Valuations Part Five: Market Value and Arm’s Length Negotiations
The fifth part of our series on valuations deals further with the topic of Market Value.
Valuation data can be gathered in various different ways. A few of these can be derived from bargaining, including arm’s length bargaining. However, there are certain legal aspects that should be kept in mind involving Stark Law and the Anti-Kickback Statute.
Fair Market Value (FMV) can be arrived at through multiple valuations approaches, including the Market Value (MV) approach, according to Blayne Rush, President of Ambulatory Alliances, LLC. There are several things to keep in mind, though, when looking to arrive at FMV.
“You need to take a close look at several elements of the definition of FMV and then look to see if the definitions are incompatible, or is there a common structure that is consistent and complementary,” he said.
Looking at the Stark definition of FMV, we see that it is defined in terms of arm’s length negotiations between well-informed buyers and sellers who do not have a referral relationship. Furthermore, Rush notes that the Stark definition also places a focus on the Fair Market Valuation’s market approach (not to be confused with MV), “which is typically centered on bona fide sales of similar businesses that have been transacted in the same marketplace at the time of the transaction (comparable sales).”
“One of the biggest challenges with this is that the majority of these transactions are private capital market transactions where the transactions are just that, private,” he said. “Additionally there are a limited number of transactions in the local markets. In other words there is very little reliable published data therefore other data sources and process need to be considered.”
Alexander Kajan, Manager at Altegra Health in the Daytona Beach, FL, area, echoes this statement, saying that while, “Revenue Ruling 59-60 seems to indicate that prior transactions in company stock, or comparable stock, may be the best method to determine FMV, finding a truly comparable company is quite difficult.”
Jason Ruchaber of Root Valuations cautions further, noting that market data is typically limited and that “tainted market data” should be avoided.
So, where does the right type of data come from?
Bargaining as Market Data
There are a variety of sources of valuation available when performing a market valuation. One of these that isn’t commonly looked to would be bargaining with other parties to obtain similar business (for example, about unsuccessful transactions which failed based on insufficient consideration offered).
“The intent with the entire process is to support that the economic value paid and to support that remuneration was not paid for something that is prohibited,” Rush said. “If there is bargaining for like quality businesses in the same market that are or can be documented, then that information can be used to support the amount paid and terms for a similar business.”
This bargaining must be “bona fide” bargainings and not information based on rumors or hearsay. There must be verifiable supporting evidence of the information being used.
Bona fide offers from arm’s length bargaining with other parties to buy the same center may also be used as sources of data, according to Rush.
“As we have discussed, the centrepiece of the Stark definition is the negotiations with the subject party and the general market as a whole,” he said. “The negotiations with other parties to buy the same center will help support the price and terms that were ultimately agreed to by the parties to the transaction. With the majority of the transactions that I am involved with and that I am exposed to, the Anti-Kickback Statue is actually what holds, and that requires the government to prove that there was intent to pay for in essence referrals or some other prohibitive value if you will.”
As long as documentation of the process and of the offers, or even the negotiation process and verbal offers, exists then that information would serve to support the economic value and terms that end up in the transaction documents.
Ruchaber notes that you must endure that the offer price is not specific to a particular buyer alone based on some strategic motivation that the current potential buyer could never realize.
“A bona fide offer from a single buyer does not constitute the ‘market’ for that investment, but it does potentially expand the pool of potential buyers and then widen the range of the overall market,” he said.
According to Kajan, if the negotiations that you are seeking to use as market data can be proved to have been performed at arm’s length, then the negotiated value should strongly approximate FMV.
“An offer would not be solely relied upon as an indication of fair market value,” he said. “Also, more detail surrounding the terms of the deal is necessary as fair market value requires the deal not only be at arm’s length, but that neither party was under the compulsion to buy or sell and that both parties had reasonable knowledge of relevant facts.”
Arm’s Length Bargaining
When actual arm’s length bargaining with the subject party regarding the specific business is within the range of negotiated offers it can come into play. However, you have to be careful.
“The tricky part here is trying to decipher whether or not parties who ARE IN FACT in a position to refer each other business can truthfully negotiate without consideration of the value or volume of referrals,” Ruchaber said. “In the vast majority of these cases the parties are in a position to refer and as such any negotiation could be tainted.”
Rush sees this type of bargaining in this context as a requirement, in fact.
“If you review the Stark definition and the supporting case law and administrative answers to questions you will see that the arm’s length negotiations with the acquiring party are the major component of the definition. It is the centerpiece of the law,” he said. “While the actual negotiations are not enough, you need to memorialize it in writing with all the terms. Supply and demand in the local market for the subject healthcare business is a large part of the fair market value process as long as it does not include what is precluded by law.”
The way he sees it, the intent of the FMV definition isn’t to set or control the market price for subject business. Rather, it is there to support that remuneration was not paid for referrals or for prohibited actions.
All things considered, it would appear that an open and unrestricted market is necessary to ensure an arm’s length negotiation. This is why Rush advocates making the proper preparations with your center and conducting in-depth due diligence.
“We understand the tenants of FMV and believe that as long as the process is well documented and prohibited economic value is not taken into account then we can get to FMV through a competitive negotiated bid process that is more accurate than the hypothetical willing buyer and seller opinion of value,” he said.
The MV process approach to FMV is a true reflection of the market in which the business is operating. Furthermore, there is no actual formula or recipe for FMV set in place by the controlling authorities.
“Preparing and proactively marketing you center to the entire market place at the same point in time, negotiating with the entire marketplace accomplishes each of the required elements of the FMV definition as long as the participants do not allow referrals to come enter into the process and is as reflective of the market place and how your business is valued by the market place at the point in time as you could get,” he said.
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