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AHLA's Speaking of Health Law
Avoiding Common Pitfalls in Health Care Transactions
Jason Ruchaber, Founder and Managing Partner, RootPartners, and Daniel Mohan, Shareholder, Polsinelli, discuss how to avoid some of the common pitfalls they see in health care transactions and what can be done throughout the deal process to ensure a successful transaction. They cover the legal and transactional pitfalls that occur during the planning/pre-marketing phase, the marketing phase through Letter of Intent, and the formal diligence phase and closing. Sponsored by RootPartners.
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SPEAKER_01:Hi, I'm Jason Rutkaber, the founder and managing partner of Root Partners. We're a healthcare-focused transaction advisory firm serving healthcare organizations and physicians nationwide. And I'm excited for this podcast today. I'm joined by a friend and colleague, Dan Mohan from Pulse and Ellie. And we're going to be talking about how to avoid some of the common pitfalls we see in healthcare transactions, and hopefully give the listening audience some pro tips on how they might be more likely to have a successful outcome in their transaction. Dan, if you wouldn't mind, maybe give a real quick introduction of yourself and your practice, and then we can dive into our topic.
SPEAKER_02:Will do. Thanks, Jason. As Jason mentioned, my name is Dan Mohan. I'm a shareholder with a national law firm in Paul Cinelli, working out of the Atlanta office. I've been practicing law for over 35 years, and much of that time has been working in the healthcare industry, representing healthcare providers with a particular emphasis on M&A transactions, joint venture and affiliation type of transactions. So I'm happy to be here with you today and discuss this very timely and relevant topic.
SPEAKER_01:Great. Well, thanks so much for joining. I can attest having worked with Dan in real deals that he's a great advisor and provides a lot of insight into these deals. And I'm excited to talk about this topic. You know, Dan, we were both down in Austin at the Advising Providers Conference put on by HLA. And, you know, we grabbed lunch and we were talking about kind of the overall experience that we had had over maybe the last, couple of quarters where M&A activity had been really quite heavy for several years. And we started to notice in both of our practices that deals were just getting a little tougher to get across the finish line. And I think there's a lot of reasons for that, not the least of which are a new presidential administration, some of the economic headwinds that we've seen, interest rates, inflation, other things. But I think deals are just getting more scrutiny. Buyers are becoming a little bit more selective in terms of what they're targeting. And when we do get into transactions, it takes a little bit more handholding to get those deals across the finish line. And so when we were talking, that's kind of the genesis of the idea for this particular podcast is providing some ideas from our own personal experiences working with physicians and other healthcare transactions on how we can better navigate that or some ideas that people entertaining the idea of a transaction might be able to think through to avoid those common pitfalls and have a better success or a better chance at success in getting that deal across the finish line. Maybe before we dive directly into the topics of pitfalls, Dan, is there anything that broadly speaking you've seen? I assume that what I just mentioned to you is consistent with what we talked about in Austin and on other occasions, but any other developments developments from your perspective as an attorney that you've been seeing recently that have obfuscated the path to a successful deal or other challenges you're seeing?
SPEAKER_02:Well, I think consistent with what you mentioned, Jason, deals are still getting done. There's no question about that. But I think the buyers are getting a lot more discerning, perhaps, in terms of the deals that they're moving forward and taking to close. And as you mentioned, some of the business factors associated with that. And what I've found is that it's easier for a potential buyer to walk away from a deal if the transaction has a little more hair on it. Whereas in a very robust transactional environment, without some of the factors that you've mentioned, putting some down pressure on deals. When there's a lot of money and the interest rates are cheap and there's a lot of competition amongst buyers for sellers, buyers, in my experience, are a little more willing to deal with potential issues or hair on a transaction than they would be in this environment. And so that's kind of what I'm seeing where deals don't close. It's where it's due to... legal or financial issues that come up, business issues in connection with the potential seller, that kind of made it easier for a buyer to walk away, whereas as we said, there's still deals getting done. But those are the sellers that are pretty pristine in terms of any legal issues that they may bring to the table in a sale transaction and certainly are much stronger financially in terms of their business operations.
SPEAKER_01:Yeah, yeah. I mean, we're seeing the same things. And I think, and we'll break this down into kind of some different phases of the transaction. But one of the other things that I've seen is there's, Fewer unsolicited deals, I would say. Those still exist, right? But dollars chasing deals, as opposed to the efforts on our part as a sell-side banker, really trying to market a deal and get in front of people so they can take a good look at it and evaluate it from their investment thesis and investment criteria. Those unsolicited deals are fewer in my experience. And I do think that changes the dynamic of how physicians or other healthcare organizations engage with buyers. Because those unsolicited deals, you've got a targeted transaction. Obviously, they're coming in with some idea of what they want to do. And maybe it's a little bit easier to get those across the finish line when there's a proactive buyer in the space, as opposed to the marketing efforts that we're undertaking now to present the valuation model and proposition and investment thesis to prospective buyers. Do you see that as well in your practice?
SPEAKER_02:Yeah, I would certainly agree with that. And I think that's kind of consistent with what we've talked about. I think the unsolicited buyers were something several years ago when we were managing and closing a pretty large volume of transactions, particularly in the physician group space. It's really much more prevalent than it is now. And I think, again, I just think that's part of the theme of buyers being a lot more careful and discerning in groups that they're targeting for acquisition. And that's probably, you know, part and parcel with the nature of the kind of the change that we've seen in the identity of the buyers. Right. I think that's kind of consistent with private equity backed MSOs kind of taking the lead in terms of certainly in the physician group acquisition space. We're still doing some hospital deals, but the volume isn't nearly what it was several years ago. And private equity has definitely taken the lead. But they've got, you know, they're very, very careful about the financial and the legal due diligence that they do. And we said in this market, they're even more careful and less willing to take on risk. Sure.
SPEAKER_01:Yeah, but, you know, and that is certainly my experience, but there is still plenty of dry powder out there. There are still private equity backed platforms that are actively pursuing deals and making unsolicited bids on things. So we don't want to be all doom and gloom here. There's still plenty of opportunity in the space, but certainly I think. preparing for a deal is more important than ever. And that's probably a good segue into our topic for today, which is avoiding some of those pitfalls and thinking about some of the things that you can do throughout the deal process to make sure that you're putting the best foot forward, that you're prepared for the process, and you're prepared for kind of the expectations buyers are going to have and getting those things in order before you start that process. So I think the best way, at least in my mind, to think about this, and obviously I'll be speaking to this topic from the perspective of investment banker and evaluation services advisor, and you'll be providing your legal lens to that conversation. I think there's some overlap there in terms of how those terms work together. But when I think about a deal, um broadly speaking i think of it in kind of three phases the first being kind of the the planning or pre-marketing phase getting ready to take a practice to market and all the efforts that are associated with that then you have the marketing phase through loi that's getting interested buyers uh familiar with the deal understanding various bids and then hopefully moving towards the formal diligence phase and working towards close in that final and third phase of the business uh transaction now in in As it relates to the legal and economic piece, I think oftentimes our roles are on opposite ends of that spectrum in terms of our heavy lifts, where we spend more time on the upfront phase, getting parties ready for a deal, going through all the economic and financial diligence, preparing the information memorandum and taking it to market. And then once we get into the LOI phase, we tend to see much heavier involvement from legal advisors as you negotiate deal terms and go through all of the litany of documents that need to be repaired there. But I think, frankly, there's opportunities for folks to engage with both their financial advisor and their legal advisor at all phases of the diligence and sale process. And I'd like to work through some of the things that we've seen and discuss those pro tips, like I said earlier, to navigating a process and putting your best foot forward. So, Dan, I'll start by giving it over to you. I mentioned, broadly speaking, that our involvement tends to be more heavily weighted towards the front end of the deal where, in my experience, the attorney's involvement is more heavily weighted towards the back end of the deal. But I think that might be a mistake for buyers. And I'd like to get your thoughts in terms of your involvement and what you might do if afforded the opportunity to help get a practice ready for a deal from a legal perspective to make sure that they're really ready for game time, if you will. Do you have any thoughts on that?
SPEAKER_02:Yeah, I do. I assumed you did. You know, I think the, we counsel, well, let me back up for a second. When deals go awry, they will typically, go awry due to some significant legal issue that the buyer discovers during the course of buyer's due diligence. Less frequently, there can be some sort of corporate legal issue. And so You know, what we try to convince clients that are setting out on a potential sale transaction to do is to allow us to do some limited seller due diligence prior to embarking on the sale process. And it's not, you know, the full scale diligence that a buyer would do, but it's a scaled back process. focused on just trying to identify significant legal issues that could prove to be a hang up during the sale transaction. And we try to do that because, you know, in our experience, it's always better for us to find out about these and to fix them, if they're fixable, before you get, you know, 75% down the road on a sale transaction. You've spent all that time, energy, and money invested in a transaction, and then you hit a potential roadblock well into the deal. Worst case scenario, that could scuttle the deal. Best case scenario, it's going to affect your valuation, how much the buyer is willing to pay, and it's going to affect things like indemnification. So So we routinely counsel clients to allow us to do that sort of high level legal and corporate diligence. And again, hopefully it comes back clean and we're off and running. But if it doesn't, we identify some things and it gives us a chance to fix them before we get into a sale transaction. The worst situation to be in as a seller in this sort of situation is for, the buyer's attorneys through their diligence to bring these significant legal issues to your attention. That's just, you just don't want to be in that position.
SPEAKER_01:Yeah. I mean, I couldn't agree more. It's so important that particularly unsolicited bids, obviously you kind of get rushed into a deal. Sometimes you don't have the runway that you might otherwise. But if you're an organization thinking about doing a transaction, getting some foundation built that will help you navigate that process is extremely important. And we always recommend that there's some preliminary legal diligence done in any transaction to make sure there aren't any skeletons in the closet, anything that needs to be addressed beforehand, because you're absolutely right. Best case scenario, it impacts valuation. And obviously, sellers are trying to get the highest value for, for in that sale event, which may be a one, one time deal or once in a lifetime type deal. So you want to maximize your value, but worst case scenario, you find something that derails the deal altogether and you start over, you have to delay entering into some sort of a sale process for a period of time. And again, that could result in market timing that's suboptimal as well. So, you know, we, we, obviously do the same thing, right? When we're given the opportunity and we don't always have a long runway, but I think the number one thing that you can do in addition to having your legal house in order is getting your financial house in order, right? You need to kind of know what your business is doing economically and develop some of that business acumen, not only so that it can be conveyed to a potential buyer, right? You want to have some thoughts around what your future looks like, what your value proposition is, but some of the blocking and tackling is really important too, right? I mean, I see particularly in the lower middle market where maybe you don't have the level of sophistication in terms of administrative oversight, tools that might be helpful to generating reports. Many of these practices just don't have the ability to report thoroughly on their financials, right? They may have multiple different systems that have been used over a period of time. So they're trying to amalgamate, you know, a change over in software. They may, this is particularly challenging with EHR changes, right? If you switch EHR billing services providers and getting some of that data out of your system, when you have multiple systems in your recent history, really, really, really tough. And I want to emphasize to everybody listening, preparing a data room and getting your financial diligence ready to go to market is a really big lift. It's no easy task, even with professional advisors assisting you. I think that's one of the things that might take sellers back a little bit is they just don't realize how much information needs to be provided. And not only once it's provided, but Oftentimes we need to go through a process of scrubbing that, understanding things that are non-recurring, being able to develop explanations and normalization adjustments to those items. And certainly if it's really messy, we want to bring in, in an ideal world, a CPA to do, at a minimum, reviewed financials, ideally an audit if the transaction size justifies the expense. As a valuation service provider, we think doing a preliminary evaluation is really important as well to make sure you have expectations around value proposition and valuation done. And again, there's going to be a lot of legal documents that are going to need to be prepared and populated in that data room eventually. So going through that process early on and getting as much of that done as possible is really critical. in my perspective in getting a deal done.
SPEAKER_02:That's just kind of part and parcel of trying to maximize your opportunity for a smooth and efficient transaction going
SPEAKER_01:on. Yeah, absolutely.
SPEAKER_02:Let me ask you a quick question on the valuations. We routinely encourage our clients, physician clients in particular, to obviously engage clients valuation and investment bank financial advisors to help them through the process. One issue that always comes up on the financial side is whether they should go ahead and commission a fair market value appraisal of their practice. And we often, we will routinely recommend that. A lot of our clients are reluctant to spend the money, but in my mind, it's kind of like we've talked about on the legal side. I kind of, I, view this as putting yourself to be in a position to go on offense, or are you gonna play defense? And on the financial side, my clients oftentimes come back with me with, well, the buyer's gonna provide us with their appraisal, fair market value appraisal, and why don't we just react to that? And my response is always, I would prefer not to react to something that somebody else has prepared representing the buyer. I'd rather us know going in what we think your practice is worth based on a good solid fair market value appraisal and kind of take the offense in that piece of it as well.
SPEAKER_01:Yeah. I mean, I think the broader point of setting realistic expectations, not only in terms of valuation, but other elements of the deal as well, you know, duration to close, those sorts of things. Getting proper expectations is super important to having a successful deal. We always do valuation work when we're getting a client ready for a transaction to help set those expectations. And it is important to note that a buyer is going to do their own financial due diligence, right? And they may come up with a different valuation for that business. But some of that may be due to the deal terms or how they're going to structure compensation or other elements of the transaction. But starting from a solid foundation of knowing your starting point, right? That's really helpful to sellers knowing what their valuation is. And you know, it's not uncommon for physicians who have heard that, you know, doctor XYZ down the road sold the practice for, you know, millions of dollars. They don't understand any of the deal terms. They don't understand the compensation model, the buyer type. And so expectations that are unrealistic can lead to a poorly executed deal. And in many cases result to, you know, acrimony in the process because the doctors just don't understand why the valuation is coming in so low from the other side or why their value isn't isn't higher. So getting that valuation done is really important. I will also say it doesn't need to be kind of a formal valuation that we might do for, you know, like a hospital buyer. They're going to want to have their own compliance-focused valuation to meet the fair market value standard. And that's going to be commissioned whether we do a valuation or not. They're going to hire somebody to do that work. But I do think having some of the valuation done early on with the correct fair market value standard, somebody who's familiar with how valuation should be done in a healthcare space, sets a proper baseline for understanding where the other side comes in. And Yeah, I think doing the valuation is super important. It doesn't have to be a super costly thing. process but it will highlight other issues right other issues that come up in the diligence for evaluation are going to be similar to the diligence items that will come up in formal diligence in terms of run rate analysis normalizing earnings looking at balance sheet items all those sorts of things that a buyer is going to want to see the valuation firm is going to want to see as well and so getting ready for that and going through that process really puts uh the best foot forward in my opinion yeah yeah You know, I mentioned a hospital buyer versus PE buyer. And maybe there's a third buyer group for a lot of these organizations, which is other physician practices. In some cases, we're not already PE backed. From an economic standpoint, there's a lot of differences in terms of how to navigate a process with those different types of buyers. From a legal standpoint, do you see any significant differences in how you approach transactions with those different buyer groups as you're preparing a client for a deal? I mean, again, we can get into the formal diligence phase in a little bit, but do you see any major differences there from a legal perspective on what a client should expect?
SPEAKER_02:Well, yeah, absolutely. I mean, they're just fundamentally different transactions, right? You know, there is some... There's more scrutiny, obviously, on the PE deals now, particularly from a healthcare regulatory standpoint. But historically, because the private equity buyer is not an entity that the physicians would refer patients to post-closing, they're not bound by a lot of the regulatory constraints that a hospital buyer is bound by. So you're likely to, the valuation is different what we see typically on a hospital buy side is just basically an asset value. There's an inverse relationship, right, between the compensation and the amount that a hospital can pay for a physician group. So physicians are either going to have to accept a higher purchase price, but much lower compensation arrangement going forward, forward after sale or accept a lower purchase price, usually just based on some asset value of their business, but that will allow them to participate on a full compensation plan going forward. So they're just very, and of course the consideration is different on the private equity side, consideration often includes rollover equity. The numbers are just bigger, but you know, to the extent that their purchase price is tied up in some percentage of rollover equity, then there's certainly risk associated with that because, you know, you've got risk as to whether that equity is going to grow in value over time and how long and the strings that are attached to you being able to exercise any sort of sale rights or otherwise realize some cash on that equity in the future.
SPEAKER_01:Yeah. And I don't think that a lot of physician sellers fully understand the differences in those models. Right. And that goes back to my point about, you know, hearing that the doctor down the street got some sort of, you know, liquidity event for their practice and the expectation being that. all sales are going to be homogenous in terms of how the deal economics and purchase price works. But that is certainly not the case, right? And you made a point that is just so critical, particularly in physician practice deals, which is the post-acquisition compensation model for a hospital buyer and a private equity buyer is vastly different, right? And so helping doctors understand how those different models work and working through the economics there in terms of the compensation, private equity office, oftentimes with a scrape or a reduction in compensation to justify the purchasable earnings. But those are very different, right? And I think that maybe leads to one of my next and perhaps last points that I think is really important in the pre-sale phase or leading up to the marketing phase. And that is working with the doctors to get goal alignment and understanding what your target buyer is, right? Because that can mean a lot of different things for different physicians, right? In my experience, doctors that are obviously nearing retirement or further on in their career they prefer the liquidity event, right? They would want the scrape of the income and the big cash infusion or cash payout at the front end. Whereas younger doctors may be more concerned about the long-term earnings of the business, that rollover equity piece, how that's gonna grow over time. And those differences in expectations can lead to internal strife regarding the pursuit of the ideal buyer. And that's just around economics, right? And then you also have the concern around culture, right? A hospital buyer is gonna have a very different culture than a PE-backed buyer. And so working through some of those internal differences of expectations regarding your targeted buyer, the optimal work culture, the compensation model, all of those things need to be worked out early on in the process because you get into a full negotiation and you have individuals within your group that don't agree on what they want to accomplish, it can really put a lot of strain on the deal. And I've experienced firsthand where deals have fallen apart because of this exact reason.
SPEAKER_02:Yeah, no, I couldn't agree more. I had a deal fall apart. a year and a half or so ago on that very issue. Fortunately, you know, for our client, the doctor group, it was, it's something that they identified relatively early on. And so they didn't get too far, you know, they didn't even get to an LOI stage in that deal before
SPEAKER_03:the
SPEAKER_02:doctors sat around a table and kind of talked it out and realized that the younger partners just were not interested in selling out to a private equity backed group. But, you know, that's, In my mind, that's relatively rare for it to happen that early. And that was an unsolicited buyer. So they had not engaged somebody like yourself who kind of went through the pre-deal process of getting everybody around the table and talking through those issues. I have had deals fall apart well into the deal, but long past the LOI stage when we're negotiating transaction documents before the doctors finally got sat around a table and had that discussion. So again, it's far better to make sure everybody's long-term goals are aligned and everybody's on board with the sale process before they get deeply into the process itself.
SPEAKER_01:Yeah. And you know, again, the unsolicited deals are a little bit of a shotgun through the deal process. But even, you know, a planned sale, sometimes those can feel rushed as well. And I would encourage anybody thinking about a deal to think about it as early as possible, to start working on some of these things that we've talked about early on, maybe even two and three years sometimes. If you know that you're going to have a series of retirements or you are planning for some sort of an exit or you see some market dynamics that might suggest it is wise to consider affiliation or acquisition, merger, starting to plan for that well in advance, I think is really good advice and something that we don't see very often, but that could really avoid falling into some of these traps that we've talked about during the foundational planning phase and make sure that, again, you've got your accounting house in order, you've got any regulatory issues well in the past before you get to the deal, you've got goal alignment around the physician partner group and you understand kind of who you're looking to target as a buyer and how you'd like that deal to play out. So I would encourage anybody listening, work early. Early is definitely better, even if it is a scaled back superficial process.
SPEAKER_02:Yeah, I would certainly agree.
SPEAKER_01:All right. Well, once we get through all that and we go into the marketing phase, Obviously, at that point in time, you are moving forward with the deal process. We get most heavily involved in marketing the business at that point in time and trying to find buyers. And this is a hard period of time, I think, for a lot of physicians because it's the It's the waiting. It's the time where you have to kind of trust the process and rely on your advisors to bring in potential buyers and help you understand the terms. And again, we have a lot of involvement in that phase. And I'll talk about a couple of the things that we'd like to see and help our clients avoid. Before I dive into that, do you get involved much in that process, Dan, or are there any things that you would recommend to providers as they enter that marketing phase?
SPEAKER_02:No, we're involved very little in that. Hopefully, again, we've had a chance to do some presale diligence and kind of look at the corporate documents, make sure all the corporate hygiene is clean and fixed any issues there. But, you know, once... Once we're into the marketing phase, that's really very light in terms of the legal services that are required until we get to LOI. We'll discuss the legal piece of that once we get to the LOI stage.
SPEAKER_01:Well, I definitely want to make sure we have time for that because I know there's a lot there that you'll want to talk about. I think from my perspective in the marketing phase, maybe the biggest pitfall to avoid for anyone listening is Inserting yourself into that marketing process. As a seller, it's really, really hard not to want to be involved. It's your baby, it's your business, it's your life, it's the culmination of your years of experience, and you really want to be involved in that process. But it can really be detrimental to a deal because you don't necessarily know what information you should be disclosing at that point. Again, anything that you say can and will be used against you in this deal, particularly if you disclose information that is perhaps not conveyed in an appropriate way. It may dissuade buyers or lessen their interest in your business. And it certainly can undermine the sales process The interest we're trying to generate for the deal, trying to solicit and create some competition, if you will, for the deal. If you're having sidebars as an owner because you know one of the potential buyers or you've had a relationship in the past, it can really undermine the process and frankly will likely result in less money on the table at the end of the day. I guess without spending too much time on the marketing phase, that's the big pitfall that I see in my practice is let us do our job. We're there to represent you. It's in both of our interests that we find you the right buyer and optimize your purchase economics, both in terms of comp and purchase consideration. So leaning on us a little bit to make sure that we navigate that for you is really, really important. And I know it's hard, but if you can stomach holding back some of those words, I think it can really help you in the long-term getting to the deal phase and formal diligence. All right, well, let's talk about once that LOI comes in and you've moved to formal diligence, again, hopefully a lot of our work in terms of putting the value proposition, understanding the deal economics, getting the financial house in order has already been done, or materially done. We still have work to do. But I think this is really when, Dan, you and your team steps in and provides just an enormous amount of value to the transaction. What are some of the pitfalls that you'd like to talk about that can derail a deal in this final, most important phase of the transaction?
SPEAKER_02:Well, I think the first thing to mention is getting to the LOI stage. You know, you're correct. You've been through your marketing process. Let's assume that you've run a process, identified a potential buyer who's won the beauty contest. And so now we've got the stage where we're negotiating the LOI. Frankly, obviously, from our standpoint as lawyers, we would like to be heavily involved and need to be heavily involved in negotiation of the LOI. Unfortunately, that doesn't always happen. And I think the message there for... or clients who are in a sale position is that they sort of view it as a non-binding letter of intent, which it is, but what they don't oftentimes understand is that the terms, the major deal terms that are ultimately reflected in that LOI are terms on which the transaction documents will be based. And so it's not a situation where it's a non-binding letter of intent and the seller is going to be in a position to effectively renegotiate a lot of those terms. Because from the buyer's standpoint, the reason they're spending the time negotiating the letter of intent, albeit non-binding, is to reflect the major terms of the transaction, which again will be reflected in more detail in the transaction documents. So please get your attorneys involved to help negotiate the letter of intent.
SPEAKER_01:Yeah, absolutely. I certainly agree with that. And I think for sellers that don't often deal with sale transactions and particularly legal documents and terminology, it can be a foreign land for them to navigate. And having a well-versed legal advisor to help them navigate those docs, super, super important. What are some of the other things that you would advise clients during this phase? I mean, clearly you're going through transaction structure, consideration, indemnities, escrow, all sorts of terms. What are a couple of other big pitfalls that you would highlight for doctors looking to do deals in this phase of the process from a legal perspective?
SPEAKER_02:Well, this kind of, from a legal perspective, I think transaction structure is a big issue. And this is something where legal and the financial advisory consulting industry overlap. You know, there's certainly tax, obviously tax issues associated with any sort of a sale transaction. So what we're trying to do is structure the transaction in a way to minimize the tax consequences to our client. But the transaction structure oftentimes will be driven as much by the identity of the buyer as it is by the by the tax consequences of the transaction. And so there can be tax-free type of reorganization that we can do, but it's just a matter of sitting down and kind of identifying more tax-efficient ways to structure a transaction and the buyer's willingness to help facilitate that through a transaction structure. And one other issue that oftentimes comes up, which, again, you'd like to identify as early on as possible, but candidly, typically would not come up until you're well into a process, is how any consideration is going to be split or distributed amongst the partners and partners. That can be particularly acute if a physician group has ancillary services such as surgery centers that are involved in the deal. Oftentimes, some of the older docs who have been around and the founding physicians may have an opinion that they built this and spent a lot of time building the enterprise, and maybe they should be entitled to a larger split of the compensation or the consideration. than the younger ones. And so that's certainly an issue that could derail a transaction well into the process.
SPEAKER_01:Yeah, we've seen that a couple of times. I mean, I think the most acute example of that is when you have a large group that's on a productivity-based comp model and they're all taking compensation that eliminates any costs remaining profit during the normal course of business, but you have really high producers and you have doctors that are further down the productivity list. And maybe they all have equal ownerships, ownership percentages in the business, right? But if you're doing a private equity deal and you're taking a 20% haircut and that's the purchasable income, right? Well, those top producers are like, well, wait a minute, I'm taking a bigger haircut in my comp than you are just from an absolute dollar amount. And oftentimes that translates into different dollars going to those top producers and the upfront purchase price than the others, even though their equity values may be similar and that can be difficult to navigate. And oftentimes I don't think physicians understand those mechanics and, um, uh, can get bunched up on that. And certainly you don't want, you know, any sort of, uh, you know, minority shareholder suits for people who disagree with the deal once that happens. Although I have seen those, um, but, um, Yeah, that's a tricky one to navigate and certainly something you want to address well in advance.
SPEAKER_02:Yeah, and to your point, I certainly see that a lot on a surgery center side, right? The fact that there are big producers and if it's structured properly, they're getting their distributions right. pro rata in accordance with their ownership percentages. But if you've got a big sale liquidation of that, then some of those big producers may have an expectation that they should receive a greater share of the earnings. And, you know, you could possibly work that out from a legal standpoint, but culturally that's, that's could be a heavy lift depending on the dynamics of that group.
SPEAKER_01:Yeah. And I, you know, hopefully it's not lost on the listening audience here, but the, the factors that pertain to professional earnings, practices versus ancillary technical businesses like surgery centers, right? They're going to be somewhat different in terms of how those economics work and that issue between value proposition, equity, productivity. They might be different in an ancillary setting than in the professional setting. And again, when it's professional practice and your group owns it and you're sharing in distributions and profits and the group practice model, it may ultimately be be different in the transaction and, and working through that early on to make sure everybody is aware of, of that and aligned around how those economics are going to work is critical to getting a deal done. Yeah.
SPEAKER_02:Yeah. And then I think we touched on this earlier, but the biggest issues that would typically come up in this, at this stage would be regulatory issues that we haven't had a chance to identify pre-sale that the bar, the buyers have. has identified during their due diligence. Um, you know, that's anything from any kickback statute issues, Stark. I mean, Stark is the true, um, statute that is, that is a trap for the unwary. I mean, we had a deal recently that didn't fall apart on this particular issue, but just in the diligence, the, the buyer's council identified the fact that the the selling physician group had not been providing a notice of alternative providers in connection with a provision of diagnostic imaging services to its patients, which is a violation of an applicable Stark statute. And that, under Stark, arguably all of the income from the designated health services associated with that imaging service line should have been returned. repaid. And then there's also, you know, fines and penalties associated with that. So there's a way to remedy that issue. And we had negotiated with buyers council to file a self-disclosure on that issue. But again, that's something that you would prefer not to have because it's something that could have a material significant financial impact. In that case, it didn't blow the deal, but we were going to have to file a, agreed to file a self-disclosure, but our group wasn't going to control that self-disclosure. The buyer was going to control that self-disclosure, including the settlement of that self-disclosure. And then, of course, there were special indemnities and offsets against purchase price with respect to ultimately any payment that was made to the government. So those are the sorts of issues, again, you just would prefer not for them to come up and be brought to your attention by buyer and buyer's counsel.
SPEAKER_01:Yep, absolutely. Well, obviously there's a lot of stuff that comes up during this phase. There's a lot of minutia that needs to be negotiated, documented, formalized, and that can be tough. I think from our vantage point, one of the pitfalls we'd like to see sellers avoid is spending dollars chasing dimes. And what I mean by that is you just can't negotiate every single economic or deal point to 100% in your favor, right? You need to be willing to compromise on a few things, work towards the economic outcome that is great on the whole. And more often, and again, different personalities on different physicians in terms of what's important to them. And sometimes something that's really important doesn't really have a whole lot of economic impact, but you get hung up on those things. And it just leads to deal fatigue. And I've seen deals fall apart over just exhaustion over, you know, relitigating or renegotiating minor deal points, you want to get the big ones, right. But I think having a willingness to compromise on things that are less important to the deal economics or the overall partnership model that you have going forward. I think that's something that sellers need to keep in mind as well. And I know that you can certainly help them navigate that as their attorney. And I would certainly recommend that they be mindful of that as they negotiate the economic pieces as well.
SPEAKER_02:Yeah, no question. Deal fatigue is a real thing.
SPEAKER_01:Yeah, it is. Particularly in some of these trickier deals that are getting heavy scrutiny, right? You're 12 months into a process that you somehow expected to be wrapped up in three months, people started getting a little bit, a little bit exhausted for multiple reasons. But then any, we're getting kind of close to our time here. Any final thoughts that you have on this last phase or, or even broadly that you would say to the listening audience in terms of pitfalls to avoid?
SPEAKER_02:Well, I think again, again, We talked about the interaction of all these various pieces of a transaction kind of fitting seamlessly together. You know, one thing that oftentimes comes up is issues with the doctors. You're so focused on the transaction and the deal terms. There's less focus oftentimes on sort of the terms of their employment going forward, post-closing. And You know, as you'd mentioned, I think earlier, Jason, on the PE side, the private equity group is going to demand that the physician group take a scrape on the post-closing compensation. Their compensation will be lower than what they're historically used to, and that's the way the PE group makes sense. Yeah. It's often, I think, too important, and this is more in your bailiwick, but it's important once you get to where you're some pretty solid numbers to model out the consideration and model out what post-closing compensation might look like so the docs get a big picture on the whole financial package. Because I think a lot of times you'll get a purchase price that's a It seems to be a pretty big, acceptable number. But by the time you break it down into components of cash consideration versus rollover equity, and then you make some allowances for whatever tax impact that deal is going to have, the net number might not be what the doctors were expecting. And so you need to kind of manage those expectations and that information as well.
SPEAKER_01:Yeah, I mean, we see that as one of our primary jobs in this phase is helping to understand the, you know, interpret how this ultimately impacts total consideration in these different buckets on an after-tax basis so they can fully understand, you know, where the trade-offs are and what is in their best interest. Because if they get too laser-focused on a single number, they may miss some of the important component parts downstream. And so we'll model out all those scenarios and help the physician understand that, make sure they're well-versed on how those different components play together. But that is a great, great point.
SPEAKER_02:And I think the last point kind of to that is on the private equity side of things, well, the hospital groups, any buyer will require generally a five-year commitment on the employment with some pretty significant non-compete and other restrictive covenants. On the private equity side, the doctors will need to understand that if that employment terminates for some reason other than very specific and narrowly crafted termination rights, under most circumstances, if that agreements terminates before the end of five years, there's gonna be some clawback of consideration. And it may just be, they lose all of the, or some significant proportion of the rollover equity, But, you know, if the buyer is very aggressive, they may want to pull back some of the cash that was distributed as well. So, again, it's just part of the doctors being fully informed of all the ramifications of what their post-closing commitment will be to the buyer.
SPEAKER_01:Yeah, I think the issue of that duration of time is particularly important if you do have docs in the group that are looking towards a– A complete exit, right? When you're ready to hang up your coat, that's not the time to do a deal. And it can certainly change the deal economics and change the perspectives on the transaction. So hopefully you've gone through a process early on, as we talked about, to understand the deal economics and partner goal alignment and expected outcomes early on so that everybody understands how that will play out, because it can certainly derail a deal if you wait until this phase of the process. to work through some of those items.
SPEAKER_03:Yeah.
SPEAKER_01:Awesome. Well, Dan, thank you so much. This has been a great conversation. Thank you to everyone who's tuned in to listen to this podcast. Really enjoyed it and I hope you found it useful as well. Thank you to AHLA for giving us this opportunity to talk about some common pitfalls that we see in healthcare transactions. Thank you so much.
SPEAKER_02:Thanks, Jason. Take care.
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