When You Get “The Call”
The healthcare industry saw robust mergers and acquisitions (M&A) in 2022, with more than 2,300 transactions and an eight percent increase in activity since 2021.[1] In the year 2023, healthcare continues to be a target market for private equity firms and investors alike, mainly due to its high volume of revenue coupled with its continual evolution of technology usage.
Although healthcare practices are considered a great investment, practices may be struggling internally to meet patient demands due to staffing limitations, complexity of medical billing, Medicare reimbursement cuts and the looming retirement of the baby boomers. It’s understandable that you may be highly motivated to sign a letter of intent after receiving a call from a potential investor who is offering you what seems to be an astronomical amount of money to buy your practice. After all, the investor understands the struggles of being a healthcare provider in today’s market, and they claim to have all the tools and resources needed to take your practice to the next level while providing you with a retirement fund that exceeds your wildest dreams. You may already be imagining that 90 days from now, all the stress and burden of running a practice will be a distant memory.
If it sounds too good to be true, it usually is! The reality is that for a buyer, selling your practice is just doing business. As the owner, you have poured your passion and resources into serving your community through your healthcare practice, and while there are many great reasons to sell your practice, there are factors that sellers should understand prior to getting “the call.”
Dissecting the Offer
In many instances, the buyer will propose a potential sales price based on limited financial data, such as revenue, number of providers and market share. The mention of a proposed purchase price is designed to entice the potential seller by providing a good reason to sign a letter of intent. But before you sign, beware that a proposed purchase price does not equate to cash in your pocket.
Once a letter of intent is signed by both parties, the buyer will require that the seller provide extensive financial, operational and legal documents, which will undergo extensive scrutiny by third-party professionals. This is designed to protect the buyer from any potential pitfalls that may not have been obvious with a surface level review of your practice and often leads to renegotiation of the original offer price.
Although it may not be clear during the first stages of diligence, the purchase agreement usually includes “claw back” provisions. For example, one common claw back provision typically requires that the seller reinvest a portion (between 20 and 30 percent) of the purchase price in a new venture. This means the seller will continue to own a minority interest post-closing. In most instances, the reinvested interest is earned over a period of time if the seller complies with an agreed-upon work arrangement. The buyer is usually required to work a certain number of years before receiving the full value of their vested interest. As such, the claw back provision provides the buyer with time to establish their own goodwill before the seller exits the market.
Other common reductions to cash at closing may include indemnification and target working capital. The indemnification escrow is designed to protect the buyer from any potential indemnity obligations that may arise post-closing, and target working capital provides the buyer with enough liquidity on hand to operate the business for a specific period of time post-closing. Payment of outstanding debt, sellers’ expense for professional services related to closing the deal and post transaction tax implications should also be considered by the seller prior to signing the letter of intent.
Additionally, be aware that the extent of potential reductions to the purchase price are not apparent until the seller and buyer have invested a significant amount of time and energy into the deal, causing what is hence known as “deal fatigue.” Deal fatigue can cause both parties to consider removing themselves from negotiations altogether, or in some cases, influencing one or both parties to move forward without fully vetting the negotiations.
Mitigating the Pain
While you may not be able to completely avoid hurdles throughout the negotiation process, we have some tips that may help you mitigate the pain associated with selling your practice.
- Understand the value of your practice by obtaining a business valuation. A valuation prepared by an objective third party will provide you with an independent, unbiased view of what your company is truly worth.
- Do your own due diligence. Engage a professional to assist you with a quality of earnings review of your company. A professional with experience in M&A will help you gain an understanding of the due diligence process and provide insight into the numerous adjustments that a potential buyer will make to your financials when determining the target purchase price.
- Seek the advice of a tax professional. Having an in-depth understanding of the potential tax implications of selling your practice is imperative. Knowing your potential tax liability before you sign a letter of intent will provide fresh perspective and help to alleviate surprises on the back end.
- Know that you have the power to negotiate. Seek legal counsel with extensive knowledge in M&A. Experienced legal counsel may cost more on the front end of the deal, but you could save money over the life of the transaction with experienced negotiators in your corner.
If you have received “the call” or if you are approaching retirement and considering selling your practice as an exit strategy, our team of professionals is ready to support you no matter what stage of the process. For more information, contact your Windham Brannon advisor, or reach out to Melissa Purvis.
[1] Healthcare M&A Activity Breaks Records in 2022. Healthcare Facilities Today. Jan. 19, 2023.
