• Jason Ruchaber, CFA, ASA

Is my healthcare transaction FMV?

Updated: Feb 20, 2019


The term Fair Market Value (FMV) is theoretical construct used by appraisers that answers the question "value to whom?" This is referred to as a "standard of value" in the appraisal literature, and FMV is but one of several standards of value, which among others, include fair value, strategic value, intrinsic value, etc. FMV is arguably the most commonly used standard of value, with applications in tax reporting, marital dissolution, shareholder transactions, and, of course, healthcare transactions regulated under the Stark law or anti-kickback statute (which is the focus of this post). And despite its widespread usage, there are varying definitions and interpretations of FMV that can add confusion to those seeking to determine whether or not a healthcare transaction is properly priced at fair market value.

The standard definition of FMV as promulgated by the American Society of Appraisers, which is consistent with that found in IRS Revenue Ruling 59-60, is as follows:

“the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms’ length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”

As applied to healthcare transactions the definition of FMV contains additional limitations imposed by the anti-kickback statute and the Stark law. With these limitations FMV is defined as:

the value in arm's-length transactions, consistent with the “general market value”.[1] ‘‘General market value’’ means the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between well informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement. Usually, the fair market price is the price at which bona fide sales have been consummated for assets of like type, quality, and quantity in a particular market at the time of acquisition, or the compensation that has been included in bona fide service agreements with comparable terms at the time of the agreement, where the price or compensation has not been determined in any manner that takes into account the volume or value of anticipated or actual referrals. ([1] 42 CFR §411.351 as set forth by the Centers for Medicare and Medicaid Services).

There is a lot to unpack in reconciling these two definitions, and it is easy to get caught up in the minutiae (for those who are curious I explored this in more detail in a 2014 article found here, and I touch on some of the same points below). That is not to say the details are not important, and the valuation and due diligence process for healthcare transactions is often highly complicated. It occurs to me, however, that whereas well-informed and reasonable experts can disagree on certain assumptions or inputs into the appraisal, the truly problematic transactions are those where the parties lose sight of the bigger picture. To distill this into a basic roadmap to FMV I have prepared the simplified infographic below.


Though the points of inflection offered above are largely intuitive, it is surprisingly easy for parties that want to get a deal done to miss the big issues.

1) Is something of value being conveyed? Well of course, right? Why else would we need a valuation? Believe it or not, this first critical question is often taken as a given when it should involve some analysis. Does the physician actually have to do something to receive compensation under the arrangement? If not, there may not be anything of value being conveyed. Or what about letting a physician use that extra space in your office building that you aren't currently using? It doesn't cost you anything right? Well the use of that space conveys value to the physician that can and should be measured, and the failure to recognize that is likely a violation of FMV. Less obvious examples that may involve a conveyance of value include the grant (or revocation) of contractual rights or shareholder provisions, disproportionate assumption of risks, asymmetric or preferred distributions, forgiveness of debts, use of infrastructure, etc.

2) Is the transaction legally permissible? Like the above, this may seem obvious but is worthy of examination. Violations of licensure provisions, fraudulent billing practices, prohibited self-referrals of DHS, impermissible relationships, corporate practice of medicine restrictions, etc., are but a few examples. I once had an assignment involving the valuation of contributions to a joint venture. One party claimed to have significant IT assets including proprietary software. During due diligence it was discovered that the party did not have a license to use the source code, and not only could they not contribute this asset to the joint venture, they likely didn't have the right to use it in their existing business. A transaction cannot be FMV if it is legally precluded, or if an underlying element of the business (or behavior of service provider) is illegal.

3) Does it consider the value or volume of referrals? Well, um, not directly....... The standard is very clear on this issue. FMV must not be determined in any manner that takes into account the volume or value of anticipated or actual referrals (directly or indirectly). Healthcare transactions often involve parties that have a pre-existing business relationship or history of referrals. Because of this, parties may find it difficult to isolate the transaction and evaluate it on its merits alone. However, it is critical to do so if the transaction is to be FMV. The simple rule I follow as an appraiser is to not consider anything extraneous to the actual transaction being contemplated. I also work closely with legal counsel to work through the structure of the deal to ensure that there are no terms (such as the payment mechanism itself, compliance protocols, etc.) that may result in future payments that vary with the value or volume of referrals and deviate from FMV.

4) Does it consider factors specific to either of the parties? FMV requires the contemplation of a price that results from negotiation between hypothetical and unrelated parties. This means that consideration of any synergistic factor specific to one of the parties is a violation of FMV. Imagine being blinded to the names of the actual buyer and seller, and simply pricing the deal based merits of the business (or service) itself, with appropriate consideration of market and other economic normally contemplated by market participants. For example, is a practice overstaffed or poorly managed? It may be appropriate to reduce staffing to market norms. Similarly, it may be appropriate to make certain changes to the cost structure that could be reasonably attained with competent oversight and management. It would not be consistent with FMV, however, to completely eliminate staff or other operational costs due to redundancies with the buyer's organization. The seller could not realize this synergies independently, and the resulting value would be reflective of strategic or investment value.

5) Are the valuation model inputs based on reasonable market data? We live in an age where there is a tremendous amount of data at our fingertips. In some ways, this makes the notion of having "reasonable knowledge of the relevant facts" more complicated as it is simply impossible to consume and incorporate all of the information out there. That being said, a transaction cannot be FMV if it ignores readily available market data. This highlights the need to engage experts familiar with the healthcare industry and the economic and regulatory conditions impacting healthcare businesses and services. FMV should reflect prevailing interest rates, risk factors, capital structures, and growth expectations. Often these factors are condensed into what are known as valuation multiples, but the proper allocation of a multiple requires careful consideration of all of the underlying factors. Similarly, there is a significant amount of information available regarding physician compensation, but the data are often poorly understood or applied in a manner inconsistent with the surveys.

6) Are cheaper alternatives with equal utility available? This last point touches not only on FMV, but also on the notion of commercial reasonableness. All things being equal, a rational investor would pay no more for an asset or service than what would be required to obtain a reasonably suitable alternative with equal utility. It would not be commercially reasonable or FMV to pay a physician $300 an hour to mow your lawn simply because he or she is a physician and earns that rate in their clinical practice. There are plenty of yard crews and neighborhood kids that will deliver the same or better utility (i.e., do a better job) for less money. FMV is not specific to the individual performing the task, but is rather a function of the qualifications necessary to perform the task. The example above is fairly straightforward, but there are also less obvious scenarios that could violate FMV such as paying a specialist when an PCP or midlevel provider could perform the role proficiently, incorporating excessive mark-ups or interest rates on leasing arrangements and shared-staffing models, paying for travel time when other service providers are more geographically proximate, etc.

Hopefully this road map and the examples above will serve as guide to help keep your transaction FMV. If you have a question regarding any of the topics above, or need FMV analysis on a specific transaction, please give us a call at 720.390.6673.

#fairmarketvalue #Healthcare

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