The management services organization (MSO) business model seems to be really popular of late. This is especially so with telehealth businesses since most are structured as an MSO and friendly PC model. HVG is regularly asked to issue an FMV opinion on the management fee related to a management services agreement (MSA). Here is a short explanation of how appraisers should estimate the FMV of management services.
As an appraiser, we encounter certain unique challenges when it comes to opining to an FMV management fee. First, in certain states with restrictions on fee-splitting and/or where the corporate practice of medicine (CPOM) is in force the management fee cannot be contracted (or expressed) as percent of reimbursements or patient volume. And second, there exists no relevant and/or sufficient market data on “management fees” to utilize as a suitable comparison, similar to physician compensation or private company transaction data. This begs the question of what does a proper and defensible FMV opinion for management fees look like?
One of the more appropriate methods for an appraiser to utilize is what’s called the cost-plus method. Meaning, the MSO charges the provider company (i.e. friendly PC) the actual expenses incurred to provide management services plus a FMV mark-up. For example, let’s say the MSA incurs $20,000 per month indirect expenses to manage a single provider-friendly PC or provider entity. Further, assume the fair and reasonable mark-up is 15%, the FMV monthly management fee can be calculated as:
$20,000 x 1.15 = $23,000
But, how does an appraiser determine the “fair and reasonable mark-up” on the actual expenses incurred? First, we start by examining and analyzing the construct of the management company. What services are they providing? Are they outsourcing the billing and collections? Are they staffing their own administrative personnel? Are they doing the actual bookkeeping for the provider company? A good appraiser will look at the expense structure and the assets of the management company to determine the true nature of the business and the inherit business risks. Are they entering into non-cancellable contracts? Are they investing large sums into technology and staff? And finally, does the management company have only one provider organization to manage or multiple? So, the ultimate question the appraiser must answer is “what type of return is the management company entitled to earn?” This is done with a thorough analysis of the management company and its business risks. And once the fair and appropriate return for the management company is determined, then the FMV management fee can be calculated just as it was calculated above.
So, how do appraisers determine the “fair and customary” return for a management entity? Appraisers analyze the return earned by guideline public companies that provide some of the similar functions as a typical MSO. For example, we can analyze the historical returns of public companies that provide billing, care management, communications, consulting, staffing, technology services, transcription, workers comp./payer services and calculate their mark-up on costs. This market-based “mark-up on costs” serves as a proxy for a mark-up on the costs actually incurred by an MSO.
Often times the MSO is a start-up and the actual costs/expense are unknown. So, what is the appraiser to do? MGMA reports cost data on a number of specialties and the practice cost data is expressed in terms of FTE physician providers. If the business owner of the MSO doesn’t have a proforma of expenses, the appraiser can estimate the necessary costs of the provider’s practice by considering the number of FTE providers of the entity to be managed and looking at the corresponding MGAM benchmark data.
With respect to a telehealth business, there are a few points to remember when analyzing the risks of a business. I often hear clients refer to their management company by stating “…but we’re a telehealth company..” The friendly PC, not the MSO, is the actual telehealth company because that entity carries the traditional risks of a healthcare provider, such as provider salaries, malpractice insurance premiums and fluctuating reimbursements, while the MSO possesses a different set of risks. Therefore, it’s important for the appraiser to carefully analyze the actual risks of the MSO entity when estimating a fair and appropriate return for the management entity.