Private Equity and Fair Market Value

healthcare transaction accountantThe Fair Market Value (FMV) standard is an obvious cornerstone to the sale of a healthcare business to a hospital.   However the question should be addressed on whether the FMV standard still applies to other groups like Private Equity.

Roger Strode, partner at Foley & Lardner LLP says that by definition, FMV is what a willing buyer will sell for, and what a willing seller will pay for an asset or business, with neither being under a compulsion to buy or sell, both having knowledge of relevant facts.  In addition, FMV assumes cash paid at settlement.

“The “fair market value” standard arises in a number of contexts, including the Stark Law, the Anti-Kickback Statute and the Internal Revenue Code.  Thus, any buyer that needs to structure a transaction to comply with any of the above statutes/laws will need to ensure that the overall economics of the transaction comply with fair market value,” Strode says.

“Now, what constitutes “fair market value” can vary from buyer to buyer, especially depending upon the context of the transaction. Often, private equity transactions are priced via an auction process lead by and investment banking group.  That may not be the case in the context of a purchase of the same business by a hospital.”

Strode says that one other thing to keep in mind is that hospitals have, increasingly, found themselves targets of actions and investigations by the Federal Government related to Stark Law and False Claims Act violations.

“The same isn’t necessarily true for private equity buyers. This isn’t to say that there is any lower legal requirement on those groups, but is meant to highlight why hospitals are very (and rightfully so) sensitive to the FMV requirement,” Strode says.

Mark Norris, managing director at Tucker and Meltzer Valuation Advisors says that in the case of private equity buyers, they can, in fact pay more than FMV for a healthcare practice.

“Basically, a not-for-profit entity, which many hospitals are, cannot pay more than FMV for an acquisition.  Since Private Equity firms are non not-for-profit entities, they do not have to comply with that regulation.  Therefore, they can structure an acquisition any way that they want to,” Norris explains.

“Let’s say if a private equity firm and a not-for-profit hospital is targeting the same medical practice acquisition.  The hospital is limited to FMV in its purchase price, whereas the private equity firm can pay whatever they want.”

Norris says that although there aren’t really any regulations on how much a private equity group can pay for a medical practice, they won’t pay more than what makes economic sense.

“That is the bottom line; but what they can factor into their purchase price are synergies, consolidations and so on, where applicable.  What happens in many cases is a seller will take a look at a potential buyer, like private equity versus hospital.  Although the private equity may offer a higher price, many times the terms of the deal are more technical and more strenuous which may include claw backs and so on, if the medical practice does not achieve certain financial results.  Therefore, the purchase price in the end may not result in as high a price due to different provisions in the acquisition agreement that reduce the price if the performance doesn’t match the agreement,” Norris says.

Chris Foster, manager at CBIZ Valuations Group LLC says that situations involving higher payments or higher valuations by private equity are, in his opinion not fundamentally because of the standards that are involved.

“I think it has more to do with things that the private equity firm may bring to the table; whether that is greater, or cheaper access to capital, greater ability to act quickly and dynamically in the rapidly changing healthcare environment, greater ability to realize synergies with existing portfolio companies or decrease inefficiencies etc.” Foster says

Foster says that ultimately an ASC or any healthcare provider for that matter, is likely to have patients that are beneficiaries of government programs.

“If that’s the case, it has less to do with who the potential buyer is and more on who the seller is, and what types of services they are providing and who they are providing them to.  If they are providing services to beneficiaries of government programs, the transactions involving that seller, are going to have to be consistent with FMV to comply with the federal guidelines like the Stark Law and Anti-Kickback Statute,” Foster says.

Foster emphasized that specific to ASCs, the types of services provided may not be classified as “designated health services,” possibly exempting them from the scope of the Stark Law.  Depending on the circumstances, ASCs may qualify for the ASC Safe Harbors under the Anti-Kickback Statute.  However, if an investor, including a private equity investor, is in a position to provide items or services to the ASC, the arrangement likely will not qualify for the ASC Safe Harbors.

Foster stated “many of the publicly traded ASC companies remain subject to the Anti-Kickback Statutes because they provide, or are in a position to provide, management, billing or other ancillary services to their ASCs.”

Strode says that focusing on the seller over the buyer in a business transaction is important when judging the FMV regulations of a deal.

“Any time you pay a physician more than FMV for a business to which that physician may continue to refer you risk potential violations of a raft of laws.  The focus probably should not be on the buyer, but on the seller. If the physician owner(s) is exiting the business and will not (won’t) refer to the business then selling the business for greater than its fair market value will have little regulatory impact,” Strode says.

Norris goes on to explain that there are advantages for the private equity firms who decide to pay more for a business.

“One reason would be that if they have already acquired several medical practices that are in that same specialty, then they have the ability to consolidate costs related to the operation of those medical facilities.  Therefore, when you consolidate costs, you reduce costs; if you reduce costs, you increase the profitability.  If you increase the profitability, the value of all of those practices which would be representing an investment pool in that particular healthcare sector, become more profitable,” Norris says.

Norris explains that this means the private equity firm would be able to pay more to pull that particular practice into that investment pool.

“It’s basically what happens in many industries and is called a “Roll-up.”  In many cases, the private equity firms will target certain industries or sectors and they will go in and roll-up the companies within that sector.  Because they are all the same type of company, they can centralize the cost and overhead costs and pull those together in managing all of the different companies,” he says.

Norris says that these higher price purchases may also be able to enhance the revenue in some ways.

“They can factor this into the purchase price; whereas the hospital, again is limited to FMV.  With FMV, in some cases, when a hospital acquires a medical practice, the contracts that they have with insurance providers would include reimbursement rates that are higher than the medical practice on its  own can achieve.  The valuation cannot take into consideration those higher rates because that would not represent FMV anymore but would represent investment value.  That’s the biggest difference I see.  When private equity acquires companies, in essence what they are paying is investment value.  In almost all cases investment value is higher because they can consider all types of synergies, revenue, consolidations of expenses and so on,” Norris says.

Foster says that in the case of hospitals purchasing private equity owned practices versus physician owned is ultimately pure economics and comes down to supply and demand.

“It wouldn’t be any different for any other type of business.  If, for example, in this case, private equity owned an outpatient center within the primary service area of the core market of the hospital; it’s available for sale, and the hospital is looking at expansion opportunities, they would be as interested in that as any other.  Now, if it were  all else equal and there were two available for sale; one is held by a private equity owner, and one is held by a private group of physicians, I’m not sure that the hospital would have a preference.  Presumably, the private equity company can bring greater efficiencies, less emotional involvement, greater performance, greater reporting capabilities etc. “ Foster says.


If you would like to learn more about the concepts covered in this article, want to sell your business or discuss how Ambulatory Alliances, LLC might be able to help you out, contact Blayne Rush, (469)-385-7792, or

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