by Mark Spurlin, CPA
Many people assume the concepts of Fair Market Value and Commercial Reasonableness are basically the same and/or if an arrangement is FMV it is also commercially reasonable. There was also the common belief that if an arrangement was not profitable, it was not commercially reasonable. While this may be true in some cases, this is not the general rule. There is in fact a clear distinction between Commercial Reasonableness and FMV.
Commercial reasonableness refers to whether a transaction makes sense from a business perspective, and whether it aligns with the goals of the parties involved. On the other hand, Fair Market Value is the price that would be agreed upon in a transaction between a willing buyer and a willing seller, both of whom are knowledgeable about the market and under no compulsion to act.
However, the misconceptions that Commercial Reasonableness and FMV are one in the same are understandable given that while the concept of Commercial Reasonableness has been around for decades, it wasn’t clearly defined in the regulations until 2021 when 42 CFR § 411.351 was published, providing the following definition:
“That the particular arrangement furthers a legitimate business purpose of the parties to the arrangement and is sensible, considering the characteristics of the parties, including their size, type, scope, and specialty. An arrangement may be commercially reasonable even if it does not result in profit for one or more of the parties.”
Basically, does the arrangement in question make business sense, even if not everyone involved makes a financial profit?
One of the most common examples of how an arrangement can be FMV, but not commercially reasonable, is in regards to Medical Directorships. It may be FMV to pay a Cardiologist $250 an hour to perform medical director duties, but if a nurse can provide the services for $50 an hour, it doesn’t really make sense to pay the physician.
Nuances like the difference between Commercial Reasonableness and FMV can have a huge impact and navigating this space can be quite the challenge for physician practices. At Root Valuation, we help physician leaders successfully navigate business and employment transactions to that their value is fully realized. Have a question about physician compensation, speak with Mark Spurlin at 720.458.3766 or contact us at info@rootvaluation.com.