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Are You Considering Selling Your Imaging Center or Practice? Or Merging With Your Healthcare System? Part 2 of 2. Richard S. Cooper, Esq. McDonald Hopkins LLC 600 Superior Avenue, E., Suite 2100 Cleveland, OH 44114 (216) 348-5438

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Are You Considering Selling Your Imaging Center or Practice? Or Merging With Your Healthcare System? Part 2 of 2

Richard S. Cooper, Esq.

McDonald Hopkins LLC

600 Superior Avenue, E., Suite 2100

Cleveland, OH 44114


Kirk A. Rebane, ASA CFAHaverford Healthcare Advisors43 Leopard Road, Suite 102Paoli, PA 19301(601)

List the steps should be taken prior to selling or merging a radiology business in order to maximize the purchase price and optimize the terms obtained in the transaction
  • Outline the key issues that will need to be addressed in connection with the sale or merger of a radiology business
  • Articulate the typical process involved in taking a transaction from start to finish, and the most important aspects, documents, and arrangements to such a transaction
Valuation fundamentals
    • Future cash flow
    • The two most common descriptors when discussing radiology and imaging practice valuations are pro forma and/or sustainable net revenue and EBITDA
Valuation fundamentals: Pro forma and/or sustainable income statement
    • Typical adjustments
      • Excess officer’s or physicians’ compensation
      • Real property lease
      • Non-recurring revenue
      • Non-recurring expenses
      • Run rate in revenue
      • Run rate in expenses
      • Which referral sources or clients are at risk?
      • Excess professional, management and billing fees
      • Other personal or discretionary expenses
Valuation fundamentals: Value-based management
    • In addition to providing assistance in selling your radiology and imaging practice, knowledge of the factors that drive value and knowledge of how to value a practice allows shareholders to practice value-based management
    • A good manager who practices value-based management seeks to:
      • Maximize sustainable value
      • Monitor performance on a fairly real-time basis
      • Understand and monitor the direct correlation between actions and value creation
      • Manage the internal factors which can be controlled
      • Anticipate the external factors which cannot be controlled
Valuation fundamentals: Three basic approaches to valuation
    • The Income Approach
      • Discounted Cash Flow Approach
    • The Market Approach
      • Public Market Comparable Approach
      • Comparable Acquisition Approach
    • The Cost Approach
  • Future cash flow
    • Value = Present value of future cash flows
    • What factors will impact future cash flows?
Factors that influence value
    • Management should understand the internal and external factors which drive value
    • Whether a tangible exercise listed on the manager’s to-do list, or whether an implied responsibility within a job description, a manager should be practicing value-based management
    • A true organizational leader should be managing a radiology practice or imaging center operation with the goal of creating value for the stakeholders, including equity value for the shareholders
    • Understanding the correlation between actions and value-delta is critical to success, and can serve to optimize the planning process
Internal factors that influence value
    • Pro forma sustainable financial performance
    • Historical growth trends
    • Growth potential: Proactive or reactive
    • Size (net revenue, EBITDA, test volume of scans, number of centers, breadth of modalities, etc.): There is a scarcity of large acquisition targets
    • Profitability and cash flow
    • Stability/reputation
    • Professional subspecialties and quality
Internal factors that influence value
    • Composition of revenue
      • Collected revenue per scan
      • Specialty vs. routine volume mix
      • Inpatient vs. outpatient vs. freestanding imaging centers
    • Sustainability and quality of revenue and EBITDA
    • Professional/technical mix
    • Billing compliance, collection rates and payor mix
    • Location and competition
    • Verifiability of financial and operating data
Internal factors that influence value
    • Customer, client and referral source relationships
    • Hospital contract terms
      • Exclusivity
      • Term and termination provisions
      • Compensation
      • Change of control
      • Call provisions
      • Quality of relationship with administration
    • Equipment age, functional utility and deferred CAPEX
    • Depth, quality and versatility of management and staff
    • Information technology
    • Corporate structure: C-corp. vs. S-corp. vs. Partnership vs. LLC
Internal factors that influence value
    • Deal structure and tradeoff between buyer post-transaction transaction value
      • Higher post-transaction expenses paid to seller (PC, medical director, management fee) which implies lower post-transaction income for buyer which implies lower transaction value
      • Lower post-transaction expenses paid to seller which implies higher post-transaction income for buyer which implies higher transaction value
    • Level of working capital or net asset value to be delivered at closing
External factors that influence value
    • State of general economy
      • Availability of patient funds for healthcare
      • Credit market for buyers
      • Government stimulus plan
    • Preventive medicine and diagnostics
    • EMR
    • Volume impact from broader health insurance coverage
    • Expiring capital gains tax rates
External factors that influence value (continued)
    • Industry demographics
      • Reimbursement trends
      • Paradigm shift from inpatient to outpatient setting
      • Rapidly aging population
      • Many screening tests are performed based on age
      • Increased incidence of cancer
      • Shift from prognostic and monitoring tests to preventive medicine
      • High growth in new technology, new test development and implementation
      • Strong fundamentals continue to attract investment from large consolidators and private equity
External factors that influence value (continued)
    • Opportunities for the buyer, (i.e. Synergies)
      • Revenue growth from existing clients and referral sources
      • New marketing
      • New services and offerings
      • Subsequent “fold-in” acquisitions
      • An intelligent buyer will make an acquisition only if it adds to the value of the acquiring company. Such acquisitions are said to be accretive. Buyers can afford to pay more for an acquisition as the relative value of their own company increases
External factors that influence value (continued)
    • Taxation and finance theory factors
      • Benefit from the lower tax rate on capital gains
      • Conversion of future earnings to lump sum distribution today
      • Value protection and asset diversification
Governance agreements specify important characteristics such as:
    • Types and size of equity classes which exist
    • Rights, privileges and limitations associated with each class of equity
    • Governance of the entity, including the voting rights and control elements afforded to each class of equity
    • Restrictions placed on the marketability of each class
    • Provisions for allowing new equity holders, including conditions, terms and purchase price
    • Provisions for allowing liquidity events by existing equity holders, including conditions, terms and purchase price
In a joint venture or other form of partnership, you will need the valuation of the initial contributions and an allocation of equity holdings
  • If valuation balancing problems arise, they can be solved using:
    • Tiers of equity
    • Tiers of governance
    • Differing income allocation
    • Tiers of entities (via modality, professional/technical, geography, etc.)
    • Tail protection provisions
    • Measurement dates for look-back provisions
Common valuation mistakes include:
    • Using investment value instead of fair market value
    • Bifurcating business valuation from compensation analysis
    • Failing to properly analyze operating data
    • Failing to properly assess deferred capital expenditures and future capital needs
    • Failing to assess capacity issues
Stark law and other regulatory concerns, including anti-kickback regulations, the False Claims Act and the IRS, require that payments made relating to professional compensation arrangements and medical director agreements must be consistent with Fair Market Value, and must be commercially reasonable
  • Whenever a physician receives compensation in exchange for providing professional services to or on behalf of the hospital, the physician is deemed to have a financial relationship with the hospital. Such a financial relationship must be compensation for services rendered, as opposed to payment for referrals
Compensation arrangements could include:
    • Administrative services
    • Administrative, supervisory and teaching services (AS&T)
    • Call-coverage services
    • Employed physician compensation arrangements
    • Management services agreements
    • Co-management agreements
    • Medical director services agreements
    • Professional services agreements
    • Lease agreements for equipment, space or staffing
    • Billing agreements
Fair market rates:
    • Depend on the unique facts and circumstances of a situation
    • Estimate the time and cost to perform tasks by internally-employed personnel (cost approach)
    • Collect information related to comparable agreements for similar services, either within the particular healthcare system in question or within the greater marketplace (market approach)
    • Analyze comparable compensation market data contained in multiple, objective, independently published surveys (survey approach)
    • Adjust the findings for inflation, specialties, productivity, taxes and benefits, geography, and other factors to ensure comparability
Do a final sanity check on the remaining profitability of the payor, i.e., is there a reasonable rate of return for the employer?
  • Beware of the impossible day
  • Verify that compensation components from separate fee arrangements do not overlap or provide duplicate payment for identical services
  • Compensation arrangements, and fair market opinions, can be bifurcated into a fixed component and a variable/incentive component
  • Prudent to have certain measurement dates for look-back provisions and to allow for periodic adjustments to the compensation
Compliance programs
    • Lack of compliance with regulatory concerns by a healthcare organization can lead to large fines, disruption of the organization, lost jobs, imprisonment, lost goodwill in the marketplace, loss of tax-exempt status, and exclusion from Medicare/Medicaid programs
    • Therefore, it is important for the healthcare organization to conduct a compliance review, in which all payments made to physicians are identified, documented, categorized, and justified
In a compliance review, you should check for:
    • Expired or unsigned contracts
    • Contracts that do not specify the exact services to be covered by the arrangement
    • Contracts that are not correlated with any and all other arrangements between the hospital and the physician
    • Contracts which specify aggregate services to be provided by the physicians which exceed those that are reasonable and necessary for legitimate business purposes
    • Lack of legal counsel or board approval
    • Lack of appropriate, or insufficient, FMV data or analysis
    • Contracts that have changed fees during the term of the contract, or in which the fee or fee formula has not been set in advance
    • Contracts that contain fees impacted by the volume or value of referrals, or other business generated by the physician for the hospital
Lack of time sheets or work logs, especially for non-clinical services
  • Lack of invoicing documentation
  • Payments made without a contract, payments that do not match the contract terms or payments that do not match the time sheet or invoice amounts
Maintain active checklists, databases and work papers which allow for the continuous monitoring of all financial relationships with physicians
  • FMV justification does not necessarily require the use of a third-party appraiser. Instead, develop an internal policy as to when outside third-party FMV opinions should be obtained, as opposed to internal analyses
  • Having a third-party appraisal does not provide full protection from an investigation, but it demonstrates that the organization considered relevant facts and sought an expert opinion
The facts
    • Every radiology group/imaging facility has problem areas
      • Some will be modest, others serious
    • Problems can affect whether you get offers, deal value, whether a deal gets done and deal timing and cost
    • Not all problems are known. A true understanding requires an “audit.” An audit can be done internally or through an independent source.
    • It is better to know about and correct problems or deficiencies now rather than have them detected by buyers or partners and have corrective measures imposed on you
    • A thoughtful, timely audit and correction of problem is less onerous on and disruptive for management and staff
Be prepared for extensive and thorough buyer’s/partner’s due diligence
    • Focus areas:
      • Ownership/governance
      • Financials and financial trends
      • Legal (tax structure, compliance, licensure, litigation, other current, threatened or anticipated third party actions including government actions, etc.)
      • Operations
      • Clinicians/management/employees
      • Customer relationships and profile
Start thinking about a transaction well in advance of actually beginning the process – years rather than months is best
    • A proper deal readiness approach can reduce risks associated with selling and the negatives of fixing problems during the transaction process (confidentiality breaches, government intrusion into deal, distracted management, deal fatigue/failure)
Regulatory and legal compliance
    • Buyers will heavily scrutinize legal compliance issues as part of evaluation of the business. The issues are broad ranging. Potentially the biggest risk area for buyers.
    • Key areas include:
      • Coding and billing issues
      • Fraud and abuse issues
      • Licensure and accreditation
      • HIPAA and data security
      • Taxes
      • Employee vs. independent contractor issues
      • Contract compliance
Regulatory and legal compliance (continued)
    • If problems are uncovered, buyers may back out, delay deal until fixed, or require purchase price to be reduced. Problems detected after closing will likely constitute a breach of reps and warranties and may hit the escrow.
    • Coding and billing compliance (including fulfilling all overpayment disclosure obligations and RAC patterns)
      • Most buyers focus heavily on billing in their “due diligence” review
      • Sellers should make sure their billing practices are appropriate and will survive scrutiny
      • Seller should consider doing its own audit/review prior to putting facility up for sale – remember self disclosure obligations
Regulatory and legal compliance (continued)
    • Referral source relationships
      • Do you have business relationships with referral sources that are less than “market rate?”
      • Are you providing benefits to referral sources at a “discount” that might be characterized as an impermissible?
      • Do you have agreements in place to protect against improper use of EMR and other equipment?
Regulatory and legal compliance (continued)
    • Marketing activities
      • Fraud and abuse laws and regulations
      • Practices proscribed by OIG fraud alerts
      • Review all marketing materials and products
    • Consider having a Compliance Plan and HIPAA and Data Security Plan in place
  • Licensure
    • Confirm that your radiologists are licensed in every state in which they are required to be licensed
    • Confirm that facility is properly licensed and accredited in every state where licensure/accreditation is required
Clinician, management and key employee retention
    • What is in place to retain key clinicians/management/employees during and post-transaction
      • Strength of relationship
      • Incentives to stay
    • Proper non-compete and non-solicitation provisions
Use of “standard form” employment and independent contractor documents
    • Standard form, “one size fits all” documents may not be legally enforceable; particularly acute in sales representative agreements
    • In order to be enforceable, agreements need to be tailored to individual state law requirements. What works in one state may not work in another
    • Agreements need to be tailored to the people being covered (senior executives, sales reps, rank and file employees)
Should start well in advance of deal-consult tax advisor early
  • Beware of common trap: Selling assets from “C” corporation (double tax issue)
  • Interplay with estate planning
  • Charitable gifts: Tax savings opportunity
  • Even non-profit owners may have significant tax issues
  • Section 481 adjustments
Asset Sale by a “C” corp.
  • Example of “Double Tax” on Sale of Assets by “C” corporation

Sales Price of Business $10.00mm

Tax to Corporation (35%) 3.50

Distribution to Shareholders 6.50mm

Tax to Shareholders (15%) .98

Net to Shareholders $5.52mm

Asset Sale by an “S” corp. or LLC
  • Example of Tax on Sale of Assets by “S” Corporation or LLC

Sales Price of Business $10.00 mm

Tax to Shareholders (15%) 1.50

Net to Shareholders $ 8.50 mm

Difference: $8.50 - $5.52 - $ 2.98 mm

  • Seller financing (seller notes & rollover equity)
  • Earn-outs
  • Control over operation of business
  • Employment/Consulting terms & restrictive covenants
  • Employee matters & benefits
  • Indemnification
  • Taxes
  • Consents & licenses
  • Transition services/integration
    • Not a legal concept but informs everything in transaction
    • Buyer and seller expectations on issues will depend significantly on perception of premium
    • Items in deal agreements will be revised to reflect valuation model – e.g. one-time charge v. recurring
    • Typically negotiated at letter of intent stage before attorneys are extensively involved
    • Can include purchase price adjustments
Seller notes
    • Used to bridge gap between seller and buyer price expectation
    • Risk of non-payment
    • Subordination and security concerns
  • Equity rollovers
    • Significant incentive for sellers to continue to produce positive performance
    • Upside downside risk
    • Tax issues
    • Stockholders agreement (governance, puts, calls, etc.)
    • Tie to employment/consulting agreements
  • Earn-outs
    • Used to bridge gap between seller and buyer price expectation
    • Also can be significant incentive for performance post-closing
      • Capital gains and ordinary income treatment
      • Regulatory considerations
    • Potential for significant conflict post-closing regarding operation of the business
Control of operations
    • Before closing, buyer will want some visibility and control over operations. Seller will be willing to provide visibility, but must be able to maintain control and operate as business needs arise.
    • After closing, buyer will expect complete or near complete control over operation of business
    • Can cause expectation problems for sellers
Employment terms
    • Professionals can be key driver of the value of the business being acquired
    • Employment terms can also represent significant portion of value for sellers
    • Key terms include: duration, termination triggers (for cause and good reason), duties, vacation, benefits
    • Note that benefits packages likely will change post closing and often are not as generous
Restrictive Covenants
    • Three main Covenants
      • Non-competition
      • Non-solicitation (customers, employees, referral sources)
      • Confidential information of the business
    • Purchase agreement Covenants
      • Will be based on snapshot of business at closing
      • Will run for fixed period of time from closing
    • Employment agreement Covenants
      • Will resemble purchase agreement Covenants
      • Will change with changes in business over period of employment
      • Will address exceptions to non-competition/non-solicitation restrictions
      • Outcomes depend on determination of “for cause” and “without cause” terminations
Employee matters
    • In addition to seller employment agreements, compensations for employed physicians and other will change as well
    • Prospect of partnership for up-and-coming physicians/employees will disappear – may require additional compensation to offset
    • Diminished control over bonuses
    • Promise of seller to make buyer whole for:
      • Breaches of representations and warranties
      • Breaches of Covenants
      • Anything else agreed to by the parties
    • Promise buyer to make seller whole for:
      • Breaches of representations and warranties
      • Breaches of Covenants
      • Post-closing Covenants and operation of the business
    • Is effectively a purchase price adjustment for the business not being in the condition promised
    • Gives teeth to all of the other provisions
    • Watch impact on applicable insurances

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