CPA.net

Cash Equivalence

In my previous post, I raised the problem with determining the cash-equivalence required by the definition of "fair market value" when using "deal-based" market data. Besides the database that bears his name, Dr. Shannon Pratt (and his co-authors) devotes a chapter (#27) in Valuing Small Businesses and Professional Practices to the topic. Of particular interest is the comment regarding personal guarantees on page 494 (suggesting an interest rate premium over bank lending rate of 3% where there is no personal guaranty) and the example on page 500 dealing with contingent buyout payments. In that example, the cash-equivalent price is 55% of the deal price.

Nuff said.

Fair Market Value in Cash or Cash Equivalents

Caveat: I should preface my comments below by stating that this is not intended to be relied upon by others as statistical analysis –you have to do that analysis for yourself.

I have been evaluating dental transactions in the database Pratt’s Stats.  From my analysis of 230 post-1/1/2000 transactions, 102 had an answer to the question of whether or not there was a personal guaranty of a note given by the buyer in connection with the purchase. Of those, 56% had an answer of "no personal guaranty." 47 (20%) of the transactions reflected a down payment of 100% and the median down payment for the 230 transactions was 28.4%. This suggests to me that the notes given in those transactions do not represent a cash equivalent, even if secured by the underlying assets, since the seller would have to retake possession and incur the costs (e.g., legal fees!) of the repossession of assets.  This would be a difficult task, for example, for a seller who has retired and relocated. In addition, the notes are non-negotiable to begin with, negotiability is a requirement for being considered “cash-equivalent.”  Further, a bank or other lender in the business of making loans, as opposed to a seller financing the sale of his or her practice, is in a much better position to enforce collection activity.

This highlights one of the many problems with the market approach for a determination of fair market value in cash or cash equivalents – as required by the FMV definition accepted by all the major valuation and appraisal organizations and most Courts.  Converting a secured note absent a personal guaranty to a cash equivalent is a difficult task.  IF one could find empirical evidence of what a third party lender would charge for interest on a personal note lacking a guaranty but secured by equipment, then that would be a start.  Bear in mind that the majority of the value of a dental practice is typically intangible and not equipment.  Lenders generally do not loan unsecured money on intangible assets and certainly not without a personal guaranty – that is why only 44 of the transactions had down payments of 100%.  Absent a transaction involving a Dental Practice Management Company or similar operation, it is unlikely that another dentist purchasing a practice from the seller would have 100% of the purchase price lying around in cash.  Whatever the problems, you have to make some type of an adjustment to equate the underlying data to cash-equivalent.  The problem here is not with the data, which is pretty comprehensive as databases go and may well be the best, the problem is using it without studying it.

Anti Trust Policy

During my work on the in-progress 3rd edition of my book, I reviewed the current stance of the "Agencies" - Federal Trade Commission and Department of Justice - with respect to joint negotiations and similar activities by physicians (Improving Health Care: A Dose of Competition, July 2004). Predictably, I found no change in the longstanding opposition to same and continued strenuous enforcement activity. Several things were of particular interest, however.

Allied Health Professionals such as CRNAs or dental hygienists are an increasingly critical part of the healthcare delivery system. In many instances, they represent a critical profit center for the physicians (or dentists) who supervise them. In the case of CRNAs for example, in many states they cannot practice independent of physician supervision; in states where they are permitted to, hospital policy may preclude it. Although they do much the same work as anesthesiologists, they are paid less than half the salary.

Dental hygienists generally cannot practice independently of a dentist's supervision. Given the profitability of the typical hygienist in a dental practice - one of the principal value drivers of the practice - it is not difficult to see why the Agencies believe that a change in licensing would lead to lower prices. Therein lies the Agencies' problem with state-based licensing of Allied Health Professionals by Boards often controlled by the supervising profession (again, physicians or dentists) who have a vested financial interest in reducing potential competition.

I would observe as well that the move of mega-retailer Walmart and CVS into the in-store walk-in clinic using physician extenders gives this issue particular import.

Anti-trust enforcement is shared with the individual states' attorneys general and the Agencies pass along their recommendations. Therefore "stand by for news..."

MEDPAC 2007 Report

Unfortunately, MedPac did not offer us much insight this year on the physician side, limiting their recommendations to:

The Congress should update payments for physician services in 2008 by the projected change in input prices less the Commission’s expectation for productivity growth.

There are indications in the Report that the growth in high tech imaging slowed in 2004-2005 from its recent historical levels. Next year's data should be particularly interesting to see if the reductions in Technical Component for same day scans and the DRA changes reduced or increased utilization. Increased utilization often comes from reduced fee per unit.

Physician practice expenses were expected to grow at 3.1%; including physician compensation, the increase is 3.0%. Physician productivity growth is estimated at 1.3%, suggesting an increase in the fee schedule of 1.7%. However, there does not appear to be any money for this and the conversion factor has been flat for three years now.