Legal Update | Selling Your Practice to Wall Street

Selling Your Practice to Wall Street

Provided by John D. Fanburg, Esq., Mark Taffet and Leonard Lipsky, Esq.

As a follow-up to last month’s article, Selling your Practice to a Hospital, this month’s legal update focuses on issues surrounding the sale of a physician practice to a large publicly-traded or venture capital-backed physician practice group. These Wall Street practice groups are usually created by the merger or acquisition of numerous smaller specialty practices, which then seek to leverage their greater purchasing and negotiating power to spread the cost of IT upgrades over a larger revenue base and expand the range of services offered to their patients.

To grow efficiently, institutionally financed practice groups will approach and negotiate with dozens or even hundreds of target physician practices at one time, with only 1% to 5% of targets actually being acquired. To assure that valuable time is not wasted, best terms are achieved, or if necessary, negotiations are terminated appropriately and efficiently, it is imperative for a selling group’s partners to be equipped to interface with a potential buyer’s transaction professionals. M&A specialists should be hired or contracted to run the acquisition program, providing an expertise that managing partners of most target practice groups do not have.

For Wall Street practice groups, valuation ultimately drives transactions. As a result, it is important for the target practice group to keep things in perspective on a potential transaction. This requires a target practice group to understand both its own motivations for selling and those of the potential purchaser for buying.

Understanding each other’s goals also provides negotiation parameters for what the group can concede and where it must stay firm.

Is a transaction right for the practice and its partners?

There are many reasons why partners of a target practice group may want to sell. Health care economics are uncertain; competition with large multi-specialty groups and hospitals is increasing; IT and other infrastructure investments are large and financing often requires personal guarantees by the partners; and payors are increasingly reducing reimbursement. A merger or acquisition could result in cash to the partners, professional management of their practice, superior infrastructure, and greater negotiating power with third-party payors.

Exploring an institutionally financed practice group’s good faith inquiry to purchase a practice takes a significant amount of time and effort. Accordingly, it is imperative that the target group’s partners be on the same page prior to entering negotiations. Besides the significant costs associated with evaluating acquisition or merger proposals, the process will distract from running the practice and the practice of medicine itself.

Understanding each other’s goals also provides negotiation parameters for what the group can concede and where it must stay firm. If the partners do think that they could benefit from a sale or merger, they are encouraged to pursue discussions efficiently and knowledgably.

Being smart may not be enough

Smart, analytical and seasoned physicians may feel that it is best to simply invite a potential purchaser to their office to negotiate a transaction. Such an approach may
not be prudent. The issues involved are complex and outside the normal range of activity and experience of many physicians. Transactions often involve valuation, operational, governance, legal and regulatory issues with which even veteran physicians are not familiar. Enlisting the help of a CPA, investment banker and legal advisor may be necessary to successfully complete the transaction.

Determining valuation from the perspective of the purchaser

Publicly-traded or venture capital-backed practice groups primarily seek a superior return on investment. The specific purchaser may have an interest in health care services and even more specifically in the target group’s specialty. Unlike, however, a sale of a physician practice to a hospital or another privately-held physician group,
which may take into account community relations, professional expertise and certain other goodwill considerations, Wall Street acquisitions are typically driven by the valuation of the target practice and the financial return the transaction will provide to its investors.

From the purchaser’s standpoint, there are three critical points of analysis, which are often intertwined, that help determine if they will complete a transaction and what they want to pay for the physician practice: Quality of Earnings, Synergy and Scalability.

Quality of earnings focuses on how likely it is that the target practice’s profits will continue after its acquisition. Factors affecting quality of earnings include whether the target group has long-term referral arrangements in place, dominates its geographic market, and expects third-party payor reimbursement to increase.

Synergy revolves around the degree to which costs and expenses can be eliminated, or revenues increased, in the target practice through a merger with the purchaser. Potential purchasers will analyze how administrative costs can be reduced, medical malpractice rates improved, and if a stronger negotiating position will impact reimbursements from third-party payors.

Scalability addresses whether or not the revenues of the target practice will grow due to its acquisition by the institutionally financed practice group. For example, potential purchasers will analyze whether the transaction would increase the likelihood for the target practice to acquire additional local practices, obtain new contracts, open additional office locations, offer a wider range of services or retain more referrals.

If the stars line up, a purchaser will be able to cut the target practice’s costs, improve reimbursement and increase revenue. If all of these things happen, the purchaser is in a position to pay more for the practice in the form of cash, salaries, bonuses and stock. Often, however, all of the stars do not align and a valuation compromise must be reached.

It is also important to understand that, after a transaction is closed, if profits do not meet an institutional buyer’s requirements, it is likely that cost cutting measures may be taken in an attempt to maintain a financial return on the investment. A buyer may not be as sensitive to non-financial issues as are the partners of a privately-owned practice, nor will they be sentimental toward former partners or staff in seeking their financial goals.

Target practices are encouraged to retain the services of an experienced investment banker that can assist them in countering the expertise of M&A professionals employed by a potential purchaser and who will work to maximize value and minimize risk in a transaction.

Regulatory framework

Besides the valuation issues pervasive in transactions, the target practice should also be aware of the applicable regulatory issues. It is common for publicly-traded or venture capital-backed physician practice groups to enter into management services agreements with third-parties that provide a host of services to their entire organization, such as general administrative services, billing and collection, staffing, and maintenance. Because such management companies are often owned in part by nonphysician entities or individuals, physicians should be careful not to run afoul of the corporate practice of medicine rules and feesplitting prohibitions in certain states.

For example, New York has stringent corporate practice of medicine and fee-splitting statutes that do not permit physicians to share professional fees with non-healthcare professionals. Obtaining the advice of counsel knowledgeable in such transactions is crucial to appropriately structure any merger or acquisition to comply with all applicable state and federal laws.

Entering into an agreement to sell or merge one’s practice with a publicly-traded or venture capital-backed physician practice group is not an easy decision to make, nor one that should be undertaken without careful reflection and analysis. Understanding the nuances of such transactions, particularly the valuation and regulatory considerations that drive such transactions, are critical to negotiating favorable terms and getting back to what matters – practicing good medicine.

John D. Fanburg chairs the health law practice, and Leonard Lipsky is an associate in the health law practice of Brach Eichler L.L.C., a Roseland, NJbased law firm. Contact Mr. Fanburg at jfanburg@ bracheichler.com or at 973-403-3107. Mark Taffet is the President and CEO of Mast Advisors and can be reached at mtaffet@mastadvisors.com or at 973-718-7341.