This article is written by Todd Mello, Partner and Co-Founder of HealthCare Appraisers, and Nick Newsad, Senior Associate at HealthCare Appraisers.Business valuations take into account all facts and circumstances known or knowable as of the valuation date. Independent of an ASC's operational and financial performance, there are specific transaction business terms that can also affect the purchase price paid.
Working Capital
Working capital is the investment a company must make to support its daily operations. From an accounting definition, net working capital is calculated as current assets minus current liabilities. Within a valuation context, however, appraisers typically only consider required working capital balances, which exclude excess cash and marketable securities and interest bearing liabilities that are part of the capital structure of the business. Most valuation models yield values that are inclusive of required working capital, so the treatment of working capital in a purchase agreement will have a direct effect on purchase price. In a stock purchase working capital is generally transferred, but in an asset purchase it is common for some or all of the working capital to be excluded. This requires a reduction in purchase consideration relative to the indicated value, and for a high revenue business with a low profit margin, this may mean the difference between a million dollar valuation and no purchase consideration.
1) Current Assets: Cash, Receivables, Inventory
Current assets are working capital assets that can be readily liquidated. Cash, accounts receivable, and inventory are all current assets that contribute to the value of a business. The elimination of one or more current assets from the deal necessarily decreases the purchase consideration.
For example,
assume that inventory and receivables are excluded from a business sale. If the new owners have to put in their own cash to pay to purchase new inventory and support operations until receivables are paid, then it costs the new owners more money to operate the business. Because it costs the buyer more money to operate the business, the sale price should be lower to account for the extra financial burden. When receivables and inventory are included in the sale, it costs the new owners less money to operate the business, and the sale price will be higher, all else equal.When current assets are excluded from the sale of a business, the buyer will subtract the value of a "reasonable level" of current assets from the overall business value rather than the actual current asset values. This is because the business may, in fact, have too much or too little cash, receivables, and/or inventory at the time of the sale. Regardless of the actual amount of a business's current assets, only a reasonable level is needed to operate the business.
If actual current assets are included in the business sale, it may be found that the business has a surplus or a deficiency from reasonable levels. A surplus would be added to the business value, because it is above what is needed to operate the business. A deficiency of current assets, such as a lack of inventory, would decrease the business's value because the new owners have to fund higher than normal expenses to restock.
2) Current Liabilities: Accrued employee benefits, payables
Current liabilities, like accrued expenses and payables, are liabilities that the business is typically expected to pay within one year. Excluding a current liability from a business sale increases the business's value because the buyer is burdened to a lesser degree by future cash demands.
For example, if an ASC is sold and the nursing staff's accrued vacation time is cashed out by the seller before the staff starts working for their new employer, the new owner saves money because it does not owe the employees money the first day it takes ownership. The corresponding reduction of cash should account for the difference, depending on whether such a payout leaves adequate cash for operations. Staff vacations and paid time off can be costly, depending upon how much time they are permitted to accrue. For example, if a director of nursing has accrued 300 hours of time off, this could easily represent a future decrease in cash to the buyer of $10,000 to $20,000.
Similarly, if accounts payable is transferred between seller and buyer in a sale and the business hasn't paid its vendors for 90 days, these excessive accounts payable will decrease the ASC's value because it places immediate cash demands on the new owner. The new owner will have to spend more of the business's cash paying vendors and will subsequently retain less money for itself.
3) Debt
Typically, if the buyer is assuming a business's debt and the business has been valued before accounting for debt service payments (i.e., on an invested capital basis), then the value of the debt is subtracted from the business value as of the transaction date in arriving at the value of the equity.
If the buyer is not assuming the business's debt, and the seller is still liable, then the debt is not subtracted from the business value, and the purchase price paid to the seller is comparatively higher. However, the seller is expected to pay the debt out of the proceeds of his or her sale price, so effectively, there should be no difference.
4) Non-Competes
The inclusion or exclusion of non-competes in a purchase agreement affects the risk associated with the business. A majority purchase of ASC ownership that completely liquidates the most productive physician users is more risky than a majority purchase of ASC ownership that partially liquidates all of the ASC's users. These factors affect business valuation through the risk assigned to a business's cash flows. If the perceived risk is higher, then the business's value is lower. Under FMV, it is generally presumed that the sale of a business includes a covenant not to compete from the seller. In other words, the value associated with a non-compete is already reflected in the baseline FMV (i.e., the buyer assumes they will get the business they are paying for), but the absence of the covenant will result in a reduction in value in most transactions.
5) Post-Transaction, Related-Party Agreements
Changes to related party expenses can increase or decrease a business's value. In the context of ASCs, common related-party expenses include real estate lease rates, medical directorships, management fees, billing fees, equipment leases, and staff leases.
Real estate is a very common related-party transaction. If an ASC seller owns the real estate and negotiates a higher lease rate with the buyer of the ASC, this higher expense decreases the ASC's future cash flow. Conversely, reducing a real estate lease rate upon the sale of an ASC will increase the business's cash flow, all else equal. This also comes into play depending on whether or not the tenant improvement assets are owned by the landlord or sold to the new ASC owner. Notwithstanding the foregoing, when a non-physician owner buys into or all of an ASC owned by physicians, the parties should maintain an FMV analysis related to the lease payment. Depending upon the resulting FMV conclusion, a prospective adjustment to the lease rate may be required, and the impact of the adjustment should be reflected in the business value.
Another example of a related-party transaction is the provision of professional services (e.g., billing). If an ASC relied on billing staff from a physician office in the past and was not otherwise charged or charged FMV for the service, then a prospective adjustment would need to be reflected in the valuation of the business.
Conclusion
Without making any operational or financial changes to an ASC's business, there are several decisions a seller can make during the negotiation of the purchase agreement that directly affect the purchase price. As discussed, sale terms that disadvantage the buyer may result in a lower purchase price for the ASC itself, but the seller may realize the foregone purchase price value through favorable terms for working capital, debt, non-competes, or related party transactions. The overall value realized by the seller is usually the same regardless of whether it is all accounted for in the purchase price or through a combination of other means.
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