Determining Fair Market Value

At What Price? Fair Market Value and the Valuation Process: Determining the Value of a Nonprofit Corporation’s Assets

A nonprofit corporation is made up of many different types of assets. Assets include not only the bricks and mortar of a nonprofit (the building, its equipment, etc.), but its list of subscribers, its good will, its reputation in the community, any revenue, profit or surplus it has accrued, and the value of its trademark/service mark. The “cross” and “shield” service marks of the Blue Cross and Blue Shield plans are well known and carry with them value as a distinct product, similar to the product trademark “Coca Cola.” Similarly, a nonprofit hospital has an established reputation and the incoming for-profit corporation is banking on using that name - a name that the community often trusts.

The determination of the proper value of a nonprofit corporation or the reallocation of assets is critical in the review of any conversion because valuation determines how much must be paid for the nonprofit’s assets. The higher the price, the more money that will be preserved for nonprofit purposes and be available to meet the community’s health needs. Undervaluation of assets not only can allow public charitable assets to benefit private individuals or be used for for-profit purposes, but also removes from the nonprofit sector the assets available for community health needs.

There are many examples of the undervaluation of nonprofit corporations and their assets that have converted, particularly where regulators and communities have not been vigilant.

UNDERVALUATION OF HMOS

HMO	Amount to Charity at Time of Conversions	Later Value	Current Value
Family Health Plan (FHP)	$38,456,000 (1984)	$135,628,000 (1986)	$1,711,000,000 (1994)
Foundation Health	$78,000,000 (1984)	$302,500,000 (1985)	$1,873,000,000 (1994)
Pacificare Health	$360,000 (1984)	$45,300,505 (1985)	$2,193,000,000 (1994)
Inland Health Care	$663,000 (1985)	$37,500,000 (1986)	Not Available

Anne Lowry Bailey, “Charities Win, Lose in Health Shuffle,” The Chronicle of Philanthropy, June 14, 1994, p. 12.

In each of the undervalued deals illustrated, the nonprofit corporations did not preserve the full fair market value of the assets for nonprofit purposes, but instead some of the assets benefited private individuals, public investors, or for-profit endeavors.

Valuation is an inexact science, often using a number of different theories and formulas to determine the fair market value of nonprofit corporations. Defining the value of a nonprofit corporation’s assets is best done by experts, such as investment banking firms, independent of the parties to the transaction. However, regulators and local groups working to ensure that a fair market value is calculated should remain involved in the process.

Communities that have been able to ensure a fair market value share common characteristics, including:

• The use of independent experts. If the nonprofit conducts an independent valuation, an expert can review the valuation and other financial aspects of the transaction. This can be an expensive undertaking, beyond the means of most community groups. If the nonprofit does not conduct its own independent valuation, regulators should hire an expert to undertake an independent valuation at the parties’ expense. In choosing an expert, regulators must examine the relationship of the expert(s) retained to all the parties involved in the proposed transaction, past, present, and future, for any actual or potential conflicts of interest.
• The requirement that the valuation be made available to the public prior to a public hearing.
• The effort to obtain the highest possible value for the nonprofit converting. To ensure the highest possible value, a regulator might require the converting nonprofit to elicit and consider competing bids. With the method of valuation and the price open to the public, the reaction of competitors and other possible suitors could well determine whether fair market value is obtained. Settling for the lowest or a reasonable value within a range is not maximizing the nonprofit charitable assets and could even be considered a breach of the fiduciary duties of board members.
• Valuation assesses the value of a nonprofit corporation as it will perform in the for-profit market.
• The valuation includes a historical analysis of the company’s operations. In some transactions, the value of the company is based only on a one or two-year look back into the nonprofit’s operations, without recognizing the nonprofit’s role in the community over time. If a nonprofit conversion proceeds over those one or two years, the nonprofit may have reduced its charitable activity in order to make it more profitable for potential buyers. A valuation that takes into consideration the full historical analysis of a nonprofit’s operations is more likely to illustrate the true value of the company to the community.

Check out these documents for more on valuation:

An open and transparent bidding process is one way to ensure full fair market value is received. “The Colorado Bidding Wars” (PDF) tells the story of how a competitive bidding process increased the purchase price of BCBS of Colorado by $111 million.

Is the Selling Price Too Low? (PDF) contains information about common valuation methods and tips on how consumers can have a voice in valuation.

Techniques for Determining the Value of Health Care Organizations (Gerald Kominski) (PDF)