Business Value and Post-Sale Compensation

In valuation it is important to know when to use hypothetical assumptions versus actual facts and circumstances.  A common example in the valuation of medical groups involves post-sale compensation of the selling physicians.  In a discounted cashflow method the valuator’s goal is to project all revenues, expenses and net cashflows.  One major expense item in the forecast is the physician labor cost component.  If the valuator uses historical compensation or survey benchmark data instead of actual post-sale compensation, then they may be producing an inaccurate value for the business.

wRVU Compensation Rates

Health systems often provide work RVU based compensation to physicians after they acquire their medical practices.  System rates are often different than those offered in private practice settings, so post-sale compensation in a health system may look vastly different than what the physicians have received historically.  Higher compensation results in less net cashflows and thus a lower value for the business; lower compensation generally has the opposite affect on equity value.  Plugging-in actually negotiated compensation rates into the discounted cashflow model can have markedly different affects as a result.

Tax Court – Derby versus Commissioner

Derby v. Commissioner is a commonly cited tax court case which addresses this fact in healthcare.  Actual negotiated compensation rates must be plugged back into the valuator’s forecast in order to calculate an accurate equity value.


  • John Rickers
    February 18, 2016

    So what do you do when post sale compensation exceeds historic compensation and leads to negative net cash flow. Do you still have positive business value or intangible value?

    • HealthMerger
      February 19, 2016

      John, in many cases you can still have intangible value even with negative net cashflow. The practice may still have discretionary earnings and the ability to remain operating as a going concern. I would argue that a marketability discount or economic obsolescence factor could be applied.

  • Desmond Miles
    February 19, 2016

    Is the use of a particular proposed post-sale compensation offer applicable to all hypothetical customers? The very nature of such an offer implies it originates from one hypothetical buyer, and does not seem to take into account potential offers that would be made by other buyers.

    • HealthMerger
      February 19, 2016

      True, considerations for one “specific” buyer would normally imply strategic value but in this case it’s different. We need to consider the actual facts relevant to the forecast. We are not considering the value or volume of referrals related to the specific buyer, downstream revenues, etc….so we are still considering a “hypothetical” buyer but we need to factor in the actual post-sale compensation.

  • Ted Greenwood
    February 19, 2016

    Chris, great insight. Understanding how post sale terms of employment factor into the value prevent the seller from receiving the benefit twice, once in the valuation and again in the terms of employment.

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