State laws normally dictate whether an MSO can contract with a provider organization on a % of reimbursement fee structure. In most of the cases we see at HVG, the healthcare attorney has stipulated that the management fee be a fixed fee (rather than % of reimb.), especially if any type of “marketing services” are involved. States with strict fee-splitting laws generally prohibit a % of reimbursement management fee.
The fair market value management fee should be developed by looking at the perspective from both the MSO as well as the provider organization.
The safest and most common method of arriving at an FMV management fee is by use of the “cost plus mark-up” method. This is a technique where the appraiser analyzes the specified management functions to be performed and the actual (or forecasted) expenses and applies a fair and customary mark-up on the expenses/costs (i.e. “cost plus a mark-up”). The theory is that an enterprise with expenses and assets like that of the subject MSO normally earns an XX % profit margin, or what is referred to as a “fair and customary” return on its investment. Appraisers will identify the profit margins earned by other companies in the market that provide similar services. Once the appropriate profit margin is identified, the appraiser can impute or back-into the revenue that an MSO should earn based on their expense structure and a market-based return. This exercise reveals the annual revenue of the MSO which implies the FMV management fee. Another method appraisers use is a fixed $ amount per FTE physician provider. MGMA publishes clinic cost data on a per FTE basis for various specialties. Where things get a little complicated is when an MSO plans to scale up and provide management services to additional providers. In situations like this, a 1-year pro forma of expenses might be used.
The FMV management fee should also be calculated by looking at the cash outlay from the perspective of the physician practice. This is particularly important in cases involving private equity firms acquiring physician practices. The management fee expense shouldn’t be so high as to drain the physician practice of the necessary working capital for expenses and a fair profit. The physician practice should have enough excess cash to pay the FMV physician salaries and, in some cases, enough cash remaining to pay the physician-owners a fair return. If the MSO is proposing to provide all the FF&E and essentially all operating expenses, then it is a good idea to benchmark the expenses and capital reserves of the MSO to ensure there is enough cash for the MSO to meet its management obligations.
Finally, the estimated management fee can be tested/verified by comparing the calculated management fee as a percent of practice revenues to other third-party publicly available management fee data. This should only be a sanity check and not necessarily the sole method of determining the management fee.