Maximizing Endoscopy ASC Value and Sales Price
This article is written by John Poisson, EVP of strategic partnerships for Physicians Endoscopy.
Roughly one-half of the GI centers considering selling a part of their EASC don’t actually close on a transaction. With the increased awareness among the GI community that now might be the right time to consider diversifying your financial portfolio, while at the same time bringing another level of professional management to your facility, there are several important actions you can take to increase your chances of completing a transaction with the right partner under the right terms. At Physicians Endoscopy (PE), we have identified six key areas that almost always lead to challenges when attempting to sell part of your EASC. By properly addressing these upfront, prior to starting the sales process, you not only maximize the chances of completing a transaction, but generally will maximize the sale price within the type of structural model you desire. These six key areas are:
1. Legal structure of the EASC: Are you organized legally to allow nonphysician ownership?
2. Pre-sale preparation: Are your seller goals and objectives clearly defined?
3. Selecting the right potential buyers: shotgun versus rifle approach?
4. Buyer interviews and presentations: What roles do the buyer and seller play during the interview meetings?
5. Selecting the "finalist" potential buyer: Which organization best matches your defined goals and objectives?
6. Closing the transaction: What is expected and how long should this take?
LEGAL STRUCTURE OF THE EASC:
The most basic pre-sale action to accomplish is to ensure that the current legal structure of your EASC is acceptable to a non-physician buyer. Whether you lean towards a sale to a management company, a hospital or a combination of the two, each of these buyers are limited in the types of legal structures in which they can participate. If your EASC is setup as an S-corp or PLLC, both of which prohibit non-physician ownership, then a potentially costly and time consuming conversion process must be undertaken prior to a sale to a non-physician buyer. These conversions are possible, but not without legal, tax and cash flow impacts resulting from the conversion process.
Case study: In 2011, PE reviewed a mid-Atlantic EASC with nearly 10 GI owners that performed more than 7,000 procedures annually with a great payor mix. However, the center was set-up as an S-corp. After significant expenditures toward legal and accounting consults, the end result was a conversion that would take 9 to 12 months with tax liabilities of >$100,000 to the owners. In addition, nearly all the third-party payors would require new contracts to be negotiated under the new Limited Liability Company structure after new state licensure was obtained, a requirement due to the conversion. Accordingly, all these factors lead to short-term decreased cash flow. Fourteen months later, this center still has not completed the conversion and a sale has not occurred.
Even if your EASC has an acceptable legal structure, the most common being an LLC, but there is no clear distinction between your practice and the center, this can also be problematic. Many times we’ve encountered potential sellers that have so integrated staffing, expenses and other financial considerations between the practice and center that it is very difficult to gain a clear understanding of how the center’s financial performance would present if separated fully from the practice as a freestanding entity. A buyer will generally desire a conservative view of the true cost accounting resulting from the separation analysis, so it is important that you, as the seller, have done this analysis yourself to ensure you are being offered a fair value in terms of pricing.
This is a critical step within the sales process. Proper planning will demonstrate to the buyer pool that you are serious about selling and not just tire-kicking. The most important action for the ownership group to undertake is deciding their collective goals and objectives pertaining to the sale of your center. Some common questions to answer within your ownership group are:
• Is maximizing sales proceeds the single most important element of the sale?
• Is there a desire to continue the hard work of growing and developing your facility; and will a partner be positioned to assist with these activities, and do they have a track record of doing so in similar historical transactions?
• Is there a desire now or possibly in the future to form an equity relationship with the local hospital or healthcare system?
• Are all physicians planning to actively practice for a minimum of five more years? If not, then what is the succession plan for new recruits?
All buyers want the same thing: to minimize their effective sale multiple over the course of the transaction. This nearly always requires a center to continue growing and to add new physicians not only to replace retiring doctors, but to add net new incremental providers during the first two to four years of the relationship.
Case study: Recently, PE reviewed a west coast EASC performing over 8,000 annual procedures with seven active GI physicians. The challenge was that three of the physicians, and possibly a fourth, would retire within three to five years. With no real succession plan in place, a buyer would to be required to recruit three to four new GI physicians just to maintain status quo. Eventually, all bidders dropped out of consideration in this transaction
A second important planning step in this pre-sale stage is to develop a launch package. All potential buyers will desire a review of certain common documents such as financial statements, tax returns and legal agreements (such as the center’s operating agreement, management agreement, medical director agreement, anesthesia service agreement, lease, financing note and possibly employment agreements). Each of these should be prepared and assembled for release after executing a non-disclosure agreement with the buyer to ensure confidentiality.
As important as these base agreements can be, of even more interest from the buyer pool is your outlook towards future growth of the facility. For instance, have new physicians joined the professional practice(s) and is there a pathway for their equity ownership in the EASC?
Are other GIs in the area available to recruit to the facility? Can new payer plans be brought into the center? Are there other ancillary service revenue lines that can be integrated into the facility operations to improve operational performance?
A "yes" to one or more of these questions helps provide the buyer with confidence that the center has continued growth potential and this in turn can help you maximize your purchase price.
Lastly, as part of the pre-sale preparation, we recommend scheduling interviews with prospective buyers that allow for two to three hours to be spent with each candidate organization. Stacking three of four buyers back to back for 45 minutes each on a single night won’t provide you with enough time to gain a perspective of each buyer’s strengths and weaknesses and, more importantly, its organizational culture.
Plan for a meeting in a quiet place accompanied by light snacks and nonalcoholic beverages for the attendees. A great way to start the meeting is an around the room 30-second introduction by each participant.
Case study: PE met with an East Coast EASC with 10+ physician owners performing nearly 10,000 annual procedures. In this case, we first met with the center’s board of managers initially and answered a variety of questions and gained a good appreciation of the GI owners' goals and objectives for the sale. At a later point, we met with the full membership of the facility and were impressed that each physician was actively engaged in the conversations that lasted more than three hours. We expect to close on this transaction before the end of 2012.
SELECTING POTENTIAL BUYERS:
There are a variety of buyers in the industry and each has its own preferred model(s) — some are flexible in their approach and others are rigid and must seek sale transactions that limit the flexibility a buyer might seek. There are two common categories of buyers available in today’s market: management companies and hospital institutions.
Management companies can be broken down into two basic categories as well: those that seek a 51 percent controlling equity interest purchase; and those that seek a minority equity position in the EASC.
Some common elements of the 51 percent model are:
• Multiples generally in the 5.5x to 7.5x range
• Not willing to dilute below 51 percent to accommodate new physicians recruited
• Possibly seeks board control — or at a minimum a 50/50 split
• This model always positions the EASC as a competitor to the hospital in that there is no equity available to sell to the hospital in the future if needed.
In the minority equity model there are some common elements, such as:
• Multiples generally in the 4x to 5.5x range
• Equity levels usually in the 20 to 40 percent range
• Physicians always maintain board control
• Equity dilution to accommodate new physicians may be considered
• The hospital may also be part of the equity ownership in this model
Another type of buyer is the hospital or healthcare system. As is true with the management companies, different hospitals seek different types of arrangements — some are rigid at the 51 percent equity level, others will consider a minority position.
One element that is common among hospitals and many management companies is the requirement for a services contract (also sometimes referred to as a management agreement) to be executed between the buyer and seller as part of the sale. It is important to understand the deliverables of any such contract and how this new added expense may be offset with current costs the center will avoid when the services are replaced.
Some other important considerations when selecting a potential buyer are:
• Governance: Will the physicians maintain board control?
• Hospital relationship: Will the center forever be locked into being a direct competitor with the hospital? If so, do you really want to sell a non-dilutable 51 percent equity position to a management company?
• References: Does the buyer have solid references across its acquisition base? If the potential sale includes both a management company and hospital, do/does the buyer(s) have proven track records of joint venture experiences between hospitals, physicians and management companies?
• Number of buyers to interview: Do you want to see a variety of buyers or do you prefer to focus on those that can institute a model you prefer? Is a single-specialty buyer a better fit than a multi-specialty buyer when it comes to an EASC?
We think so, as the single-specialty buyers generally have some depth of focused resources and may utilize performance metrics and specialty benchmarking as part of their ownership model. When it comes to interviewing more than one hospital, beware, it is a small community out there and word spreads easily — even if you are under a non-disclosure agreement. We recommend selecting one hospital to interview first and work the process to either completion or move on to another institution. Pitting one hospital against another might sound good on paper, but in practice this usually results in a negative outcome.
Demonstrating a unified physician group (or coalition) to buyers will assist in driving the best possible positioning of your EASC. It is important that sellers know their roles and what is expected of them when meeting with prospective buyer groups. As a first order of business, we recommend that all physician owners attend meetings with prospective buyer organizations. Minimal attendance by physicians at the initial meeting is a major turn-off to prospective buyers. Likewise, meetings with physicians either generally inattentive (or possibly sleeping) present poorly to the buyer pool.
We recommend deciding what questions to ask each buyer in order to provide a relative comparison across the different organizations. An interactive discussion is the most productive and it also allows the sellers to control the flow of the meeting as opposed to sitting through another "canned presentation."
By asking frequent questions throughout the course of any presentation, you gain a better appreciation of how the buyer truly views your facility and market opportunity, instead of allowing the buyer to entirely control the content and flow of the meeting. We recommend that each physician within your ownership group be charged with asking certain questions of each buyer. This provides two benefits: First, it shows the buyer that all physicians are engaged in the process, as opposed to having one to two spokespeople for the group. Second, it ensures that the physicians within your group are truly part of the selling process and not just on the sidelines watching the action.
Buyers want to hear about the center's growth and development strategies and are especially interested in learning about:
• New physician recruitment
• Procedural volume increases
• Access to new payers or patient bases
• Development of ancillary service lines
One should also discuss plans to minimize or eliminate potential downside risks that might cause concerns to a buyer. For example, if a physician will be retiring within one to two years, a buyer wants to know the succession plan to ensure procedural volume does not substantially weaken. No one wants to buy into a business that is experiencing shrinking profits. We also recommend refraining from joke answers to buyer questions. I’ve often heard the line "once I get the check I can retire." Although meant in jest, it still causes some hair on my neck to rise occasionally.
Case study: At a conference last year, a physician approached our booth about selling equity in his center. He described his center as having been profitable for many years and a good investment for a buyer. Inquiring about his reasons for the sale, he stated, "I'm going to retire next year, my hands have arthritis and I can no longer do procedures without a lot of pain." When asked how many physicians perform procedures at the center, he replied, "There used to be two of us, but now it’s just me."
Lastly, the buyer presentations should result in two clearly defined goals. First, this is your chance to interview the buyer and understands their philosophy, business model and corporate culture. Secondly, this is your opportunity to "sell" the merits and benefits of why your EASC is a great investment — which ultimately raises the likely premium a buyer would be willing to pay.
CLOSING THE TRANSACTION:
Once a potential buyer is selected by the physician owners, often a non-binding letter of intent is executed between the two parties. Typically, the document will contain a mutual standstill clause, which essentially restricts both the buyer and seller from soliciting or discussing the transaction with other competitive parties for a stated period of time. At this point the buyer usually will conduct secondary due diligence activities, which often include in-depth financial analyses, operational and clinical audits and possibly chart coding reviews. This process allows the buyer to validate its pricing structure and business terms. There are a number of common issues that could arise prior to the closing that could impact or destroy the transaction:
• Material adverse finding: Due diligence results identify a substantive error in the center’s financial records or operations. This may result in a reduction in purchase price. For example, a $200,000 reduction in EBITDA on a 7x sale reduces the purchase price by >$700,000 on a 51 percent equity sale.
• Incomplete legal documents: If the parties don’t come to mutual agreement on all legal terms, then either an adjustment to the purchase may be warranted or the buyer may choose to walk away. For example, one common problematic area may be the noncompete. A buyer that is prepared to pay handsomely for equity in the EASC will want the physicians to be restricted from developing other similar business interests within a defined geographic area for a period of time, even after they may have left your EASC.
• Adverse event: Either a severe adverse event arises during negotiations or is found upon discovery (that had not been disclosed upfront).
• Culture clash: One or both of the parties conclude the two organizational cultures just are not compatible. Assuming none of the above negative outcomes occur, the buyer and sellers usually will execute a number of documents as part of the transactional close, including:
• Amended and restated operating agreement: Most commonly the management company will desire to utilize its own form template as opposed to the operating agreement currently in place.
• Administrative services agreement: If the management company is to provide services to the E ASC then this agreement details the deliverables and fees.
• Medical director agreement: Most buyers will insist on a written services agreement for clinical leadership detailing obligation, expectation and the stipend for services.
• Membership interest purchase agreement: This document governs the terms of the equity sale and contains a variety of disclosures, representations and warranties to be agreed upon by the seller. This agreement may be the most difficult to address as disclosure schedules are often made on behalf of both the EASC as well as the individual owners of the EASC.
The final part of the transactional close is the wire instructions and the delivery of funds from the buyer to the sellers. Once this point has been reached, the long pathway of researching buyers, selecting the right partner and agreeing upon a future plan of action can now be celebrated. Best of luck to you and your center should you decide that now is the time to explore the option of selling part of your EASC!
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