Valuations Part One: Fair Market Value – An Introduction

Part one of our series on valuations is intended to give a deeper knowledge of the regulatory, practical and logical aspects and applications of Fair Market Value (FMV). With so much information out there, as well as knowledge gained through the practical application of FMV by professionals, it can be difficult to understand the substance of the matter.

Here, we present concrete research and a thorough explication of FMV.

valuation outpatient facilityFair Market Value Defined

The best platform to jump from for our purposes would be the definition of FMV.

The Internal Revenue Service defines Fair Market Value (FMV) under Revenue Ruling 59-60 as, “the amount at which property would change hands between a willing seller and a willing buyer when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, and when both have reasonable knowledge of the relevant facts.”

To further deepen the matter, there exists another definition of FMV under Stark Law, which is:

“The value in arm’s length transactions, consistent with the general market value. ‘General market value’ means the price that an asset would bring as a result of a bona fide bargaining between well-informed buyers and sellers who are not otherwise in a business 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.” (42 CFR §411.351)

As in all court rulings, there are most likely a few terms present in these definitions that could prove unfamiliar to the owner operator of an ASC or outpatient center. For example, what exactly constitutes a “willing seller” and a “willing buyer”?

According to Blayne Rush, President of Ambulatory Alliances, LLC, there are a few factors that compile together to constitute the willing buyer and seller.

“Any willing buyer and seller must be independent of each other, have the ability to consummate the transaction, have all the relevant information,” he said. “In other words, all must be knowledgeable about the subject business and the market and be motivated to enter into the transaction but not under any force to do so.”

These two terms don’t appear verbatim in the Stark definition. However, Curtis Bernstein, managing director at Altegra Health, notes that the reference to “informed buyers and sellers” corresponds to “willing seller” and “willing buyer.”

“Regardless of semantics, the valuation community has defined both to mean an entity that is in a position to sell the company and an entity that is involved in the industry in which the subject company operates and would have an interest in purchasing that entity,” he said. “Accordingly, the hypothetical buyers would be a limited number of individuals and/or companies that operate in a market.”

It is similarly significant to make note of the portion of the definition of FMV that refers to the “knowledge of the transaction.” At face value, “knowledge” as it is used here can be taken to mean different things to different individuals. The definition fails to specify how much knowledge constitutes “knowledge.”

Rush observes that “knowledge” here could refer to “facts.”

“I am not sure that the law requires the parties to be knowledgeable of the transaction,” he said. “It does require any one that gives an opinion of value to have all the facts of the transaction. I believe the parties are to be knowledgeable of all the available information, such as information of the business through the usual due diligence process. They should understand the specific marketplace and the specific industry at that point in time. They need to be well-informed.”

Jason Ruchaber of Root Valuation in the Greater Denver area echoes the reference to “knowledge” as involving any and all available information.

“The parties involved must be fully knowledgeable of financial, economic, industry and other considerations impacting the investment,” Ruchaber said. “Any information that is publicly available or necessary for a prudent investor to conduct the appropriate due diligence should count. Basically, there are no hidden factors in the analysis. The one caveat is that definition, at least for healthcare transactions, is that the relevant facts cannot include consideration of the value or volume of referrals.”

Another term that jumps out from the Stark definition of FMV would be the reference to an “arm’s length transaction.” According to Deepa Menon, Managing Director at CBIZ Valuation Group, LLC, this term is in reference to third or unrelated parties.

Bernstein takes this one step further and ties in the “arm’s length transaction” to the referral process.

“While most buyers and sellers negotiate a deal at arm’s length, the OIG is skeptical that a buyer that can benefit from the referrals of the seller can maintain a position that does not consider the benefit earned by the buyer through the referral of patients,” Bernstein said. “Accordingly, the Stark Law was written with a definition that includes wording around not including the value or volume of referrals.”

Rush views this point in the definition as a bit of a weak spot in terms of the types of transactions that are conducted today.

“There was a court decision I believe it was with McLaren out of Michigan where the court specifically spoke to the significance of the actual negotiations between the parties to this transaction in coming to the FMV, giving the negotiations significant weight over an expert’s valuation analysis,” he said.

Regulatory Requirements

The regulatory requirements of FMV generally involve the level to which payments or anything of value measure up to the general market.

“The general market value is the price that results from actual negotiations between any willing and well-informed buyers and sellers that do not take into account the value or volume of referrals or any other business generated between the parties on the date of the transaction,” Rush said.

Some of the more significant regulations surrounding FMV involve both Stark Law and the Anti-Kickback Statue.

“Ambulatory surgery is not considered a designated service under Stark Law,” Bernstein said. “However, if a surgeon owns an interest in an ASC and the surgeon refers patients to that ASC, a price which the surgeon pays to own the interest in the ASC must not take into consideration the value or volume of referrals to comply with the Anti-Kickback statute safe harbor. Accordingly, the purchase price must be set at fair market value.”

Further, if the shares are sold by a 501(c)(3) entity (e.g., a not-for-profit hospital) to a private individual (e.g., a surgeon), the price of the share must be set at market value as to not inure the private individual and violate internal revenue service code governing transactions entered into by not-for-profit entities. The legal and valuation community has further defined market value to be consistent with fair market value as defined under IRS revenue ruling 59-60.

According to Menon and her associate, Jennifer Smith, who works in healthcare valuations at CBIZ, the penalties for violating Stark regulations can include civil monetary penalties ($25K per infraction plus treble damages), loss of eligibility to participate in government programs and prison. Infractions against the Anti-Kickback Statue can result in fines of $15K per fraudulent claim, reimbursement of money to feds, and loss of eligibility in government programs.

One common question that arises concerning regulatory requirements of FMV involves the methodologies used to determine FMV. However, Bernstein observes that no such regulation exists.

“In Stark II, Phase III, CMS stated that there is no single, correct methodology to determine FMV,” He said.“‘[N]othing precludes parties from calculating [FMV] using any commercially reasonable methodology that is appropriate under the circumstances and otherwise fits’ the definition of FMV.”*

Rush attributes this lack of regulation to the nature of determining FMV as a “fact specific process.”

“FMV is determined based on the fact and circumstances of the specific transaction,” he said. “CMS has stated that any range of methods can be used to determine FMV under Stark, obviously within some parameters. It has to be commercially reasonable, and you will need to be able to support the transaction price with evidence that shows that the economic value of the compensation paid is comparable to what is typically paid for the healthcare business in the business’ location by buyers in an arm’s length transaction that is not in a position to refer to one another.”

The reference points for valuations experts, rather, are the generally accepted standards.

“We have third party resources or trade standards, for example, put out by the American Society of Appraisers that pertain to valuations so that there are different ways to look at valuing an entity or a transaction,” Smith said. “Three of these are market approach, cost approach and income approach, and they are just different ways of looking at what value is had by an entity and then reconciling those on facts and circumstances but keeping in mind general valuations standards. It’s like legal standards in that you are in the profession and you get a feel for what they are over time.”


In the next installment, we will dive further into the different approaches to determining FMV. As with any process, there are strengths and weaknesses that should be addressed in regards to FMV on the whole.


*72 Fed. Reg. 51015
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