Healthcare M&A: Key Considerations for Buyers

Cash-basis accounting that doesn’t provide an accurate picture of financial trends

It’s imperative to perform thorough financial due diligence for any potential healthcare transaction. As part of that process, it’s important to consider whether the target uses a cash-basis or accrual-basis method of accounting and what this might mean as you assess their financials.

As there can be significant lags between when medical services are performed and when an insurer reimburses the claim, financial statements calculated on a cash-basis may not give an accurate picture of whether a practice’s revenues and profits are growing or shrinking. Smaller practice groups – often the targets for acquisition – tend to use the cash-basis method of accounting. For buyers considering acquiring such a practice, it’s critical to understand the significance of the impact between cash-basis and accrual-basis income levels.

The effort can be worth it. Consider this simple example: A gastroenterologist group has a thriving practice with several vital fee-for-service contracts with insurers. If the practice’s patient volume decreases by 20% due to the physician group no longer accepting one of their main insurance plans, the hit to revenue may take several months to show up in financial statements which are calculated on a cash-basis due to the lag in time between the date of service and the payment of the claim. When reviewing financials completed on an accrual-basis, the decreased revenue would be evidenced almost immediately.

Coding procedures that may need to change

Smaller practices generally have fewer resources to pour into understanding how to properly document and code procedures for reimbursement from insurance companies. Furthermore, with government payors, such as Medicare or Medicaid, significant regulations exist that could create significant risks to a buyer for coding issues that existed prior to an acquisition. Therefore, it’s important to conduct a thorough coding compliance review prior to finalizing an acquisition.

Some coding practices may need to change when a practice becomes part of a larger organization. Take this example: A dermatology practice performs several basic procedures on a patient during a visit. The coder/biller of the claim for the practice, either knowingly or unknowingly, selects CPT codes for the procedures which reimburses the practice at a 35% higher rate than the specific CPT codes which otherwise should have been selected. Furthermore, the practice’s documentation was not sufficient to support the CPT codes billed. Imagine if this were going on for years prior to the acquisition and totaled hundreds of thousands of dollars.

While the above example addresses a potential significant issue, there are times where coding changes can positively impact revenues – such as when improving coding and billing procedures at a smaller practice through further education and training may lead to increased reimbursement from payers. In both cases, performing a coding compliance review prior to an acquisition provides the buyer with the necessary knowledge to make informed decisions.

True earnings potential after the transaction

Sometimes, the strategy behind buying a physician group may be to gain access to an entity with favorable payor reimbursement rates in a specific geographic area. However, due to contractual terms with insurers, typically reimbursement rates are not allowed to be shared between parties. As such, how would a buyer fully understand whose rates are better and/or what the true earnings potential of a merger or acquisition would be after closing a transaction? In these cases, the buyer would benefit from hiring an independent third-party advisor to perform a black box analysis, which could help provide transparency in this situation.

Strategic fit and post-deal integration in healthcare M&A

As with any merger or acquisition, it’s important for buyers to determine how the acquisition of the target aligns with their strategic vision and goals, and to have an action plan from the beginning for post-deal integration initiatives. If the selling physician(s) understand and support the strategy, the deal is more likely to be successful.

An integration strategy should consider the following questions, among others:

• Does the buyer have the capability to fully integrate the new practice, including the time and investment required?
• How does the geographic reach of both, the buyer and acquisition target, overlap or complement each other?
• Will any new or ancillary services be offered to the existing patient base?
• Is growing the overall patient base part of the strategy; if so, how quickly is this expected to occur?
• How will the acquisition target be integrated into the acquiring company’s existing IT infrastructure, billing and other back-office functions?

Change management and staffing changes

Any integration strategy should also include a change management plan.

To get buy-in from employees, the buyer should place an emphasis on transparency and therefore communicate the strategy, vision and goals of the newly combined organization. A change-management plan may also include further communications about new policies and procedures, organizational hierarchy, and training on new IT systems among other items.

Payroll is one of the largest fixed costs for medical practices, and an acquisition or merger may present the opportunity to cut costs by combining back-office operations, which may entail staff layoffs. If any staffing or benefit changes are planned, be prepared to communicate with the employees about the specifics of the changes and how they will be affected.

For employees who stay on after the transaction, there may be adjustments as well. For example, a practice manager or administrator may have had near-autonomy in running the practice under the old structure; however, that person will have different responsibilities and/or a new reporting structure after the acquisition. Another problem which may arise is that staff at every level may be fiercely loyal to the physician(s) who previously owned the practice, potentially leading to personnel issues. Buyers will want to investigate how these changes could play out:

• How will physicians, nurses and other employees who are retained respond if other long-time employees are let go?
• How will a practice manager or administrator respond to a change in power or responsibilities?
• How will back-office employees who are retained fit into the larger organization?
• In general, how might a change in reporting structure or culture affect staff’s productivity, job satisfaction and patient service?
• What kind of financial impact will occur from a change in employee benefit packages or the necessity to pay out severance to terminated employees?

How owners will respond to becoming employees

In addition to retained staff, when a healthcare practice is acquired, the former physician owners often stay on as physician employees. It’s likely been a long time since they’ve had to answer to anyone about how they practice medicine or run their business. Therefore, buyers should be mindful of how they may help the prior owners navigate this transition.

Buyers should ask themselves questions such as:

• How might former owners respond when other employees no longer report to them?
• Will the prior owner(s) be content with solely practicing medicine and not operating a business, or will they still want to have a hand in decision-making situations?
• Once they’re no longer owners, will they remain committed and motivated to maintain certain revenue or patient volume thresholds previously achieved which were the overwhelming basis of the acquisition?

Take the example of a dentist who sold his practice to a larger organization. At first, he was happy to be able to concentrate exclusively on dentistry and his patient relationships. Over time, however, he began to resist the buyer’s implemented changes. He was required to meet sales quotas for certain new services or products to his patients, and the new vendor supplying the implants and dentures was different than what he was accustomed to. Ultimately, due to all of the changes which occurred, his productivity went down, and patients noticed his drop in enthusiasm.

Buyers should get to know the owner(s) and assess how they will respond to key changes.

A common deal term negotiated by many buyers, includes incorporating part of the purchase price as an earn-out bonus after closing based on meeting certain desired financial and operational results. The earn-out bonus provides the seller with further payments based on either how the practice performs after the acquisition, how he or she specifically performs, or a combination of both. This can help maintain productivity and motivation after an acquisition, as well as minimize certain risks and exposures of the buyer.

Legal grey areas in healthcare M&A

At certain times it may be beneficial to have a healthcare attorney review a key contract or a contract where possible risks exists. Consider this scenario: The practice you’re seeking to acquire maintains a lease agreement with a referring physician at a price per square foot that is in excess of fair market value. Based on the terms of the contract, there could be potential compliance concerns which would not be caught by an untrained eye, but could however, have serious legal ramifications. Information, such as this example, is critical to obtain prior to closing a transaction. In this or similar situations, if as a condition of completing the acquisition, the buyer requires the seller to make significant changes to current business arrangements, profits of the business could be greatly impacted.

Increasing the odds of success in a healthcare M&A deal

Buyers need to evaluate a variety of factors for any potential M&A deal. After all, across industries, many deals don’t live up to expectations. While it can be difficult to accurately predict how a merger or acquisition will ultimately play out, buyers can increase the odds of a favorable outcome by engaging an experienced transaction advisory professional to help them prepare for a healthcare M&A transaction, identify the risks and exposures outlined above, and conduct thorough buy-side due diligence.