Throughout the United States, medical practice acquisition activity has increased significantly, driven primarily by ongoing uncertainties resulting from:

1) Health Care Reform

2) Declining Reimbursement From Medicare

3) A desire for hospitals and health systems to bolster integrated delivery models and achieve greater physician alignment and integration, to enhance patient care and reduce costs.

With the increase in acquisition activity, appraisers in healthcare have been challenged to find a solution to a valuation conundrum where the regulatory framework for medical practice acquisition may seem to be contradictory to the real world considerations that drive fair market value (FMV) and the acquisition process.

The central argument among appraisers regarding practice valuation is whether or not intangible value (i.e., value in excess of the value of tangible assets) can exist in the absence of a positive income stream that fully supports the intangible value. The continuum of positions on this subject include the most conservative practice valuation practitioners arguing “no positive income stream, no intangible value,” and the most aggressive practitioners claiming that significant intangible value can, and does, exist regardless of the level of projected income (or loss) of the practice. It is our position that the correct stance lies somewhere in between, and the focus of this article is to address the deficiencies in the arguments held at either end of the spectrum while advocating a well-reasoned middle ground.


As a prelude to any substantive discussion on the appropriate methodologies for physician practice valuation, we must first appreciate the underlying regulatory environment governing appraisals in the healthcare industry. Transactions in the healthcare industry are subject to much greater restrictions than those found in other industries, and appraisers must develop their analyses in a manner that comports with these regulations. This is a result primarily of three key federal laws:

1) The Anti-Kickback Statute;

2) The “Stark” Law; and

3) The Internal Revenue Service doctrine regarding “private inurement” or “private benefit.”

Each of these key laws requires physician compensation paid under most compliant transactions to be consistent with FMV, which is often specifically defined, and can vary depending on the particular regulation. For example, as discussed in greater detail below, the Stark definition of FMV varies from the traditional definition used in industries other than healthcare. Other laws may impact health care transactions as well, such as the False Claims Act or various state laws. Furthermore, each of the key laws above is supplemented by advisory opinions and other commentary and guidance provided by the government agencies charged with carrying out the particular laws, as well as case law interpreting the laws. For example, the Office of Inspector General (OIG) has issued guidance to hospitals stating compliant transactions with physicians will generally have compensation consistent with Fair Market Value, and when physician compensation is not consistent with FMV, it may be evidence of an improper inducement.1


The term “fair market value” is a widely recognized and well-defined term of appraisal practice, first formally defined in the Internal Revenue Service Revenue Ruling 59-60, and further refined in the International Glossary of Business Valuation Terms published in 2001. The International Glossary defines fair market value as:

[T]he price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. (emphasis added)

In the healthcare industry, fair market value is a specifically defined term in the Stark Law and regulations as follows:

[T]he value in arm’s‐length transactions, consistent with the general market value. ‘General market value’ means the price that an asset would bring, as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party; or the compensation that would be included in a service agreement, as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement. (emphasis added)2

CMS provided additional clarity with the following guidance in the commentary to the Stark II Phase II regulations, stating:

“Moreover, the definition of ‘fair market value’ in the statute and regulation is qualified in ways that do not necessarily comport with the usage of the term in standard valuation techniques and methodologies.” The guidance goes on to qualify this statement with an example hinting at the possible inapplicability of a market approach, by stating, “For example, the methodology must exclude valuations where the parties to the transactions are at arm’s-length but in a position to refer to one another.”3

OIG has also voiced concerns regarding the proper interpretation of fair market value in health care, stating:

When considering the question of fair market value, we would note that the traditional or common methods of economic valuation do not comport with the prescriptions of the anti-kickback statute. Items ordinarily considered in determining the fair market value may be expressly barred by the anti-kickback statute’s prohibition against payments for referrals.

Merely because another buyer may be willing to pay a particular price is not sufficient to render the price paid to be fair market value.

Accordingly, when attempting to assess the fair market value (as that term is used in an anti-kickback analysis) attributable to a physician’s practice, it may be necessary to exclude from consideration any amounts which reflect, facilitate or otherwise relate to the continuing treatment of the former practice’s patients.

This would be because any such items only have value with respect to the on-going flow of business to the medical practice. It is doubtful whether this value may be paid by a party who could expect to benefit from referrals from that ongoing physician practice. Such amounts could be considered as payments for referrals. Thus, any amount paid in excess of the fair market value of the hard assets of a medical practice would be open to question.4 (emphasis added)


There are three generally accepted approaches to valuing a business or business interest, which can broadly be defined as follows:

Income Approach— A general way of determining a value indication of a medical business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated future economic benefits into a single present amount.

Market Approach— A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold.

Asset (or Cost) Approach— A general way of determining a value indication of a business, business ownership interest, or security using one or more methods based on the value or cost of the assets.

No single valuation approach is appropriate in all situations, and when considering the relevance of each approach in arriving at a final conclusion of value, the appraiser must consider many factors. According to Rev. Ruling 59-60, Section 3.01,

“A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will be generally applicable to the multitude of different valuation issues… Often, an appraiser will find wide differences of opinion as to the fair market value of a particular stock…. A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance.”

Though one valuation approach may be found to be more appropriate in a particular health care transaction, advocating a single approach to the exclusion of the others is not consistent with the standards of appraisal practice.


Recent articles regarding medical practice valuation argue that the Income Approach is the only valid methodology in determining a practice’s value and that the use of the Cost Approach has no supportable argument. This is simply incorrect. As indicated above, a competent appraiser will consider all approaches, and no one valuation approach will be appropriate in all circumstances. Too often, health care appraisers try to focus on absolutes to create defensible positions devoid of subjectivity. Not only does this render the appraisal process impotent, but this also undermines the economic reality of the hypothetical negotiation the valuation expert is attempting to replicate under the FMV standard.

As suggested at the beginning of this article, the heart of the valuation issue for healthcare practices is the identification and assignment of value to intangible assets. An intangible asset is defined by the International Glossary as “nonphysical assets such as franchises, trademarks, patents, copyrights, goodwill, equities, mineral rights, securities, and contracts (as distinguished from physical assets) that grant rights and privileges and have value for the owner.”

The IRS recognized that its position on practice valuation was evolving, and that health care appraisers should be open to the reality that such an evolution is continuing to this day. It should also be clear from the above that the IRS recognized that all three valuation methodologies should be explored and considered in the valuation of a medical practice. There is no “one size fits all” in valuation. More-over, the IRS gives specific reference and credence to the idea that intangible assets such as workforce-in-place may be valued under the Cost Approach, which will be explored further below.


We have seen several opinions from experienced valuation professionals indicating a very narrow understanding of the real world drivers of FMV and the financial theory used to support valuation models in healthcare. The following is a discussion of some of the more salient opinions and the counter arguments to each.

Income Approach for Medical Practices

As described earlier, the Income Approach estimates value by drawing reference to the future economic benefits expected to be generated by the business of the medical practice. This is typically accomplished through the use of a DCF model that projects the earnings of the physician’s business over a discrete period, frequently five years, then discounts these cash flows to present value at a risk-adjusted rate of return. Though an examination of the financial theory behind this valuation approach is beyond the scope of this article, there are essentially two key elements in the DCF model:

1) The projected cash flow; and

2) The rate of return used to discount the cash flow to present value.

As with all valuation methods, these two core components are subject to significant manipulation by health care valuation experts, and small changes in underlying assumptions can result in material changes in the indicated value. The IRS recognized the ease of manipulation, and gave guidance that the results of the cash flow approach should be tested against other methods such as price-to-earnings and price-to-book value methods.”5

The primary challenge in applying the Income Approach to practice appraisals is the business model and mechanism for medical professional’s earnings. Most independent medical practices pay 100% of the available profit (i.e., cash flow) to their owners in the form of compensation including salaries, benefits, bonuses, and/or distributions. When valuing a physician practice, post-acquisition compensation of the physician(s) must be accounted for in the valuation model.

From a practical standpoint, advocating the Income Approach as the only means to value a medical practice is tantamount to saying that physician practices have no value beyond tangible assets. Though this may be true in some cases, especially for smaller medical practices, it is difficult to argue that larger physician groups have no value beyond their furniture and equipment.

By advocating the use of DCF only, one argues that other methods for valuation are either inapplicable, overly risky, and/or in violation of regulatory guidance. This is simply not correct.

Asset (or Cost) Approach Generally

The Asset or Cost Approach is recognized as a valid and appropriate methodology for medical practice valuation in the 1996 IRS CPE text, which explains that the concept behind this approach is that a purchaser has the immediate use of an accumulation of assets that allows the purchaser the ability to walk into a medical business and operate it immediately. This text specifically details the use of the Cost Approach to value assembled work-force, stating:

The Value of Work-Force-In-Place

“A well trained, organized, and efficient work force is a valuable asset in any business . . . The use of the cost approach is based on the premise that for a potential buyer to re-create the particular practice it has to hire and train a similar workforce; that hiring/ training process has identifiable costs—for recruitment, orientation, training and lost salary—that form the basis of the valuation process.” The text continues, “Medical Practices have going concern value.

The buyer of an existing practice purchases a turnkey operation and receives immediate value from the assembled workforce and other assets needed to operate the business.”

Health care appraisers frequently identify and value intangible assets in medical practices. These include, among others, workforce-in-place, trade names, and patient charts. It has been argued that there is a continuum of risk as it pertains to these intangible assets, with the most “risky” intangible asset in a physician practice being the workforce. We believe this is contrary to logic and reality, and in fact, the physician workforce is often the most valuable asset of a practice and the most difficult to replace or recreate. Because a discussion of the application and risks of valuation methodologies to each of the intangible assets listed above is beyond the scope of this article, the authors will focus on the specific issue as it applies to the asset of workforce-in-place.

A well trained, organized, and efficient workforce is a valuable asset in any business. This is particularly true for service-centric businesses, such as physician practices, where the vast majority of value is derived from human capital. Assignment of value to the workforce-in-place is not a violation of the concepts of FMV, commercial reasonableness, or valuation theory, and as previously demonstrated the IRS CPE text makes specific reference to the value of this asset and suggests the Cost Approach is the preferred method for its appraisal. It is our position that the value of the workforce-in-place is tantamount to ascribing value to those key protections found in the physicians’ post-transaction employment contracts.

We believe that the conceptual framework for assigning value to the workforce-in-place is equally valid and appropriate for both physician and non-physician staff.

Adding up the items discussed above results in the unadjusted value of each physician member of a particular workforce-in-place. When properly applied, the assignment of value to workforce-in-place is a valid and defensible approach for physician practices.

Compensation Offset

A challenge with applying the Cost Approach to medical practices is that, unlike the Income Approach, the Cost Approach does not have a direct mechanism by which to account for post-acquisition compensation of the physicians. Generally, the post-acquisition compensation for doctors must be accounted for in the business value. In simpler terms, the same economic benefit cannot manifest in both the purchase price and the post-acquisition physician compensation.

Under the Income Approach, increases in post-acquisition compensation can be incorporated into the projection model directly, which will translate into a reduction in forecasted profits for the business and hence, a reduction of compensation value under this approach.


While multiple opinions regarding valuation will be advocated by appraisers, healthcare attorneys, physicians, and buyers, HealthCare Appraisers believes the most defensible position is a balanced position. What should be obvious for this article and others is that most medical practices do have value, and a supportable position will be one that is based on sound logic, informed judgment, and the economic realities of the current marketplace.

  1. See “OIG Supplement Compliance Program Guidance for Hospitals” 70 Fed. 4858, at 4866 (January 31, 2005).
  2. 42 CFR § 411.351.
  3. Excerpt from Letter from D. McCarty Thornton (Associate General Counsel, Inspector General Division) to T.J. Sullivan (Office of the Associate Chief Counsel, IRS) dated December 22, 1992.
  4. Pratt, Valuing a Business: The Analysis and Appraisal of Closely Held Companies, Fifth Edition (New York, McGraw-Hill, 2008), pg. 366.
  5. See Gordon V. Smith and Russell L. Parr, Valuation of Intellectual Property and Intangible assets, p. 232 (1989).