Resurgence of Medical Practice Acquisitions in Private Equity

By: Jeff Cohen

Private money (e.g. private equity) is back chasing those selling medical practices and medical business acquisitions.  This time around it is very different from similar activity in the 90s.  Back then, the movement was public companies aggregating gross income dollars, which for a time drove stock prices.  Today’s private money buyers are looking to maximize profitability through achieving efficiency and aggregating large groups for leverage and the development of new income streams.  Though stock (in the form of warrants and options or stock itself) if often on the table, it doesn’t have to be.  Buyers are doing all cash deals, albeit to some degree on an earnings basis.  If you want the full price, you have to remain involved and do what you can to maintain revenues and perhaps even drive them up.

Physicians especially have to know what they’re dealing with and then have at least a basic understanding of the issues that will drive these deals.  To begin with, “private equity” simply means private investors (typically a group that pools their capital) that buy a portion or all of a company.  Their investments are usually much larger than venture capital firm deals.  They are not publicly traded entities.  What do they want?  To invest money in mature businesses, grow a company’s profitability and then “flip” their ownership to another buyer, typically in three to five years form their launch date.  In contrast, venture capital firms usually invest in start-ups, buy 100% of the company and require control.

Medical Practice Sale Issues

The up-front issues medical practice sellers ought to focus on include:

1. Buyer experience. How much experience does the buyer have in the space occupied by the seller?  Since the buyer promises to grow the seller’s profitability, sellers need to know the buyer has experience growing the very sort of business being sold by the seller, and also need to see specifically how the growth will occur.
2. Impact on the seller. Sellers need to understand how the transaction will affect the seller.  Will it hurt the seller’s culture?  Will it mean big changes at the C Level?  What sort of changes in control will the buyer require?  Sellers would do well to speak with other sellers to see what life is like after the acquisition.
3. Buyer plans. Issues like timing of other rounds of investment are critical too, especially if there is any stock (stock, warrants, options) involved in the transaction.  If the usual flipping period is 3-5 years and the buyer is in its first year of options, stock would likely have no value at all for several years (since the buyer is just buying and incurring debt for a while).

Prepping for the Sale

Sellers considering a sale need to get prepared to maximize value at least a year in advance.  There may be loans on the books and other things that impair profitability.  Since purchase prices are based on a multiple of earnings, sellers need to clean up their books to increase profitability.  Similarly, there may be a variety of legal “clean up” that needs to be done to remove fears of the buyer.  Are corporate documents in place and signed?  What about state filings?  Are there UCC-1s that need to get resolved?  This is all early work that needs to be done with the seller’s accountant.

Getting the Practice Sale Done

The sale process usually begins with non-disclosure agreement signed between the parties.  The NDA is designed to simply have the parties keep all information and documentation exchanged as confidential.

Next is the non-binding letter of intent. Sellers who think the terms of the LOI aren’t important (because it’s non-binding) will be stunned to learn that the entire transaction is actually driven off the LOI.  That doesn’t mean changes can’t happen to the deal once the LOI is signed.  It just means it’s often difficult for material changes to be made after that point.  In fact, both parties tend to consider material changes after LOI to be a “bad faith” sort of move.  Sellers must have input from their accountants and lawyers before signing the LOI, since seemingly innocuous things (e.g. stock vs. asset transaction and purchase price allocations) can have a big impact on the value of the transaction.

Due diligence is the period of time after an LOI is signed (30-90 days), during which time the buyer will dig through all aspects of the business to identify any issues.  They are seeking to avoid upsetting surprises.  And of course, these surprises are often used as leverage to reduce a purchase price.

Sculpting the deal is critical early on.  How much will the buyer be required to reserve under the banner of “operating capital” (which is typically left on table for the buyer)?  If a buyer isn’t careful, the buyer may claim that all the receivables are operating capital.  Are the accounts receivable allocated to the buyer or reserved to the seller?  If the buyer wants them, you will have to discuss their net value.  Is real estate part of the transaction?  If it is not contained in the Letter of Intent, or if it is not specified in the legal documents, it is not part of the deal.

Legal Documents for the Medical Practice Sale

Buyer typically propose all the legal documents in a purchase transaction.  And of course it’s normal for all of the terms and condition to favor the party that drafted the agreements.  For instance, the reps and warranties (promises made by the seller) will be extensive.  But many of the things you will have to promise about your company are not even knowable.  For instance, governmental or licensing board investigations are confidential.  You won’t even know about them.  So how can you rep and warrant that there are none?  Indemnification obligations can be “first dollar” and unlimited, which is a huge risk to the seller.  Sculpting a proper indemnity threshold and cap is important.  Sellers can expect at least three rounds of changes to the proposed agreements, plus perhaps many discussions on the client level (between purchaser and seller representatives) and legal counsel level.  Sellers need to understand that the buyer is most impacted by ensuring the seller (not their lawyer) is reasonably happy.  As such, these deals do not typically get done at the lawyer level.  Knowing which issues the client will carry and which ones the lawyer will carry is critical.

Regulatory Climate

All transactions occur against a back drop of healthcare regulations.  The Stark II law is a Federal self-referral law which requires each of the foregoing to be handled in a particular way.  Practices with designated health services (DHS) like diagnostic imaging and physical therapy, DME and clinical lab services have to understand how profits will be allocated after a transaction.  The Federal Safe Harbors describe ways of handling the transaction so that you will not violate the federal Anti-Kickback Statute.  Medicare has peculiar regulations such as the “incident to” services requirement, for instance, that will impact certain core aspects of the purchase and compensation arrangements.  And Florida (and many states) have fee splitting prohibitions that affect the way physician compensation can be paid.  These are up front issues that often need to be thought about before an LOI is executed.  Ask your healthcare lawyer and advisors to explain these things to you.  If they cannot, you need to find professionals who understand these laws and how to apply them to your situation.

Conclusion

Selling a medical practice (or any healthcare business) is an exciting time, but not one where you want surprises.  Your advisors will help you on that journey and will reduce the risk to you while maximizing the value you receive.