment models kind of remains to be seen. So I think for the most part, we still see mostly the hybrid based draw, and some incentive tied to productivity or maybe quality metrics. That's kind of what we see across most of our physician practices.
Once those value-based payments do kind of kick in and become more preferable, then you should see better cash flow, because the purpose of those is to cut costs in the business and increase the quality of outcome. So at the end of the day, that should result in higher profitability, but we just haven't really seen too much of it yet.
Robbins: I think that we're slowly moving that direction. But I think we're still largely in the health care space that is mostly a fee for service business right now. And I think it's going to continue to remain that way. Now, maybe some of the developments that Chris just mentioned will spur some momentum in that direction. But right now, we're seeing more alternative payment models, but it's still a very small portion of the health care business.
Medical Economics: One of the aspects that's often overlooked by the physician selling a practice are the tax implications? What will the selling physician face after the sale?
Robbins: Before I really get into the specifics of your question, I think it's really important to note that doctors should always have their own tax advisor in these physician transaction deals, because every deal is unique, and their interests may not be aligned with the buyers interests. So the physician shouldn't be relying on the buyers tax advisers to watch out for their own interest. But I think the answer to what kind of tax consequences that physicians face really depends on a couple of factors. First of all, whether you're talking about a stock or an asset sale. So for example, in a stock sale, a selling position, really is going to recognize a gain or loss based on the difference between the price paid for his practice and his or her current basis in the stock or their equity in the practice, if you will.
And that's usually subject to capital gains treatment, and there can be some exceptions to that. But in an asset sale, we're talking about recognizing a taxable gain or loss based on the difference between that purchase price that the buyers going to pay, and the assets and liabilities that Chris was talking about valuing. So that can be both the hard assets and also there are intangible assets like goodwill, which can be a significant asset for physician practice. But I also want to say that the physicians really need to remember that tax consequences can also depend on their structure. We see some physician practices set up as actual corporations, and they're subject to a different regime of tax then those that are partnerships or LLCs. They could be taxed as a flow through entity, maybe they're just having that single level of taxation. And that can actually alter tax consequences as well. And finally, I do want to note that where physicians get something other than cash in a deal for the sale of their practice, that can complicate and create a more complex tax situation. We see these when the doctors are interested in retaining a piece of interest in their own practice after the sale, or in some cases, the physicians actually want an equity interest in the buyer of their practice after the sale. Those kinds of complications can lead to some really complex tax issues. And that's another reason that physicians should probably get their own tax advisors because sometimes a buyer will come to a physician practice and want them to actually do some restructuring before the sale ever occurs. And the doctor should be looking to make sure that their own interests are being protected and not just rely on the buyer to represent them.