Health Law Highlights

How Post-Transaction Physician Compensation Structure Affects Fair Market Value of Physician Practices

From VMG Health, by Dylan Alexander, CVA and Gerrit Elzinga, CVA:

As of January 2024, there are over 338,000 physician group practices in the U.S. The compensation structure for shareholder physicians, which often changes during business transactions, plays a significant role in the valuation of a practice. Higher post-transaction physician compensation typically results in a lower valuation for the practice due to less available earnings. 

Physician compensation can take multiple forms, including salaries, benefits and payroll taxes, discretionary expenses, and other forms of compensation such as profit sharing and distributions. The compensation levels vary from practice to practice and are a vital factor in determining the earnings available for transactions.

The profitability of a practice, which influences the available compensation, is determined by factors such as physician productivity, reimbursement rates, ancillary service offerings, and effective use of mid-level providers. Expense management is also critical, as practices with high operating expenses are less profitable.

Three main valuation methods are used for physician practices: income approach, market approach, and cost approach. Both the income and market approaches are sensitive to the level and structure of physician compensation. Lower compensation levels can increase projected free cash flows and the earnings multiple, thus increasing the practice’s valuation. However, compensation should align with market levels to avoid sustainability risks.

Physician practices have the autonomy to determine their service offerings, providers, and compensation structures. Understanding the relationship between post-transaction physician compensation and the fair market value of a practice is crucial for both buyers and sellers, as it significantly impacts the practice’s valuation.

Health Law Highlights

Recent $345 Million Settlement Underscores Critical Importance of Appropriate Physician Compensation

From Baker Donelson, by Alissa Fleming and Joseph Keillor:

  • An Indianapolis-based health system recently settled with the Department of Justice for $345 million due to allegations of Stark Law and False Claims Act violations related to its physician compensation arrangements, highlighting the importance of appropriately structuring physician compensation to avoid fraud and abuse enforcement.
  • The health system was accused of providing false information to appraisers, inflating physician salaries, and ignoring warnings about the large discrepancies between high physician compensation and moderate productivity. Additionally, it was alleged that physician compensation was dependent on the volume or value of referrals, which violates Stark Law’s restrictions.
  • The actual compensation for many specialties was either fixed guaranteed compensation or wRVU-based compensation for personally-performed services, which under the December 2020 rulemaking, should not violate the Volume/Value element.
  • The government argued that exceeding fair market value does not necessarily implicate the “indirect compensation arrangement” definition in place at the time, and that fair market value is only relevant where the parties have implicated a threshold volume/value standard.
  • The settlement emphasizes the importance of structuring physician compensation appropriately, with the health system now under a five-year corporate integrity agreement with an independent review organization and a compliance expert. Unsettled claims from the relator are still pending, and attorney’s fees relating to the settled claims may be added to the $345 million settlement.
Health Law Highlights

Overlooking Executive Comp Packages Puts M&A Deals at Risk

From Bloomberg Law, by Ian Sherwin (Reed Smith):

  • Compensation and Motivation: Understanding the compensation structures and philosophies of a target company is crucial in M&A transactions. This includes executive compensation, which can be a significant cost, involving base salary, bonuses, severance entitlements, and health and welfare programs. It’s also subject to various tax, securities, corporate, and employment-related rules and regulations.
  • Transaction Structures: The nature of the transaction, whether it’s an acquisition or a merger, impacts compensation-related decisions. For private companies, disclosure concerns are minimal, but public companies have significant disclosure obligations. For carve-outs, considerations include potential employment termination and re-hiring by the acquirer, who bears the cost of severance, and the form of consideration for equity awards.
  • Severance and Bonuses: Severance protections can help maintain employee performance during a transaction. The value and duration of severance can vary based on seniority and job level. Transaction and retention bonuses can also be used to motivate and retain key employees. The former encourages employees to complete the transaction, while the latter incentivizes them to stay through certain milestones.
  • Covenants: Buyers often set restrictions on what the target can do between the signing and closing of a transaction. These include changes to benefit plans, compensation, hiring or termination of employees, and equity awards. Targets often seek post-closing employment-related covenants, such as guaranteed compensation and benefit levels, and continued participation in severance programs.
  • Sections 280G and 4999: Golden parachute rules (Sections 280G and 4999 of the Internal Revenue Code) are a major focus in most transactions. If triggered, a 20% excise tax could apply to certain service providers, and the target may lose a compensatory tax deduction. Mitigation strategies can include reasonable compensation analyses, valuing non-competition agreements, and shifting compensation to the current tax year. Private companies may opt for a shareholder cleansing vote to avoid these issues.

Revisions to Stark Law Rules Covering Physician Profit Sharing and Bonuses

The new provision allows a member of a group practice to receive profits from DHS directly attributable to the physician’s participation in a value-based enterprise.

CMS clearly has made the determination that participation in such enterprises is so essential that it is allowing a direct tie between a physician’s participation and the profits derived from DHS.

CMS also clarified that if a group has five or fewer physicians, overall profits means the profits from DHS from the entire group; but if a group has more than five physicians, the group may designate a component of at least five physicians to aggregate the profits for the purpose of distribution.

Although other portions of the Final Rule go into effect January 1, 2021, the profit sharing and productivity bonus provisions do not go into effect until January 1, 2022.

Source: Revisions to Stark Law Rules Covering Physician Profit Sharing and Bonuses