In light of recent health-care reform and reductions in reimbursement, more and more physicians are entertaining the possibility of selling their practices to a hospital. However, another potential suitor could include a sale 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 percent 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. Merger and acquisition (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.
It is important for the target practice group to understand both its own motivations for selling and those of the potential purchaser for buying.
Is the Transaction Right for the Practice and Its Partners?
Whether the deal is right for the physician is an entirely different question. This decision should not be made lightly. Physicians who are contemplating selling their practice need to understand the benefits and disadvantages of this transaction and how their personal and professional lives may be impacted as a result.
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.
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 issues, governance, and legal and regulatory issues with which even veteran physicians are not familiar.
A selling physician must also understand that as an employee in the new model, the physician may not be able to generate the same level of compensation that he or she earned in his or her own private practice. Because the acquiring entity bears the risk of the investment, it also reaps the rewards. Such physicians must accept that they will no longer be compensated as partners of the practice, but instead will be retained as fixed-salaried employees for a certain period of time or based on “relative value units.”
At the same time, these physicians no longer need to worry about slow years and fluctuating revenue. This stability and security is often welcomed by risk-averse and risk-seeking physicians alike, particularly in an economic climate where reimbursement rates are continually reduced by private and government payors.
Another benefit is that the physician is no longer responsible for the overhead associated with running a private practice. Such physicians do not need to allocate resources toward rent, payroll, supplies, marketing, etc. Their only concern is maintaining their patient relationships and providing high-quality, cost-effective care. By reallocating their focus, selling physicians may be better positioned to improve patient care.
While it certainly means fewer headaches, it also means reduced autonomy in the management and day-to-day affairs of the practice. Physicians who once controlled every aspect of their practice soon learn that, as employees, they have very little say over management decision-making. While some aspects of control are negotiable terms in the transaction, selling one’s practice may still require an adjustment period for those physicians who have grown their practices from the ground up. It is not always an easy transition from owner to employee.
An important benefit of selling a practice is the increased resources that a hospital can provide to a physician’s patients. With health care shifting from reactive medicine to improved preventive care, access to a wide range of resources can significantly improve patient care.
For the physicians personally, a hospital fully subsidizes certain employee benefits. For example, as an employee, a physician is not required to purchase his or her own medical malpractice coverage. Depending on a physician’s specialty, such savings can be quite substantial. Of course, just as with the management of a practice, physicians should remember that as employees, they have very little influence over the type of benefits they are afforded.
Determining Valuation from the Perspective of the Purchaser
In making the decision to sell one’s practice, an important consideration is the valuation of the practice. 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 of the target practice acquiring additional local practices, obtaining new contracts, opening additional office locations, offering a wider range of services or retaining 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, 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 who 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.
Besides the valuation issues pervasive in these 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 billing and collection, staffing and maintenance and general administrative services. 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 fee-splitting prohibitions in certain states.
For example, New Jersey’s stringent corporate practice of medicine and fee-splitting statutes do not permit physicians to share professional fees with nonhealth-care professionals. A new practice entity will need to be formed that must be owned by New Jersey licensed physician(s). This new entity will, in turn, employ the selling physician and/or the selling physician’s employees.
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 them, are critical to negotiating favorable terms and getting back to what matters — practicing good medicine. •