Written by Frank Fehribach, MAI, MRICS; Danny Cuellar
There was once a time when no one considered a lease as an asset. It was just an expense to be paid at the end of the month and ignored until the following month. Then ASC 842 came around in 2018 and operating leases became assets—right-of-use assets (ROUs), to be exact. ROU assets had to be put on the balance sheet and depreciated. Then they had to be tested for impairment. Now, for some firms that are downsizing their operations (or downsizing their physician practices), they must be impaired.
In the beginning, there was FAS 13, Accounting for Leases. For lessees, leases were either operating or capital leases. Operating leases were expensed and capital leases, if they passed the test, were put on the balance sheet. To be a capital lease, you had to meet one or more of the four criteria:
FAS 13, which came into effect in 1977, became known as ASC 840 under the codification of the accounting standards. ASC 840 would continue until it was replaced by ASC 842 in 2019 for public companies and 2021 for private companies. ASC 842 was developed over nearly a decade and released in 2016. The main difference between the ASC 840 and 842 was that all operating leases greater than 12 months in term would be recognized on the balance sheet as both an ROU asset and a liability. The Financial Accounting Standards Board had hoped this difference would increase transparency. It certainly had the effect of producing large lease guidance manuals from all the major accounting firms. It also produced a whole new category of assets that potentially need to be tested for impairment, and to be impaired if they failed.
Accounting firm guidance indicates that ROU assets are subject to ASC 360-10 impairment guidance applicable to long-lived assets. ROU assets must be assessed for potential impairment if there is an internal or external indicator, like the decision to vacate a leased space entirely or partially. However, vacating a leased space does not mean that it has been abandoned. Abandonment accounting would only apply if the space were vacated and not used at all (even for storage) without intent to sublease the space.
ASC Topic 360, Property, Plant, and Equipment was issued in August 2001. Because of ASC 842, former operating leases of more than one year are now long-lived assets. These leases are subject to the same asset impairment guidance in ASC 360 that applies to any other property, plant, and equipment assets. ASC 360-10-35-23 states, “For purposes of recognition and measurement of an impairment loss, a long-lived asset or assets shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities.”
An ROU asset has identifiable cash flows based on the lease payments. Testing is performed based on an undiscounted cash flow. During normal business operations, leased space is often vacated as operations are right-sized to the current business environment, creating a need to test for impairment. If the undiscounted cash flow is lower than the carrying amount of the asset, ASC 360 requires the owner of that ROU asset to reduce it to its fair value.
What is the fair value of an ROU asset that is no longer used for the purpose that it was created for through the lease? To answer this question, we must know what market participants would pay for this asset if offered on the market as of the trigger date. For an ROU asset, this would be a sublease and the present value of future sublease payments. Typically, there is a certain period to find a sublease tenant, and then the sublease tenant would occupy the space for the remainder of the primary term. Option periods, that before may have been included in the ROU asset, may be excluded because the landlord may not allow it, or the actual tenant may want to end the lease and not exercise an option. If option periods were included in the ROU asset value originally, the impairment amount would increase. Additionally, the discounting of the sublease payments is done at a market rate not an internal borrowing rate (IBR) used to establish the ROU asset value initially.
During a lease term, an organization’s operations in the leased space can be completely shut down or downsized. Typically, a completely vacated space will fail Step 1 of the testing, as there is no cashflow being generated for the lease space. For a partial vacancy, the Step 1 test becomes even more important, as part of the space is still being utilized. However, our experience is that a partially vacated space will still trigger the need to test for impairment. For a completely vacated lease, there is usually the assumption that the ROU asset must be impaired.
In this new world of ROU assets, health systems need to be wary of physician practice downsizing in a leased space. Downsizing in a leased space could and should trigger impairment testing and possibly adjustment to fair value. The transition to ASC 842 represents a significant shift toward greater transparency in lease accounting, as the new standards provide a clearer picture of an entity’s financial obligations, though they also require more complex accounting. VMG Health has extensive experience assisting health systems and physician practices with this financial reporting exercise.
Written by Isabella Rosman and Tim Spadaro, CFA, CPA/ABV
The following article was published by Becker’s Hospital Review.
Throughout VMG Health’s client base, we are privileged to work with many major players across the physician practices landscape—from solo practitioners and independent physician groups to large platform practices, private equity (PE)–backed physician practice rollups, and those affiliated with large health systems.
VMG Health has been engaged to assist clients in varying capacities associated with transactions, ranging from providing business valuations to financial due diligence (quality of earnings). This insight has provided important visibility into the buyer’s perspective. Further, our work has delved into the operations of practices, including coding and compliance, physician compensation, and strategy work. As a result, our experience offers us a unique glimpse into physician practices and the underlying transaction environment. From our experience, including anecdotal discussions with clients and operators in this space, we’ve outlined a few major headwinds and tailwinds facing physician practice transactions in 2024.
Reimbursement Pressure: Physician practices continue to face reimbursement pressure. In November 2023, the Centers for Medicare & Medicaid Services (CMS) issued its final rule announcing policy changes for Medicare payments under the Physician Fee Schedule (PFS) for 2024. Per CMS, overall payment rates under the PFS will be reduced by 1.25% in 2024, following a 2.0% decline in 2023. Although the overall impact on reimbursement varies across specialties, the rate cuts will continue to suppress margins and put pressure on physician practices. For more information on operational challenges and opportunities with physician practices, see VMG Health’s most recent Physician Alignment Tips & Trends Report.
Persistent Inflation: Wage inflation (largely driven by a tight labor market, an aging physician base, and recruiting challenges) and the rising costs of drug and medical supplies have been persistent. According to the government’s Medicare Economic Index (MEI), medical practice costs are expected to increase by 4.6% in FY 2024 on top of last year’s 3.8% increase. Without reimbursement keeping pace with increasing costs, many physician practices’ profit margins have contracted.
Many physician practices seek out a partner to help combat the daily pressures they face. Practices may benefit from operational synergies by consolidating with a larger organization, particularly if the larger organization has favorable reimbursement rates or anticipated cost savings from duplicate services (back-office employees, external accounting, etc.). In fact, many buy-side clients run a managed care or “black box” analysis to assess the potential rate lift and the resulting practice economics on a post-transaction basis to better inform themselves and their investment committees during diligence. Contact VMG Health’s Revenue Consulting & Analytics team to analyze the potential rate lift on your next deal.
Record High Dry Powder: PE has been an active participant in the physician practice transaction space for many years, as evidenced by recent deal volume presented in the table below. Capital committed to PE funds but not yet deployed (dry powder) is presently at record highs for healthcare services. The current estimate of dry powder earmarked for healthcare services among U.S. headquartered PE managers is approximately $100 billion, according to Pitchbook’s Q4-2023 Healthcare Report. PE funds are regularly searching for a home to deploy this capital and physician practices are a common target.
Source: Irvin Levin, 2024 Health Care Services Acquisition Report
Source: Irvin Levin, Healthcare M&A Quarterly Reports
High Interest Rates: As the pandemic hit, fiscal stimulus and loosened monetary policy led to ultra-low interest rates relative to historical norms and spurred transaction activity. Interest rates began to materially rise throughout 2022, challenging overall transaction activity in the latter part of 2022 and during 2023 as access to capital tightened and the cost of capital increased. The below chart presents interest rates over the period as measured by the 10-year U.S. treasury.
Despite higher rates, transaction activity for physician practices has remained robust relative to pre-pandemic levels. However, there are signs that interest rates are having a lagged effect on deal volume considering the recent downward trend from Q3 2022 through Q4 2023 as observed in the above chart. While this does not necessarily mean that we should expect deal volume to revert to pre-pandemic levels, it does highlight that we have entered a new transaction environment. In this environment, the time to close deals lengthens as sellers digest lower valuation multiples and buyers increase scrutiny during due diligence given an uncertain future macroeconomic landscape. Contact VMG Health’s Financial Due Diligence team for details on how the changing tide is impacting the due diligence process.
At the start of 2024, interest rates remain elevated and volatile with an uncertain path to a normalized level, which continues to serve as a headwind for transaction activity. However, interest rates can change quickly, and the U.S. Federal Reserve has signaled that it will likely be appropriate to begin rate cuts at some point during 2024. Market participants have started anticipating rate cuts from this messaging, which could certainly serve as a tailwind throughout the remaining course of this year and into next.
Source: Federal Reserve 10 Year U.S. Treasury Market Data
Regulatory Transaction Oversight: Healthcare consumes a considerable amount of U.S. spending and is expected to continue increasing; CMS’ National Health Expenditure Accounts (NHEA) Healthcare projects healthcare spending to increase from approximately 18.3% of U.S. GDP in 2021 to 19.6% in 2031. Furthermore, it is an election year, with a current U.S. Presidential Administration keenly focused on the rising costs of healthcare. As a result, increased regulatory scrutiny has manifested itself over the ongoing consolidation across healthcare services, particularly within the physician practice space.
This heightened scrutiny is most recently evidenced by the Federal Trade Commission (FTC) suing U.S. Anesthesia Partners, Inc. (USAP), a prominent provider of anesthesia services in Texas, over an alleged “…anticompetitive acquisition spree to suppress competition and unfairly drive-up prices for anesthesiology services.” The FTC also hosted a workshop on March 5, 2024 to assess the public impact of private capital in healthcare. On that same day, the FTC, U.S. Department of Justice (DOJ) and U.S. Department of Health and Human Services (HHS) requested public comments on the effects of transactions involving PE, health systems, and payors on the healthcare providers and ancillary services space.
FTC Focus on Non-compete Agreements: It is not uncommon for physicians to a sign non-compete agreement upon joining a physician practice. The intent of a non-compete agreement, as well as the potential impact, are being hotly debated, with the FTC proposing a rule to ban non-compete clauses. A recent VMG article, Non-Compete Agreements: A Prevailing Quagmire provides details highlighting the arguments and broader implications of non-compete agreements and the proposed ban.
Overall interest in acquiring physician practices remains high, and we don’t expect that to change in the foreseeable future. The dynamics outlined above will likely dictate the path and volume of transactions throughout 2024 and beyond. To read more and stay informed as the year unfolds, please visit VMGHealth.com.
Centers for Medicare & Medicaid Services. Calendar Year (CY) 2024 Medicare Physician Fee Schedule Final Rule. Centers for Medicare & Medicaid Services website. Published November 2, 2023. https://www.cms.gov/newsroom/fact-sheets/calendar-year-cy-2024-medicare-physician-fee-schedule-final-rule
Centers for Medicare & Medicaid Services. CMS Finalizes Physician Payment Rule, Advances Health Equity. Centers for Medicare & Medicaid Services website. Published November 2, 2023. https://www.cms.gov/newsroom/press-releases/cms-finalizes-physician-payment-rule-advances-health-equity
Landi H. Physician groups decry finalized Medicare payment cuts as 2024 expenses rise. FierceHealthcare. Published November 3, 2023. https://www.fiercehealthcare.com/providers/physician-groups-decry-finalized-medicare-payment-cuts-2024-expenses-rise
American Medical Association. Only Cure for Medicare Payment Mess: Wholesale Reform. American Medical Association website. https://www.ama-assn.org/about/leadership/only-cure-medicare-payment-mess-wholesale-reform#:~:text=To%20put%20this%20into%20perspective,top%20of%20last%20year’s%203.8%25https://www.ama-assn.org/about/leadership/only-cure-medicare-payment-mess-wholesale-reform#:~:text=To%20put%20this%20into%20perspective,top%20of%20last%20year’s%203.8%25
VMG Health. 2023 Healthcare M&A Report. Published [publication date not provided]. https://vmghealth.com/2023-healthcare-ma-report/ https://vmghealth.com/2023-healthcare-ma-report/
PitchBook. Q4 2023 Healthcare Services Report. Published [publication date not provided]. https://pitchbook.com/news/reports/q4-2023-healthcare-services-report
Reuters. Fed’s Powell Set Election-Year Stage with Testimony on Rate Cuts, Inflation. Reuters website. Published March 6, 2024. https://www.reuters.com/markets/us/feds-powell-set-election-year-stage-with-testimony-rate-cuts-inflation-2024-03-06/
Centers for Medicare & Medicaid Services. National Health Expenditure Fact Sheet. Centers for Medicare & Medicaid Services website. Published [publication date not provided]. https://www.cms.gov/data-research/statistics-trends-and-reports/national-health-expenditure-data/nhe-fact-sheet
Federal Trade Commission. FTC Challenges Private Equity Firm’s Scheme to Suppress Competition in Anesthesiology Practices Across the United States. Federal Trade Commission website. Published September [publication date not provided], 2023. https://www.ftc.gov/news-events/news/press-releases/2023/09/ftc-challenges-private-equity-firms-scheme-suppress-competition-anesthesiology-practices-across
McDermott Will & Emery LLP. Top Takeaways: FTC Hosts Workshop, Solicits Public Comment on Private Equity in Healthcare. McDermott Will & Emery LLP website. Published [publication date not provided]. https://www.mwe.com/pdf/top-takeaways-ftc-hosts-workshop-solicits-public-comment-on-pe-in-healthcare/
Aguirre I. Non-Compete Agreements: A Prevailing Quagmire. VMG Health website. Published [publication date not provided]. https://vmghealth.com/thought-leadership/blog/non-compete-agreements-a-prevailing-quagmire/https://vmghealth.com/thought-leadership/blog/non-compete-agreements-a-prevailing-quagmire/https://vmghealth.com/thought-leadership/blog/non-compete-agreements-a-prevailing-quagmire/
Written by Christa Shephard
VMG Health’s own Lukas Recio joined Scott Becker on the Becker Private Equity & Business podcast to discuss the rise in private equity acquisitions in physician practices. Lukas, who is a leader in VMG Health’s Financial Due Diligence division, broke down the key factors driving the surge in private equity investments and its impact on healthcare professionals.
Private equity companies’ interest in the healthcare sector has flourished over the past 15 years, and private equity purchases of physician practices have increased by over 600% from 2012 to 2022. That statistic, Lukas says, reflects the “growth of healthcare spend as a percentage of GDP… [In the last five years], we’ve really seen the dollars, allocated specifically to investment in the healthcare space, really take off alongside those investment figures.”
Those changes and trends already taking place were exacerbated by 2020’s global pandemic. “2020, 2021, and 2022, we really saw deals happening at a frenetic pace,” Lukas says. In the wake of the global pandemic, the healthcare industry experienced a seismic shift in priorities. With the urgent need to meet unprecedented demand for care, the prevailing mentality became “grow at all costs.” Against this backdrop, healthcare buyers and sellers began requesting VMG Health’s services earlier in the transaction process than usual.
However, healthcare margins are growing thinner thanks to inflation and increasing operational costs, forcing organizations to navigate a landscape where growth opportunities must be balanced against heightened regulatory limitations. “When we think about deals themselves,” Lukas says, “2023 was definitely a down year as far as deal volume. But what we found was that quality assets in attractive markets were still experiencing healthy multiples.”
Despite the challenges posed by regulatory scrutiny, there are still ample opportunities for innovation and expansion. However, achieving sustainable growth in this environment requires a strategic approach that emphasizes compliance with evolving regulations. States are now noticing that anti-trust and access to healthcare services are not currently aligned, which has prompted some states to begin reviewing healthcare transactions.
Lukas explains, “You can easily imagine a world where it becomes more difficult to execute an investment in these states that are imposing these regulatory reviews because, in some cases, they could take months review the information before they let you know whether or not it’s been green-lighted.”
On top of these dynamic changes, Lukas urges listeners, especially those in physician-owned practices, not to view private equity partnerships as a silver bullet: “Private equity can be a really great partner, but there are also things that you need to consider that are going to have their challenges—as with any other relationship that you’re going to be in, whether it’s personal or professional.”
For more of this insightful discussion, listen to the episode, The Rise of Private Equity in Healthcare: Challenges, Opportunities, and Regulations. VMG Health is dedicated to helping healthcare entities big and small through their transaction, strategy, and compliance needs. Contact our industry experts or visit our website for more information.
Written by Grayson Terrell, CPA
The following article was published by Becker’s Hospital Review.
In today’s complex healthcare environment, mergers and acquisitions (M&A) are proving to be more challenging than ever, with heightened governmental regulations impacting both the operation of an entity and the purchase and sale of an entity.
To successfully navigate a transaction in the healthcare sector, it is paramount that buyers and sellers make informed decisions through all of the tools made available to them. For sellers, this can come in the form of understanding how their business operates, understanding inefficiencies and growth opportunities, and even understanding what their business is worth. For buyers, informed decision making relies heavily upon understanding the markets in which they are investing, including governmental regulations in some states that may impact their ability to invest and operate; understanding the key operating metrics of similar companies in similar industries; and ensuring that they are paying an appropriate amount for the business. This is especially important because, in healthcare transactions, the capital used to purchase is often provided by investors who are counting on timely positive returns.
Financial due diligence (FDD) is pivotal to the success of any healthcare transaction, as it requires detailed investigation and analysis of a company’s financial information and is used to validate a company’s true run-rate operating potential. With most healthcare M&A transactions, purchase price is based on a multiple of a company’s salable earnings before interest, taxes, depreciation, and amortization (EBITDA). As such, the buyer and seller must perform the appropriate financial due diligence procedures prior to executing a transaction. Below are five vital aspects of the financial due diligence process.
The Quality of Earnings (QofE) process consists of making adjustments to the entity’s reported financial statements to normalize EBITDA. The bulk of these adjustments involve adjusting or removing impacts of non-recurring and one-time items from earnings to arrive at an adjusted EBITDA figure that represents a more accurate view of the entity’s true cashflows. This process also gives the FDD team the opportunity to pose pointed questions related to the entity’s operations, finances, and accounting functions, highlighting key information that could negatively or positively impact adjusted earnings. Specific to healthcare transactions, some of the relevant areas of interest with respect to potential EBITDA adjustments are:
The Quality of Revenue (QofR) analysis may be the most important part of the FDD process when it comes to healthcare-related transactions, given the unique characteristics and nuances of healthcare revenue. During this process in many middle-market healthcare deals, the conversion of revenue from cash basis to accrual basis is a fundamental exercise with respect to the QofE analysis. The cash waterfall approach is the gold standard and therefore the most common method for accomplishing the cash-to-accrual conversion. With this method, detailed billing data is obtained from the entity’s revenue cycle management (RCM) system, which includes charges by date of service and payments by date of service and by date of payment. In this analysis, payments are adjusted back to their specific date of service (accrual basis), and outstanding collections on charges billed during the period under analysis are estimated based on historical collection patterns cut by payor, CPT code, or various other means.
Pro forma adjustments are forward-looking projections on certain aspects of the business, which are layered back in across the historical financial statements. These assumptions can help buyers understand potential areas of future direction and growth opportunities for the company; however, these adjustments should be thoroughly scrutinized during buy-side FDD procedures to ensure the adjusted EBITDA and purchase price are not over- or understated. These estimations tend to lean more in favor of the seller and are often a primary area of focus by the opposing buy-side FDD team. As such, a seller should understand all aspects of the business, especially as they relate to these forward-looking projections, and should be able to support the key inputs utilized to derive these pro forma adjustments. If properly supported, these adjustments often increase the sale price of the business enough to cover the cost of FDD procedures incurred by the seller, if not many times over. Some examples of commonly observed pro forma adjustments in healthcare related QofE reports include:
Another common analysis in FDD procedures is a Net Working Capital analysis, which is used to determine the working capital (current assets less current liabilities, excluding cash and debt) required to operate a business in the post-transaction environment. This subsection of FDD typically involves substantial negotiation between buyers and sellers when approaching the close of a deal, as both parties will view various inputs differently, often striving to set a working capital peg that is more favorable for themselves. As a miscalculation of this peg can cost a seller on a dollar-for-dollar basis if the agreed-upon level of net working capital is not met, it is imperative that management and their advisors are involved and knowledgeable on this calculation.
Most of the time, healthcare transactions occur on a cash-free, debt-free basis. Standard with any cash-basis business, many debt and debt-like items have the potential to be inaccurately reflected within a company’s balance sheet. As such, a Debt and Debt-Like Items analysis can assist buyers and sellers in understanding a company’s debts and liabilities as of the date of sale. These items can include potential tax-related exposures, outstanding litigation and legal settlements, deferred compensation, notes payable, and others.
In closing, FDD is a necessary step in ensuring that sellers have the keys to sell their businesses at the best possible price, and buyers can protect the money of their companies, firms, or investors by making a sound investment in the target company. This proactive approach creates trust between all parties and leads to more lucrative transactions for all.
Written by Grayson Terrell, CPA; Joe Scott, CPA; Lukas Recio, CPA; Wayne Prior, CPA; and the Baker Tilly team
The M&A healthcare industry presents a unique set of challenges, and it is important to have the proper M&A professionals involved to assist with identifying potential deal issues. In addition to financial due diligence experts, M&A tax professionals should assist with understanding and identifying the transactional tax consequences, as the identified tax issues may impact the overall deal structure or may be used to negotiate in the purchase agreement. During the M&A due diligence lifecycle, financial and tax due diligence teams must collaborate closely. This collaboration often uncovers synergies between their processes, enhancing completeness and efficiency. As their work is often completed first, the financial due diligence team may act as the first line of defense and can assist with identifying potential exposures earlier in the process. M&A tax advisors can assist with vetting and quantifying these exposures, which can assist with limiting the identified risks during the purchase negotiations. Tax considerations often influence the structure of a sale, determining whether it’s taxable or tax-free, whether assets or equity are bought, and whether taxable gains can be delayed through methods like earn-outs, installment sales, and debt.
The starting point for tax diligence is understanding the tax entity type of the target included in the transaction. Different tax issues may arise depending on how the entity is treated for tax purposes. The common tax entity types are:
S corporation:
Partnership:
C corporation:
Improper independent contractor classification (applicable to all tax entity types). While some employers misclassify their employees as independent contractors in error, others do it intentionally to avoid paying state and federal payroll taxes by passing that responsibility onto the employee. Employers found to have misclassified their employees are subject to payroll tax and penalties that could succeed to the buyer. During due diligence, it’s important to determine whether independent contractors should be considered full-time employees. A common healthcare tax due diligence issue is the misclassification of certified registered nurse anesthetists (CRNAs), doctors, and other healthcare professionals as independent contractors. It is important to request IRS Form 1099 and understand the services performed by the independent contractors. Depending on the time dedicated to the business, level of pay, direction from the employer, and several other factors, there may be contractors who could be misclassified, resulting in potential payroll tax exposures. The IRS provides a 20-factor test to help make that determination with considerations related to direction and control.
Unclaimed property (applicable to all entity types). Each state has an unclaimed property statute governing when and what types of property must be remitted to it. Examples of unclaimed property include uncashed or unclaimed refund checks, patient overpayments, insurance overpayments, payroll checks, or vendor checks. If unclaimed after a certain period (dormancy period), those checks must be turned over to the state. This is a common issue amongst healthcare providers, as there may be instances where a patient’s insurance covers more than what was originally estimated for an appointment or procedure, resulting in a patient overpayment. In a situation where a healthcare provider sees non-recurring patients, the patients are less likely to use a credit balance toward a future appointment. It is important to review the target’s accounts payable and accounts receivable aging schedules to determine whether there are any balances that give rise to an unclaimed property risk. Financial due diligence teams will likely have access to the target’s financials and can assist with pulling the documentation necessary to evaluate these potential risks. To avoid possible unclaimed property liability, buyers should determine whether the target is properly addressing its escheatable property.
Improper treatment of owner personal expenses (applicable to S and C corporations). Is the S corporation owner using a corporate account for any personal expenses? If so, these payments may be considered compensation and subject to payroll tax. If the employer’s share of payroll tax is unpaid, the buyer could be held liable for the amount owed after the acquisition, including interest and penalties. In parallel, if a C corporation shareholder is conducting similar activities, the IRS or state revenue service may classify these expenses as dividends, which are non-deductible for income tax purposes.
Unreasonable owner compensation (applicable to S and C corporations). Since an S corporation shareholder’s distributive share of income is not subject to self-employment or payroll tax, owners are often motivated to minimize their salary in favor of non-wage distributions. However, if the IRS determines an owner’s salary to be too low based on multiple factors—including profits, business activities, and the shareholder’s involvement in the business—non-wage distributions could be reclassified to wages subject to employment taxes. The buyer may be responsible for this tax if it isn’t resolved before the acquisition. Conversely, if a C corporation shareholder’s salary is too high relative to the available facts, the IRS or state revenue service may deem the compensation to be excessive and reclassify a portion to dividends.
Related-party transactions (applicable to all entity types). A related-party transaction takes place between two parties that hold a pre-existing connection prior to a transaction. There are many types of transactions that can be conducted between related parties, such as sales, asset transfers, leases, lending arrangements, guarantees, and allocations of common costs. These transactions can become problematic when an S corporation utilizes them as a vehicle to get extra cash out of the business. If a shareholder owns both Company A and Company B, and Company A pays the shareholder a below-market salary while also renting a building from Company B (an LLC taxed as flow-through) at inflated rates, it may be considered disguised compensation to avoid payroll taxes. It is important to request copies of the lease agreements and understand the fair market value of the square footage and rent of the property to determine a potential disguised compensation risk as it relates to related-party transactions. Problematic related-party transactions should be addressed during due diligence.
Cash vs. accrual accounting method (applicable to all entity types). The IRS prefers the accrual method, but if a company is on the cash basis of accounting for tax purposes, the buyer should determine whether they meet the requirements to continue using that method. The change in accounting method from cash to accrual may result in additional income that could be recognized in the post-closing period. By identifying the issue and quantifying the potential exposure, the buyer and seller can negotiate who will bear the tax on the additional income.
Pass-through entity tax (PTET) (applicable to S corporations and partnerships). In certain states, eligible S corporations can make PTET elections, whereby the entity is responsible for paying the shareholder’s share of tax at the entity level. States began enacting responses to state and local tax deduction limitation because of the 2017 Tax Cuts and Jobs Act (TCJA), which limited the allowable deduction for state and local taxes on an individual’s tax return to $10,000. The primary benefit is reduction of federal income taxes; however, use caution when evaluating whether benefit exists on state returns. PTET elections may shift the successor liability for state income taxes from the shareholder to the entity. Most of the elections are irrevocable. During due diligence, determine whether the company has made these elections for the states that have enacted these rules. Given the ever-changing PTET rules, companies should maintain a process to review company’s PTET elections.
20 Percent Deduction Under Section 199A (applicable to S corporations and partnerships). Section 199A was enacted as part of the TCJA and provides a deduction for qualified business income (QBI) from a qualified trade or business operated directly or through a pass-through entity. For healthcare providers, the application of Section 199A can be complex due to the nature of healthcare services being classified as a non-qualifying Specified Service Trade or Business (SSTB). However, certain healthcare-related businesses may qualify, such as a dermatology practice’s sales of skincare products or certain laboratories whose tests benefit the healthcare industry but aren’t independently viewed as health services. Additionally, while a doctor, nurse, or dentist is in the field of health, someone who merely endeavors to improve overall well-being, such as a personal trainer or the owner of a health club, is not in the field of health.
Built-in gains tax (applicable to S corporations). When a corporation has converted its status from C corporation to S corporation, or has acquired assets from a C corporation in a tax-free transaction and has a recognition event within five years, it may be subject to a corporate-level, “built-in gains” tax in addition to the tax imposed on its shareholders from the transaction. The buyer can leverage its knowledge of a potential, built-in-gains tax liability, as identified in the due diligence process, to negotiate with the seller such that the buyer would not inherit said liability.
Non-resident withholding (applicable to S corporations and partnerships). State and local governments are permitted to tax the income of their residents and the income of nonresidents if that income is derived from sources within their state or locality. It’s important to ensure that the S corporation or partnership complies with state and local income tax withholding regulations.
When it comes to healthcare acquisitions, it is important to consider the above items from a tax perspective. Financial and tax due diligence teams should work together to help buyers and sellers avoid tax liabilities, identify unrealized tax savings, and structure the transaction in a tax-efficient manner. Baker Tilly’s M&A tax team can assist in identifying the related risks and opportunities associated with healthcare acquisitions, all in an effort to maximize value. If you have any questions or would like additional information, please contact:
Michael O’Connor, Partner Emeritus: Michael.OConnor@bakertilly.com
Michael DeRose, Senior Manager: Michael.DeRose@bakertilly.com
Peter Dewan, Manager: Pete.Dewan@bakertilly.com
Kendra Nowak, Senior Associate: Kendra.Nowak@bakertilly.com
At VMG Health, we’re dedicated to sharing our knowledge. Our experts present at in-person conferences and virtual webinars to bring you the latest compliance, strategy, and transaction insight. Sit down with our in-house experts in this blog series, where we unpack the five key takeaways from our latest speaking engagements.
The title of my presentation was Anatomy of a Deposition. My co-speaker, Will Miller, from Higgs Fletcher & Mack in San Diego, and I discussed what a deposition is and how it fits into the steps of a lawsuit from patient injury to subpoena, the discovery phase and the trial itself. We discussed how to prepare for a deposition, the possible ramifications of not utilizing an attorney in the process, and how to answer questions during a trial honestly while learning from your lawyer’s cues. For example, if you’re asked a question and your lawyer objects and says the question is vague and ambiguous, you might take that as a hint that you need to ask for the question to be rephrased before you respond.
I received feedback from someone who was there, and they said that the presentation was a great reminder to pay attention to their documentation practices. It’s important not to get complacent with the documentation and to ensure nursing staff document what they need to while watching the scope of practice and licensure of themselves and other employees at the facility. You must always be cognizant of whether they’re functioning within their licensure or certification, and this course was a great reminder of that.
I’ve already heard from a few people who are taking this information back to their surgery centers, and they’re educating their staff on proper nursing documentation as well as risk management, and giving them a little taste of what a deposition might be like. The two cases we highlighted in our presentation included documentation issues, such as not documenting on the correct form, not adding post-op score accurately, and lack of physician orders. These issues highlight why staff must pay attention to what they document and be sure their medical record tells the story of the patient experience. Leaders can use this information to show their staff what improper documentation looks like to a jury, how it ruins credibility, and the importance of proper documentation.
ESupport is an annual subscription for ambulatory surgery centers (ASCs), and it includes a host of resources: updated policies and procedures, a forum where they can write to and learn from a consultant, tools they can use in just about every aspect of their ASCs, and continuing education modules. Specific to this issue, we have a one-page training document on nursing documentation and an hour-long webinar that dives deeper into the topic.
Within ESupport, there’s also a risk management page that talks about more than just depositions; it provides a nice overview of what risk management is and some of the tools that people can use in their risk management program.
Our parent companies, BSM Consulting and VMG Health, also provide excellent resources for ASCs, from certification and accreditation to transaction valuation.
Go back to Nursing Documentation 101. The rules have not changed, so go back to the basics. Make sure you document everything going on with your patients. Your documentation should reflect a patient’s story; if I read your medical record, it should tell me everything that happened with that patient during their episode with you.
Our team serves as the single source for your valuation, strategic, and compliance needs. If you would like to learn more about VMG Health, get in touch with our experts, subscribe to our newsletter, and follow us on LinkedIn.
At VMG Health, we’re dedicated to sharing our knowledge. Our experts present at in-person conferences and virtual webinars to bring you the latest compliance, strategy, and transaction insight. Sit down with our in-house experts in this blog series, where we unpack the five key takeaways from our latest speaking engagements.
I spoke with King and Spalding attorney Kim Roeder on different, hot-button issues that arise when structuring and valuing different value-based arrangements. It started off as a presentation of different case studies and focused on what Roeder has encountered from a legal perspective and what I have encountered from a valuation perspective. We often receive questions when it comes to structure or even value drivers, and we wanted to present solutions to what we saw or clients struggling with so that they could develop a better understanding of them.
The focus on the metrics themselves and how carefully they need to be considered seemed to be the most surprising. Recent regulations have been really focused on metrics, and that’s what we get the most questions about. I think our audience was also surprised to learn that Kim had experienced those questions as well, and metrics aren’t just a consideration on the valuation perspective. Both legal and valuation perspectives must carefully consider metrics.
Our presentation was a very pragmatic way of illustrating six key issues that often come up during valuation. It’s a great resource for healthcare leaders to reference as they go through and check the boxes to ensure they have thought through all of the considerations that we often see as eleventh-hour issues.
I co-wrote a section of the 2023 Physician Alignment: Tips and Trends Report that discusses quality incentives for providers. It captures key factors to consider, from a valuation perspective, when looking to enter value-based arrangements and where to start.
Value-based arrangements require a very orchestrated balance between legal and compliance, operational champions, and valuation teams. Operational teams should be able to focus on what changes and improvements they want to implement, valuation teams must have an understanding of those goals, and legal and compliance must be involved to ensure the approach is appropriate and compliant. Without cohesion between these three groups, we see those eleventh-hour issues pop up.
Our team serves as the single source for your valuation, strategic, and compliance needs. If you would like to learn more about VMG Health, get in touch with our experts, subscribe to our newsletter, and follow us on LinkedIn.
Written by Ingrid Aguirre, CFA
The formation of any business partnership typically begins with an eager commitment by each party to pursue a particular goal, business, or venture. Often, the endeavor begins with an eagerness and readiness to overcome growing pains and challenges at the onset. However, some challenges cannot be overcome, and instead, they may exacerbate what turns into a tenuous relationship. Healthcare partnerships are not exempt from these challenges. Over its almost 30-year history of serving healthcare clients, VMG Health has been engaged to perform a variety of damage analyses and provide its expert witness services, including, but not limited to, disputes, divorces, and commercial damages. These damages are often in the form of diminution of business value or lost profits. VMG Health has served as a trusted advisor to its clients amid these challenging situations.
Ambulatory surgery centers (ASCs) are one such example where disputes may arise. With at least 11,000 surgery centers nationwide and with multiple partners at each of these surgery centers, there are many instances where disputes arise among partners (often consisting of physicians, health systems, and management companies). Typical to any business where partners come and go, physicians will buy in and buy out of surgery centers. This opens the door to disputes in situations where one partner is offered a purchase price that may not be appropriate. Alternatively, a physician may be forcibly redeemed of her shares. Inevitably, the greater the number of partners, combined with human nature, the greater the likelihood of an eventual dispute. Of course, disputes are certainly not specific to surgery centers but remain an ever-present adversity insofar as human fallibility exists.
In these disputes, it is typical to engage attorneys who subsequently may engage healthcare expert appraisers to determine the value of the interest in question. A few examples, specific to surgery centers, whereby VMG Health has provided its expert opinion, and in some cases, expert witness testimony on, are as follows:
Marital dissolution has its challenges and unique considerations. One key component is determining the allocation of community assets among both spouses. The challenges lie in determining the value of private interests that either spouse may own. This may take the form of the entirety of a privately held business (e.g., physician practice or lab company) or an interest in a smaller, yet still private, business (e.g., interest in an ASC). Regardless of the interest owned, it is imperative to determine the value of a private business for the purpose of a marital dissolution.
Unlike other disputes among business partners, a marital dissolution has its nuanced challenges that an appraiser must understand. First, an appraiser must understand state specific requirements, through discussions with legal counsel, regarding any statutory regulations on equitable distribution. Some states follow the policy of equitable distribution, which requires a fair allocation of the assets between spouses at the time of a divorce. It is necessary to understand the jurisdiction, particularly if the state does not require equitable distribution. Second, an appraiser must understand personal goodwill. Personal goodwill may be defined as the value created and attributed to an individual’s efforts. As an example, personal goodwill may be applied to a physician owner. However, understanding that the business itself may have goodwill, it is important that the appraiser separate enterprise goodwill from personal goodwill, as applicable. Quantifying personal goodwill is necessary to understand when providing an opinion for purposes of a marital dissolution. Third, the valuation date must be defined following discussions with legal counsel. In a marital dissolution, the valuation date may be based on the date of separation, the date of filing or the date of trial.
VMG Health has provided expert opinions, and in some cases, expert witness testimony, on a variety of marital dissolutions, including, but not limited to, the following:
Last, not too dissimilar from a marital dissolution, a partnership between business owners or other parties that are contractually aligned may also fracture. The quantification of damages may take the form of a valuation, a calculation of value, or a lost profits analysis. Due to the unique nature of each damage engagement, it is imperative to define and quantify the damage appropriately. This also requires the valuation expert to work closely with the client’s legal counsel.
Lost profits and damages calculations have been performed by VMG Health along with expert witness services in a variety of scenarios, including, but not limited to the following:
In the intricate landscape of disputes, divorces, and damages, navigating the complexities can be a daunting challenge. VMG Health understands the toll these situations may take both emotionally and financially. When faced with these difficult situations, it is crucial to entrust your needs to valuation experts aligned with your needs. VMG Health provides valuation and damages guidance through these litigated and dispute resolution matters.
Wallace, C. (2023). Number of ASCs in the US outpaces CMS’ estimates. Becker’s ASC Review. https://www.beckersasc.com/asc-news/number-of-ascs-in-the-us-outpaces-cms-estimates.html
Cornell Law School. (2021). equitable distribution. In Legal Information Institute. Retrieved March 20, 2024, from https://www.law.cornell.edu/wex/equitable_distribution
Schmidt, J. (n.d.). Personal Goodwill. CFI. https://corporatefinanceinstitute.com/resources/valuation/personal-goodwill/#:~:text=Personal%20goodwill%20is%20the%20intangible,and%20not%20the%20business%20itself
Written by Alex Wiederin, CVA and Nicole Montanaro, CVA
Over the past few years, the medical transport industry has experienced constant growth, which is projected to continue into the foreseeable future. This growth can be attributed mainly to the increasing number of vehicle accidents, the growing elderly population, and medical tourism. As part of this trend, medical transport arrangements with hospitals have come under increased scrutiny from regulators as it relates to fair market value and compliance.
When entering into a medical transport arrangement with a third-party provider, it is important for hospitals to understand what services are being provided, the reimbursement environment for medical transports, and the impact of any compliance issues. Services are often provided not just by the medical transport vendor, but also by the hospital, which may offer services to the medical transport vendor as well. From a compliance perspective, fees for both sets of services should be at fair market value (FMV). Based on VMG Health’s extensive experience in valuing medical transport arrangements, we have outlined some fundamental questions to help hospitals/facilities understand the elements of their arrangement and determine which services need to be valued.
| HCPCS Code | Level of Service Description |
| A0425 | Ground Mileage – Loaded per mile |
| A0426 | Advanced Life Support I – Non-emergency |
| A0427 | Advanced Life Support I – Emergency |
| A0428 | Basic Life Support – Non-emergency |
| A0429 | Basic Life Support – Emergency |
| A0430 | Fixed Wing Transport |
| A0431 | Rotor Wing Transport |
| A0432 | Paramedic Intercept |
| A0433 | Advanced Life Support II |
| A0434 | Specialty Care Transport |
| A0435 | Fixed Wing Mileage |
| A0436 | Rotor Wing Mileage |
Medical transportation plays a critical and necessary role in the healthcare industry. Arrangements for medical transportation services can be extremely complex. VMG Health has extensive experience valuing payments for all kinds of medical transport arrangements and understands the numerous risks associated with these types of valuations, which helps clients enter arrangements compliant with FMV.
Written by Melissa Hoelting, CPA and Lukas Recio, CPA
In healthcare-related mergers and acquisitions (M&A), quality of revenue analysis represents both the most vital piece of due diligence and its most unique aspect given the nature of healthcare revenue. For many transactions, buyers rely on due diligence advisors to provide independent net revenue hindsight analyses to facilitate valuation efforts, such as growth potential, risk analysis, and financial stability. Quality of revenue analysis becomes even more crucial in healthcare transactions due to the added complexity of payor contracting and unique reimbursement mechanisms by vertical. Due to this complexity, investors and advisors need to know the key indicators that arise in quality of revenue analysis to address the issues and properly assess the merits of the transaction. In this article, our financial due diligence team previews five key considerations:
When revenues are concentrated with a select few payors, there is potential for future revenue loss from either unfavorable reimbursement rate changes or the loss of in-network status. Even minor changes in reimbursement rates may have a material impact on top-line revenue when applied to key groups. A key consideration when evaluating payor concentration comes from a large reliance on government payors, as the rates can change year to year without the company’s input or control. Payor concentration in and of itself will not impact the revenue hindsight analysis, as collections for previous dates of service will follow the current contracts, but investors and their advisors should make it a priority to understand the payor mix to properly identify and assess the inherent risks. Additionally, any upcoming contract negotiations should be discussed to evaluate the potential near-term impact of negative price adjustments to make necessary pro forma/forecasting assumptions.
Aging accounts receivable balances indicate difficulties in the billing and/or collection process, which directly impact the company’s cash flows and the reliability of reported revenues for companies on an accrual basis. Increasing DSO could be the result of certain non-recurring events, such as the loss of key personnel in the billing department or converting revenue cycle management systems, or may be indicative of deeper issues at play within the company. In the case of third-party payors, increased DSO could point to two potential issues:
Regardless of the payor type exhibiting increased DSO, decrease in collection speed should always alert the investment team that more analysis and discussion is required to properly determine the collectability of accounts receivable, and thus, the revenue accruals themselves.
Revenue analysis fundamentally begins with a reconciliation of the payment data to the bank statements to anchor the data to verifiable cash inflows. Variances between collections from the billing system and bank statement deposits could indicate that the company does not deposit all collections, certain revenue streams do not run through the billing system, or there are significant delays in posting cash receipts to the billing system. By comparing the reported revenue to the bank statements, teams can identify overstatements of revenue that are not supported by bank deposits. Regardless of the variance’s cause, any discrepancies should be investigated and discussed with management to ensure data completeness and integrity before using the billing system reports for any revenue analysis.
An entity’s gross-to-net ratios (net collections as a percentage of total gross charges) often highlight changes in underlying processes or outcomes for a given period of service; therefore, they are a key consideration during the due diligence process. Effective gross-to-net ratio analysis starts at the lowest level, such as by CPT code by payor. Significant variations at this level from month to month or quarter to quarter may indicate rate changes, an altered chargemaster, or increased/decreased denial activity. At a less detailed level, changes in this ratio may also illustrate changes in payor mix or procedure mix. In any case, the underlying drivers must be identified and their impact to future cash flows assessed to determine the true quality of the underlying revenue streams.
A foundational component in the revenue recognition process, the billing and coding process can be the area most susceptible to downside surprise. Investors and their advisors should focus on CPT code-level trending to determine key metrics, such as payment per code and code distribution. By comparing these metrics to contracted rates and industry or specialty norms, irregularities in coding practice can be identified and investigated. For example, if an organization has higher concentration in level one or level five evaluation and management codes, it could indicate consistent undercoding to avoid payor scrutiny or overcoding for work performed, respectively. On a similar note, if an organization receives similar reimbursement on office visit codes for a doctor and a mid-level provider, it could indicate that the billing team is not coding and charging the proper rates. Identified irregularities in the coding metrics should be discussed in detail, as inappropriate coding can result in downward adjustments to both historical collections and any outstanding collections, as well as takebacks owed to insurance companies for prior periods.
For any healthcare transaction, revenue analysis remains the most essential and most complicated part of the diligence process. Because of the payor contracts that underpin most healthcare revenues, investment teams must identify any variances in reimbursement, charges, and coding that could indicate errors or changes in the billing process. When considering adjustments or estimating future collections, teams must consider the changes and errors they have identified through these variances. These five considerations represent just a portion of the potential intricacies and issues that arise during quality of revenue analysis. Thus, an organization looking to enter into a transaction, whether on the buy-side or the sell-side, would benefit from the services of a financial due diligence and/or coding and compliance firm to bring an additional layer of confidence to the target’s revenues.
