According to research conducted by Modern Healthcare, the healthcare industry continues to experience a significant uptick in mergers and acquisitions (M&A) despite market uncertainties, with physician practices emerging as the most prevalent target. This surge is largely driven by private equity firms and other investors seeking to consolidate physician practices to achieve economies of scale and enhance market presence. For physicians, such strategic partnerships offer access to capital, facilitating investments in advanced technologies, ancillary services and infrastructure. However, these transactions introduce a myriad of complex legal and business issues.
Navigating healthcare transactions requires meticulous attention to compliance with state and federal laws, including the federal Stark Law and the Anti-Kickback Statute, as well as state-specific corporate practice of medicine doctrines, each of which can significantly influence the overall structure of a transaction. Additionally, prospective sellers need to carefully evaluate the economic and non-economic consequences of the transaction. Therefore, engaging legal counsel with specialized expertise in healthcare M&A before going to market is essential to effectively address these intricacies.
Some key considerations for prospective sellers in healthcare M&A transactions include:
- Sell-Side Due Diligence: Before going to market, prospective sellers, together with their legal counsel and other advisors, should engage in sell-side diligence to identify and address issues that may impact the value of the business, including reviewing and evaluating the prospective seller’s (i) organizational documents, (ii) assets, (iii) contractual relationship, (iv) licenses and permits, (v) legal compliance, (vi) litigations and investigations, (vii) billing and coding, and (viii) financial and tax related matters.
- Identifying the Right Partner: While the economics of a healthcare transaction generally dominate the discussion, it is important to keep in mind that not every potential partner is created equal. The reality is that all potential partners have access to capital and can make competitive offers for the target business. However, not every potential partner will share the same short-term and/or long-term vision for the future of the target business, nor does every potential partner have the same level of experience and sophistication to support the target business’s ongoing operations. Therefore, it is critical that prospective sellers fully vet all potential partners and identify one that is strategically and culturally aligned with the prospective seller’s go-forward vision of the business.
- Economic Terms: Potential partners, including private equity-backed management service organizations (MSOs), typically make an upfront cash payment based on a multiple of the practice’s earnings before interest, taxes, depreciation and amortization (EBITDA). This cash payment, in turn, results in a post-closing reduction in physician compensation. As such, prospective sellers should evaluate how compensation can be repaired to historic levels post-closing. Moreover, to the extent any cash payments are structured as an earnout, prospective sellers should consider how much control they will have over the post-closing business to meet the relevant targets/metrics necessary to receive future cash payments. In addition to cash payments, many healthcare transactions also include rollover equity in the acquirer (or parent company thereof) as part of the overall consideration to ensure the sellers have “skin-in-the-game” after a closing. Since such rollover equity could represent upwards to 50% of the total enterprise value, prospective sellers should confirm the value of the rollover equity and review the rollover entity’s governing documents to better understand their rights and obligations, including vesting schedules, forfeiture events and redemption payments.
- Non-Economic Terms: While a definitive purchase agreement is designed to memorialize the business deal between the parties, it primarily serves as a risk allocation tool. In particular, sellers will be required to make robust representations and warranties about all aspects of the target business’ pre-closing operations. If there is a breach of any such representations or warranties, the seller (and, in the case of an entity seller, its individual owners) will be required to indemnify the acquirer from any losses resulting therefrom. To ensure that a seller’s risk exposure is commensurate with the benefits it will derive from the transaction (i.e., the upfront consideration), sellers should seek standard monetary and non-monetary limitations on its indemnity obligations, including caps and baskets. Prospective sellers are well advised to negotiate these items at the Letter of Intent stage to ensure the parties are aligned on those risk allocation issues before investing a substantial amount of time, money and resources in negotiating the definitive purchase agreement.
Check out our deep-dive videos detailing how to prepare for private equity transactions, and everything you need to know about MSOs.
