Valuation Issues to Consider During Healthcare Acquisition Negotiations

In response to the Affordable Care Act, more hospitals and large physician groups are buying physician practices to control referral sources, service quality and operating costs. This increase in practice acquisitions is expected to continue for the foreseeable future. Because of this, it is more important than ever for both acquirers and acquirees to consider key valuation issues when negotiating an acquisition.

Among these key issues are:

1. The potential impact of the ACA on the future revenues of the acquired practice

For example, if the acquired practice has a level of patient readmissions that could cause the acquirer to receive a reduction in Medicare payment rates, the acquirer would want to reduce the valuation of the acquired practice to account for this impact on its future revenues.
2. The impact on future revenues and costs of the acquired practice due to the departure of practice physicians

Often one or more physicians will depart when the practice is sold. Sometimes these physicians retire or relocate, other times they plan to set up their own local practice in competition with the acquired practice. In either case, this will have an impact on future revenues and costs. Accordingly, the acquirer will want to adjust the valuation of the acquired practice for such departures.

3. Analyzing future competition and local conditions at each acquired practice location

Acquirers need to consider the potential impact of future competition and local economic conditions at each location to be acquired. This includes asking such questions as:

  • Is a competing hospital or large physician group planning to encroach on the area of a practice location?
  • Is the local area population growing or shrinking?
  • Are any large local employers closing?
  • Are any large local employers entering the area?
  • Are the population demographics (average age, ethnic mix, average earnings, etc.) changing?

The answers to these questions may cause the acquirer to adjust the valuation of the acquired practice.

4. Physician compensation and benefits

Acquirers and acquirees need to consider the impact of planned changes in physician compensation and benefits. Often, hospitals and larger physician practices will require more productivity-based measures for compensating physicians coming from smaller practices which have fewer such measures. However, benefits may be less generous than at the smaller practices. To account for such differences, acquirees may want to negotiate either minimum guaranteed compensation for the first few years after acquisition or an upward adjustment to the valuation of the acquired practice.

5. Other important considerations

Other factors that may impact the valuation include:

  • Whether the acquisition will affect the acquirees’ referral sources;
  • Whether there are agreements with key sub-contractors (such as outside physicians, labs, medical equipment providers, etc.) and whether such contracts must be renegotiated;
  • The malpractice insurance claims history of the acquiree; and
  • Whether receivables, medical supplies and/or specialized equipment are also being acquired.

Because of increased practice acquisition activity in response to the ACA, it is important for both acquirers and acquirees to consider the key factors identified above, and how they impact on the valuation of an acquired practice.