What To Consider When Buying A Medical Practice

As physicians retire and the era of healthcare reform rocks physicians, opportunities to purchase practices will likely surge, and not just for entities that employ physicians, like hospitals.  The big issues generally break down like this:

1. What to pay;
2. How to structure it; and
3. How to pay for it.

The Price

It depends on what you’re buying.  If all of the practice income is from personal services performed by the selling physician, the answer is generally “not a lot.”  The price typically consists of (1) the value of the fixed assets (e.g. equipment, furniture), and (2) maybe a little more in order to avoid the cost of starting up a new practice from scratch.  In the event, however, the practice also generates income from services that are not personally provided by the selling doctor, the price is increased to account for this “passive revenue.”  How much?  Maybe the amount of one year’s profit from that ancillary service.

Structure

Practice purchase take one of two forms:  (1) stock purchase, or (2) asset purchase.  Buyers that buy the stock of a medical practice are rare because the buyers get all the liabilities associated with the stock of the selling practice.  Most practice purchases are asset purchases, which makes it easier to say what you’re buying, what you’re not buying, which liabilities you want to assume (e.g. leases) and which ones you don’t want to assume.  Sellers often prefer stock purchases because the seller gets better tax treatment on the purchase price (capital gains instead of ordinary income) than sellers who sell just their assets.

Payment

There are two ways to pay for a practice:  (1) on a pre-tax basis, or (2) on a post-tax basis.  Employed physicians who become owners of a medical practice employer are often familiar with pre tax purchases because they have a portion of their salaries or bonuses applied to the purchase price, instead of getting the income, paying tax on it, then writing the seller a check.  Sellers usually favor getting paid with the buyer’s after tax dollars, but often compromise and agree to accept at least a portion of the purchase price on a pre-tax basis via some sort of compensation offset.

Now that you know the big issues, you need to know how it’s done.  The process generally involves the following:

1. Letter of intent;
2. Legal documents; and
3. Negotiating the documents.

Letter of Intent

Before people jump into a complex transaction (and pay lawyers lots of money), they usually like to “rough out” the deal points in a non binding document a few pages long which describes the guts of the transaction.  In a medical practice Letter of Intent, those points are usually:

1. What is being sold (assets or stock);
2. Whether the accounts receivable are included or not—usually not;
3. The purchase price;
4. How it’s paid;
5. Whether the seller will stay on in the practice and if so, how he/she will be paid for working for the practice;
6. The restrictive covenants (e.g. noncompete) that will apply to the seller.

The Legal Documents

In an asset sale, the parties can expect:  an asset purchase agreement; a promissory note (if payments will be made over a period of time); a security agreement (if there is a promissory note); a noncompetition agreement; and an employment agreement for the seller (if the seller will stay on).  In a stock purchase, you will have a stock purchase agreement instead of an asset purchase agreement, plus a few other more minor documents.

The guts of the key transaction document are (1) the reps and warranties, and (2) the indemnification provisions.  Reps and warranties are basically promises made by the seller about the practice.  A buyer will wants loads and loads of them.  indemnifications are essentially obligations of a seller to pay a buyer for harm that comes to the buyer which relate to the practice before the buyer bought it.

Noncompetes are often essential terms of a practice purchase.  A buyer doesn’t want the seller hanging around soliciting patients or practicing across the street.  Generally, the term runs two to five years and the geographic scope depends on the specialty and the market where the practice is located.

Negotiating the Documents

Very simple:  everything is negotiable.  Everything.  That said, there are certain things the are usually set in stone.  For instance, the buyer is gonna pay something over some period of time.  The noncompete will apply for a period of time over a certain geographic area.  Though a buyer will want a millions reps and warranties, they will probably be negotiated down.  The indemnification provision may contain a “basket” and a “cap” so that the first dollar of damage may not be passed to the seller and the total amount may be limited.  Though physicians may consider a practice sale or purchase to be a minor thing, they can be shocked at the complexity and intricacy of such issue as Medicare liability and recoupment issues.  Moreover, even once the documents are negotiated, preparing all the disclosures and attachments to the documents is extremely time-consuming, whether the practice costs $1 or $10 Million.  All the “i”s have to be dotted and the details attended to.

Conclusion

Practice purchases are a fact of life and will likely increase as the healthcare marketplace evolves.  Agreeing on the core issues is important and just starts the ball rolling.  Be prepared to engage a lawyer and accountant that have lots of experience doing these sorts of transactions.

Everything Else You  Need to Know about Buying a Medical Practice