Practice “Bifurcation” Can be Risky Business

Most hospital system acquisitions of physician practices are structured as asset purchases, with the former physician-owners and employed physicians of the acquired practice subsequently employed by the purchasing hospital or a hospital-controlled entity. Because of the financial and referral relationships in arrangements such as these, the Stark law and federal anti-kickback statute are nearly always implicated, and compliance with these laws dictates that the financial arrangements be consistent with fair market value. Exceeding fair market value can expose the parties to potentially staggering fines and penalties if found liable as part of a qui tam or government enforcement action. Yet, as discussed in a recent post, New White Paper Doesn't Settle the Workforce Valuation Debate, diversity of opinion exists on certain valuation issues in these types of transactions. 

Many physicians furnish in-office ancillary services, such as imaging and clinical lab services, to their patients. Despite the profitability of many ancillary services, many practice acquisition transactions do not exceed the value of tangible assets. In some cases, the parties have resorted to more creative transactions, including those that carve out the ancillary services for sale to the acquiring hospital system—which also stands to benefit from increased hospital outpatient reimbursement rates—leaving the remaining professional portion of the practice intact under physician ownership. Because many such services represent Designated Health Services under the Stark Law, concerns and, in some cases, disagreement exist among legal counsel as to whether these services can be valued for a sale transaction because of the Stark law’s Volume or Value of Referrals prohibition. 

When valued separately, the valuation of the ancillary service line often includes methodology under the income approach. However, there are certain risks associated with bifurcation of a practice into professional and ancillary service lines. While contemplating a transaction involving an ancillary service line of a physician practice, consider the information below to avoid serious missteps: 

• Many times, physician practices with ancillary services bill a global fee, including both professional and technical components. Incorrectly computing the split of global fees into their professional and technical components may result in an inflated value for the ancillary service line. 

• Operating expenses, especially indirect overhead, must be divided correctly to ensure those expenses are reflective of the operation of the ancillary service line. Similarly, equipment and cash flow items are also at risk of improper assignment to the ancillary service line. Incorrectly accounting for these expenses may also inflate the value of the ancillary service line. 

• If the professional portion of the practice is later sold after first selling ancillary services, the risk exists that the separate sale of ancillary and professional portions of the practice might yield a higher value than the aggregate value as if the practice had been valued as a single business enterprise. Similarly, we have seen examples of “hybrid” models of valuation, in which the ancillary service line is valued using the income approach and the professional portion of the practice is appraised using the asset approach—a model that risks overstating the aggregate practice value. Likewise, the use of different appraisers—one for ancillaries and another later for the professional practice—risks similar overstatement. 

• If the professional practice is later sold, compensation of the physicians in subsequent employment arrangements must consider the prior sale of the ancillary technical component to avoid paying twice for the same income stream and applicable Stark and anti-kickback compliance risks. 

Physician-owners must accurately account for the long-term impact the loss of service line profits has on compensation. For example, cardiologists can generate a significant portion of their compensation from services like nuclear imaging, echocardiography and cardiac CT imaging. If such an ancillary service line is sold, the cardiologists can no longer bill the technical component fee for that service and, as a result, receive a reduced compensation based solely on the professional fees billed. 

Practice bifurcation represents a risky alternative to the whole-cloth sale of physician practices with profitable ancillary services. Entering into a hospital-physician asset purchase transaction and subsequent employment is fraught with business, compliance, and valuation risks, and should not be taken lightly. Experienced health care legal counsel and valuation guidance are essential to safely navigating these risk areas.

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