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Physicians seem to assume that the “sale of the practice” will take care of itself. Bad idea.
Physician practices that consider hospital integration often focus on future employment compensation and governance issues. Physicians seem to assume that the “sale of the practice” will take care of itself. Bad idea. The sale price is typically the sole way a practice will receive any payment for the business it has built over time at considerable expense. Therefore, a practice must be proactive regarding two essential elements of the potential sale.
Identification of Assets
The first essential task is to identify the specific assets the practice will offer for sale. Contrary to common usage, physicians almost never sell “the practice.” That is, hospitals almost never purchase the stock/equity of an existing practice. Instead, hospitals typically purchase specific practice assets. It is essential, therefore, to identify all relevant valuable assets. Inaccurately or incompletely identifying assets can have a significant adverse effect on the potential purchase price.
Identifying salable practice assets is not as simple as going down a checklist. Instead, the process requires an understanding of how practice assets should be viewed/assembled to recognize their highest and best market value. Should the practice be valued as a whole (as a “going concern”)? Should the practice’s ancillary services be valued as a separate business? If the practice might be most valuable offered as an assemblage of individually-valued assets (rather than as a going concern), then what tangible and intangible assets should be included?
The process to identify the optimal offering/sale structure for a particular practice is integrally related to the second essential element: the approach used to value the business/assets.
Federal regulations prohibit hospitals from paying more than “fair market value” for practice assets. Prudent hospitals engage an independent appraiser to provide an opinion of fair market value. A practice must fully understand the methodology an appraiser proposes to employ to value the identified assets. The Letter of Intent between the practice and a hospital should give the practice the right to interview potential appraisers and participate in the selection process.
This vetting is essential because it is an unfortunate fact that appraisers have different predispositions that cause widely varying opinions of value on the same practice/data. The proper question for a practice is not “which appraiser will state the highest value.” Instead, the questions are whether a proposed appraiser:
(i) is truly independent of the hospital;
(ii) is qualified to perform the particular valuation services required; and
(iii) can clearly articulate a defensible valuation methodology.
A practice that leaves this to chance does so at its probable peril. A proactive practice will state in the Letter of Intent the types of assets that the parties will have valued and the general methodology to be applied. This approach avoids distasteful surprises months down the road that are otherwise, unfortunately, too common.
A practice should assure that the appraiser’s written engagement is broad enough to include analyses of alternative methods to offer/purchase the practice and its assets. This will assure that the parties receive the analyses to answer whether the practice is more valuable as a going concern or an assemblage of assets. Practices sometimes benefit from engaging a professional to review the appraiser’s work to assist to assure accuracy and consistency with applicable standards.
The steps recommended above benefit both selling physician practices and purchasing hospitals. They are not “us versus them” or zero sum. Both parties benefit from early mutual agreement regarding potential salable assets and the approach to obtain a reliable fair market value analysis of those assets. Whether a hospital will offer that full value is a matter of negotiation. That negotiation will more likely result in a sustainable long-term partnership if the parties negotiate from a position of full knowledge of the relevant facts.
In the future I will identify several “myths” that cause wide variance in the value assigned to or offered for physician practice assets. The parties should understand and address these issues on the front end to avoid costly surprises after they have invested months in a potential transaction.
John C. Erickson III is an attorney with Squire, Sanders & Dempsey (US), L.L.P. He represents physician groups and health systems regarding integration and co-management transactions and has extensive experience in regulatory matters, software and capital equipment transactions, valuation issues, vendor/supplier arrangements, and dispute avoidance and resolution. E-mail him here.