Cost Approach Again – NACVA June 2012July 10th, 2012 | Cost Approach | Income Approach & Methods | Medicare | Reasonable Comp | Regulatory Matters | Seminars & Publications | Valuing Goodwill
I had to turn down an invitation to speak at NACVA this past June in favor of my 35th wedding anniversary. I would not have decided differently, but was surprised to see that Bob Cimasi’s presentation was devoted in its entirety to refuting the White Paper written by me and 7 other co-authors and published in the American Health Lawyers Association Hospitals and Health Systems Rx publication.
There are a variety of specious arguments in the presentation, but I will limit myself to a few.
There are a variety of citations to IRS CPE texts and the Friendly Hills private letter ruling in support of the notion that it is appropriate to use the cost approach to value physician workforce in place. These citations conveniently ignore the fact that the CPE texts clearly state that the cost approach is used to allocate the value determined under the Income Approach (discounted cashflow method) and CRITICALLY that the appraisal in support of the Friendly Hills private letter ruling included a letter from the managing partner of the physician practice that stated the following:
“It has been clearly stated to the partners that, in the past, their compensation reflected not only the value of their medical services, but also the profits attributable to their ownership of the Network; that the latter element will be replaced by a cash payment, which they can invest … that the Medical Group’s income will thereafter be derived from arms-length contract for medical services; and that these rates will necessarily be significantly lower than the total historical income they have been receiving …”
Now, less there be any doubt what is stated here, “the Medical Group’s income will thereafter be derived from arms-length contract for medical services; and that these rates will necessarily be significantly lower than the total historical income they have been receiving” is in stark contrast to many of the transactions that take place where physician workforce is paid for and post-transaction the physicians receive a higher income than they historically earned. There is simply no basis whatsoever for believing that the IRS was unaware of the interrelationship between practice valuation and physician compensation.
I still have a copy of that letter, which was an integral part of the valuation and the granting of IRS approval for the transaction.
Perhaps the most outlandish argument is using Bankruptcy case law and theory in suport of fair market value and commerical reasonableness in a healthcare transaction.
One of the many arguments against the White Paper’s position that there be an income return analysis to establish value is that somehow a “cost decrement” or reduction in expenses gets around the requirement that the hypothetical investor of the fair market value standard would not invest in something that generates no income. Income is revenue minus expense, of course. All things held equal, if revenue stays constant and expenses go down, income will increase. However, if there is no revenue in the first instance that does not violate the prohibition against DHS referrals, even if expenses are less, there is no income for purposes of the requirement that the expense reduction be commercially reasonable in the absence of referrals.
It is hard to envision that a transaction based upon an expectation of losing money is commercially reasonable for the hospital, although the presentation supports it based upon Bankruptcy case law. Certainly, if all hospitals entered into such transactions expecting to lose money and did not have the benefit of referrals from the transaction to DHS, they would all go bankrupt. Perhaps that is the connection.
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