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.