Fair Market Value Versus Investment Value in Imaging: Understanding Standards

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The standard of value must be established in performing a valuation of any imaging business. The standard of value defines the hypothetical conditions under which a valuation will be performed. These hypothetical conditions affect many of the underlying assumptions that an appraiser or valuator would employ in establishing a value opinion. In current valuation methodology, three standards of value usually apply: fair market value, investment value, and fair value. Fair market value and investment value are the two standards most often used for transactional purposes, while fair value is most often employed for accounting and financial-reporting purposes. In the distinction between fair market value and investment value (as they apply to imaging transactions), issues such as physician ownership, health-system synergies, and Stark regulations can complicate the understanding of value. Fair Market Value Fair market value is defined as the price at which property would be exchanged between a typical willing buyer and a typical willing seller when each party has reasonable knowledge of the relevant facts and neither party is under compulsion to buy or sell. Essentially, fair market value is the value of a business as determined using the current and expected future state of operations (in the absence of a transaction). This assumes that a typical buyer or seller could not add value by providing significant operational benefits. In the imaging marketplace, typical buyers and sellers include (but are not limited to) ordinary investors, physicians, and health systems. If all typical buyers or sellers would provide operational benefits, a valuator or appraiser would be able to adjust the worth of current operations accordingly. Common benefits that a typical buyer or seller would provide (that a valuator might consider) include instances where the center has incompetent management, a below-average billing/collections function, abnormally high overhead, and excess staffing levels, compared with the marketplace. The assumption is that any typical buyer or seller would make rational managerial decisions and correct these operational deficiencies. What a valuator would not be able to consider are any benefits or synergies that a specific buyer, such as a particular health system, might bring to an imaging center after the transaction. Benefits or synergies that specific buyers might contribute include superior contracted reimbursement rates, duplicate-expense reductions, and incremental volume. While large health systems would probably be able to provide these benefits, other typical buyers (such as physicians or individual investors) generally would not. As a result, many synergies and benefits of this nature cannot be considered when the standard of fair market value is employed. Investment Value Investment value is defined as the value of a business to a specific or expected buyer, meaning that it includes the additional value that the buyer would bring to the center if a transaction were to take place. As a result, investment value is almost always (and often quite significantly) higher than fair market value. A valuator or appraiser must carefully consider what incremental benefits and synergies a buyer would bring to the center and how they would affect center operations. For example, in the imaging marketplace, one of the main drivers of value is the reimbursement environment. Health-system or hospital buyers often receive reimbursement rates far higher than those of freestanding imaging centers; many times, the difference is well in excess of 50%. Health systems also will usually eliminate duplicate expenses such as accounting, billing, and management functions, further improving operational performance after the transaction. All of these benefits can be considered in a valuation when investment value is the standard of value employed. In addition, investment value should take into account any negative consequences of the proposed transaction. Many times, buyers such as health systems are high-cost operators in the market, from a patient perspective—with higher premiums, deductibles, and so forth. Higher costs can negatively affect a center’s procedural volumes and market share as patients vote with their feet, using the services of lower-cost competitors in the area. Using Each Standard In the health-care industry’s transaction marketplace, both standards of value can be used, depending on the situation. In transactions involving physician ownership, fair market value is the standard most often employed. This is due to federal regulations that prevent payment or remuneration for physicians’ referrals; according to the Stark law, anti-kickback statute, and related laws, if a referral relationship exists between two parties (with one having physician ownership), a transaction must be consummated at or below fair market value. This applies, in most cases, to physicians who have imaging equipment. As a result, fair market value is typically the standard of value used when physicians are involved. One notable exception concerns radiologists. While specialists and other physicians might have referral relationships with buyers such as hospitals, radiologists rarely do. As a result, businesses owned purely by radiologists may be sold at prices above fair market value without violation of federal regulations. Transactions between hospitals and radiologists regularly occur at levels above fair market value—or even at investment value. Buyers usually will not pay investment value, however, as they would be paying for all of the value that they contribute: Paying investment value would basically erode any potential return that a buyer would realize after the transaction. In many instances, these transactions take place at a price somewhere between investment value and fair market value. Ultimately, the standard of value used depends on the specific situation, facts, and circumstances surrounding the transaction. Legal counsel should be consulted, in deciding which standard of value is appropriate, to determine whether any potential violations of federal regulations might occur. If a standard of value other than fair market value is possible, honest, up-front negotiations between the two parties and accurate valuations are crucial in determining the purchase price. In the negotiation process, it is often helpful to have an independent third-party valuation performed to support the transaction. William Teague is a senior analyst with VMG Health, a national health-care transaction-advisory and valuation company.