Physician Strategy News: February '08
Practice Acquisition Basics – Part 1
Many hospitals are faced with the new and unfamiliar challenge of acquiring physician practices. Acquisitions have become necessary for a number of reasons. First and foremost, the tightening supply of physicians makes it risky to depend solely on private practice. Employment gives hospitals greater control of physician supply and the associated revenue streams.
A second factor is the pressure faced by private practices to maintain stability. Pressure on revenue makes physicians vulnerable, willing to look at other opportunities that may take them from your market or to a competitor. Employment gives them some hope of stability in their compensation, reducing the risk that they will leave.
Third, growing expenses, such as malpractice insurance, put pressure on private practices. In some areas, employment has been pursued because malpractice premiums were forcing physicians from the market. In all these cases, acquisition and employment can help to ensure an adequate supply of physicians.
As you approach practice acquisition, keep in mind your long-term strategy. Don't pursue doctors simply because they are available, but consider these issues:
- Can you develop a group that is elite, a group that will be attractive to other physician recruits? To do this, you must focus on acquiring practices of physicians who are of high quality and respect.
- Can you put together a group that functions well by creating a common culture? To do this, you must attract physicians who can be team players and see the bigger picture.
- Can you develop an approach that is economically sustainable? To do this, you must not overpay for practices and must structure deals that tie physician pay to productivity.
Practice acquisition is a five step process. First is the valuation. It is important that you not repeat the mistakes of the 1990s, when hospitals overpaid for many practices. The second key step is due diligence, reviewing data to understand the operation of the group.
The third step is the compensation plan. You must avoid overpaying the physicians, although market forces at times may require you to pay more than they produce. The fourth step is developing a term sheet. This contains the core elements of the offer that will be given to the physicians. Contract development is the final step.
| Process Step | Critical Point |
| Valuation | Price must reflect actual value |
| Due Diligence | Do your homework through an in-depth analysis |
| Compensation Plan | Must be sustainable |
| Term Sheet | Lay it out in details |
| Contract | Written to support performance requirements |
Below are outlined key questions related to the valuation, due diligence, and development of the compensation plan. Development of the term sheet and contract will be discussed in Part 2 of this article, which will appear in the March edition of Physician Strategy News®
Valuation Questions.
The valuation will help define the money that will change hands in the transaction. In many cases, it is best to simply buy the practice assets that will be required for ongoing operations.
How will the practice's hard assets be valued? A diligent methodology is required to accurately value the assets and stay within regulatory guidelines. The method for determining fair market value must be defensible.
Will Accounts Receivables (A/R) be included in the assets purchased? We generally recommend against this for two reasons: First, you might determine not to continue with the existing billing and A/R system, and allowing the physicians to control the A/R makes it their responsibility. Second, you may not wish to assume the financial risk.
Will the charts be purchased? In some states this is problematic, and should be avoided if possible. When it is done, limit the price to the cost of copying the charts. Several states give direction of reasonable expenses for that activity.
How will malpractice premiums be handled? Going forward, the hospital will pay these premiums. However, if the physician must change carriers as part of this transition, a tail coverage issue will likely be created. This needs to be thoroughly researched so all parties are cognizant of it as the negotiations proceed. Some hospitals provide a signing bonus if the cost of the tail coverage is onerous.
Due Diligence Questions.
This analysis will help you define the risks involved in the acquisition. These questions also underscore the business fundamentals of the practice.
Are there any outstanding debts/loans to the practice? It is best to assume no liabilities; rather, let the physician keep those along with the A/R.
Are there opportunities to improve practice expenses? The hospital may be able to buy items more cheaply, lowering costs. There may be an opportunity to aggregate practices in one location, creating economies of scale. Or, the hospital may be unwilling to pay some expenses that are essentially personal, such as a car. In all cases, opportunities to reduce expenses must be understood.
Can the practices be in a separate corporation? If yes, you can avoid the hospital's costly wages and benefits. That will surely help the long-term viability of the practices.
How will the billing function be handled going forward? It is crucial to understand the effectiveness of the current billing system and processes. Poor billing and collections represent a major risk factor.
In a group practice, what are the details of the existing buy/sell agreement? How might those agreements affect the acquisition? This may be a particular problem if you do not want to acquire all of the doctors in a practice.
Does the fee schedule need to be adjusted to capture available charges? This is more an ongoing operations issue, but it is good to probe in your due diligence. It may represent an opportunity to improve the practice.
How long does the physician intend to practice? This will help you assess your risk of losing the physicians and having to bear the costs of recruiting a replacement.
Compensation Plan Questions.
Understanding the current compensation plan is crucial. Projecting a reasonable plan for the future is essential. Three core questions are suggested:
Do the doctors have reasonable expectations going forward? Primarily, do they have reasonable expectations about compensation and ongoing operations? Over the near term, the basic economics of the practice will not change. If the physician has unrealistic expectations, problems may be on the horizon.
Can a reasonable compensation system be created? In making this assessment, we recommend reviewing three issues: production, collections, and compensation benchmarks. The productivity data will provide insights into how hard the providers are working. If production is low, you are buying a problem. A review of A/R and bad debt will also provide insights. Finally, benchmarks will help you define what is reasonable, against which you can contrast current performance. This data should be collected as part of the due diligence efforts.
Will you allow ancillaries in the practice? This will have a big impact on practice economics. If practices can be aggregated and ancillaries grown, it could have a big positive impact on practice viability. If the hospital wishes to retard the growth of the practice in this area, you will likely have to increase your subsidy.
(For a more detailed discussion of compensation plans, please see "Keys to Effective Physician Compensation" in the January 2008 Physician Strategy News®, and our audio web cast, "Physician Compensation Models", which is available in our library of on-demand programs.)
The questions above are not exhaustive, but if you can answer them appropriately you will likely avoid many of the pitfalls of practice acquisition. In Part 2 of this series, we will address the term sheet and key contractual issues, such a covenant not to compete.
For further information on this topic please call John Hill at (502) 814-1185.
