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Preparing for a private equity transaction can help strengthen your practice’s business structure, even if you ultimately forgo potential opportunities.
If you knew you would be engaged in a future physical altercation, you would be best served by getting into shape and learning how to defend yourself well in advance. Even if the altercation never occurred, you would greatly benefit from the exercise and training involved in preparation. The same principle holds true when a medical practice prepares for a PE transaction.
Preparing for a PE transaction can help strengthen your practice’s business structure, even if you ultimately forgo potential PE opportunities. PE funds look for certain characteristics in target practices that maximize the potential for the practice to generate EBIDTA (earnings before interest, depreciation, taxes and amortization), which is essentially a fancy term for profits. If you follow the model of an ideal PE target practice, you will be in the best position to maximize your opportunity for success.
This article addresses five key areas in preparing for a PE transaction:
Focusing on these areas will improve your practice whether or not you intend to enter into a PE transaction.
Comply with regulations
PE funds seek investments that maximize profits and minimize risk. A very profitable target practice engaged in questionable regulatory behavior may be viewed less favorably than one that is not as profitable but squeaky clean. Potential recoupment actions by payers, along with possible federal or state government investigations, jeopardize a practice’s stability and future profitability. A practice anticipating a PE transaction should take basic steps to ensure regulatory compliance.
One step is to retain a third-party coding compliance firm to conduct a thorough audit of coding practices. Upcoding, improper use of modifiers and billing for services deemed not medically necessary all increase a practice’s risk of a recoupment action. It is important to understand that a procedure may not be deemed medically necessary even if it is reasonably determined to be needed for a patient’s care, if the documentation does not support doing the procedure. In other words, medical necessity requires appropriate documentation as much as it means that the procedure was literally necessary. A coding compliance firm can evaluate your practice’s coding and billing procedures and make recommendations on how to improve your process and reduce risk.
Another critical step in achieving regulatory compliance is to conduct a legal review of the practice’s business relationships. Sublease arrangements can be particularly risky if they are entered into with referral sources or recipients. Contracts with marketing companies or other third-party suppliers of health care services to the practice should also be analyzed. For instance, we have seen many internet marketing services whose compensation structure is tantamount to an illegal kickback scheme. Additionally, there are many providers of services such as mobile imaging and in-office infusion that may, often unwittingly, run afoul of the Office of Inspector General’s suspect joint venture fraud alert. The practice’s performance of in-office services such as physical therapy and laboratory should also be reviewed for compliance with the federal Stark law.
Maximizing your practice’s profitability or EBIDTA may seem obvious, but it is often approached in only one direction — working harder and increasing billings. Most PE transactions involve a payment based on some multiple of EBIDTA. If the PE firm pays seven times EBIDTA, every additional $100 of profit yields an incremental $700 in purchase price.
Cutting unnecessary costs has a direct, undiluted effect on a practice’s bottom line. Contact your medical malpractice broker and other insurance broker to see about lowering your premiums. Negotiate with your landlord — COVID-19 has placed pressure on landlords to reduce rent. Review your vendor agreements and try to shave a few percentage points. Review your health insurance and employee benefits plans to maximize benefits while minimizing cost.
Obviously, cutting costs will only go so far, so your focus should also be on changes that increase revenue. Review coding practices to see whether you are being overly conservative. Consider adding ancillary services such as specialty services, laboratory, imaging and in-office procedures. Evaluate whether bringing on an associate will increase the practice’s profitability.
Physicians and midlevel providers should spend as much time as possible performing billable work. Time spent by providers on administrative functions reduces profitability. Look for ways to optimize provider time.
Focus on Infrastructure
Infrastructure consists of staffing, physical plant/equipment and processes. Practice leases should be reviewed and extended, unless the practice intends to move. Equipment should be reviewed to ensure that it is up-to-date and properly maintained. The practice should determine whether the best people are in the right positions, whether it is overstaffed or understaffed and whether the employee manual is current.
The practice should review information technology hardware and software systems, update, upgrade or replace as needed, confirm that it has all necessary software licenses and ensure workers are properly trained on the latest software. If all software user knowledge resides in a single employee, start training at least one other to create redundancy.
Know your data
Health care delivery and payment models are increasingly data driven. Practices that understand their data are in a better position to maximize productivity, improve patient care and reduce overall cost of care delivered to patients. Payers have access to claims data but limited access to clinical data. Medical practices have access to both. Frier Levitt works with a number of vendors who can help practices establish a data warehouse consisting of clinical data pulled directly from patient records. We believe that establishing a data warehouse will, if not immediately, at least put practices in a position to better negotiate value-based contracts with third-party payers because they will know how their own practice performs better than the payers do.
Revisit corporate/LLC documents
Most medical practices have not reviewed their corporate documents in years, sometimes decades. This is a mistake that can cause shareholder disputes and dissuade potential PE suiters. Ownership documents should be reviewed approximately every three to five years. For professional corporations, this means reviewing the shareholders’ agreement, bylaws and shareholders’ employment agreements.
For limited liability companies, this means reviewing the operating agreement. Issues such as management decisions, retirement buyout formulas, termination provisions, restrictive covenants (such as noncompetes), shareholder/owner compensation and distribution formulas for a capital transaction (such as a sale event) should all be carefully reviewed and discussed with experienced legal counsel.
The following are some issues that warrant consideration:
Do the practice’s voting requirements make it difficult for the practice to effect needed change? Can a single owner veto the will of the majority?
Does the buyout formula for a retired owner fairly compensate the retiree without overly burdening the practice?
Is there a noncompete that prohibits a retiree from taking practice patients, opening an office next door and harming the practice? Is the retirement buyout still payable if the retiree competes?
Are owners fairly compensated for the professional and administrative services they perform?
Are owners responsible for recoupment actions by third-party payers related to their coding and billing practices?
Are the company documents clear about how proceeds will be distributed in the event of a sale?
Are the documents clear about how much notice must be given by a retiring owner, whether that owner can enter a wind-down phase prior to retirement and, if so, what that means in terms of voting rights, etc.?
The above process will likely take several months and require several consultants, including legal, accounting and coding issues. At the end of the process, not only will your practice experience noticeable improvements, but it will position itself to maximize its value to third parties, including PE funds, hospitals and other large practices looking to expand.
Daniel B. Frier, Esq., is cofounder of Frier Levitt, LLC. Send your financial questions to firstname.lastname@example.org. You can reach Daniel B. Frier at DBFrier@frierlevitt.com.