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Medical: Made the Decision to Merge? Bigger Can be Better with Proper Due Diligence


7/24/13

More and more, private medical practices are finding that merging with other practices can help them to compete more effectively in today’s challenging healthcare environment. To reach the critical mass they need to effectively compete, more physicians are exploring strategic mergers to form a larger group practice. Merged practices can share ancillary services and spread the cost of cutting-edge technology, equipment, and staff across a wider base while also increasing reimbursement to the practice.

The good news is that a properly executed merger — combined with a solid business plan — can improve an organization’s bottom line and, just as importantly, can mean the difference between success and failure. However, the stakes are high and the success of the merger is largely dependent on the due diligence undertaken.

Leap … or Look?

So, what separates the winners from the losers in a merger-driven environment?

According to CohnReznick’s Richard Puzo, Partner and Medical Industry Practice Leader, it is all about looking before you leap. In a nutshell – it is all about due diligence.

“The key is to go in with eyes wide open,” Puzo shares. “Once everyone has embraced the conclusion that the sum of the merged practice will be greater than the parts, it’s time to get your head around what the new entity will look like and how it will perform. In doing so, it is critical to have M&A expertise on your side to “run the numbers” and perform necessary due diligence.” According to Puzo, a review of the following can be a critical component of success once the decision to merge has been made:

Financial trends — It is important to take a critical look at the financial positions of all of the practices involved by preparing pro forma financial statements. Pro forma statements will provide a picture of what the groups will look like when they consolidate while providing transparency and a realistic indication of the financial reality of merging the practices.  In addition, reviewing trends in revenue, expenses, and profitability will provide the practice with a valuable operational management tool in order to identify efficiencies and areas for operational improvement. A key question to contemplate is: Over the past three years, has revenue trended up or are the numbers declining dramatically?

Tax aspects — Even the most straightforward transactions can have complicated tax implications. With a C corporation, for example, there may be an element of goodwill that should be evaluated for the impact it may have on taxes.

Potential cost savings — A merger can reduce many of the costs that medical practices have.  Costs involved in managing multiple facilities, operating redundant equipment, and providing duplicate services that generate overhead (e.g. lab, billing, and accounting processes) can be significantly reduced. In fact, with proper planning, overhead as a percentage of gross collections can decrease substantially. However, it is important to recognize that, even with a well-planned merger, considerable economies of scale may not be realized during the first year as the nuances of the merger are being developed and addressed.

Negotiating leverage — Greater volume means greater leverage—and not just with supply and equipment vendors, but with insurers, payers and hospitals. It is important that medical practices analyze their payer mix and uncover potential reimbursement increases. “When you reach a size large enough to control a certain geographic area, payers have to start interacting differently with you because they need you to service their patient group in that area,” Puzo notes. “Projecting out the potential impact of that leverage is important.”

Overhead allocation — Whether economies of scale come into play or not, overhead still needs to be allocated fairly. “There really is no right or wrong way to allocate overhead,” Puzo explains. “But what needs to be understood is that there are different ways to allocate expenses, and the groups involved should at least arrive at a general allocation method that everyone is comfortable with.”

Ancillary income — Mergers certainly increase the opportunity to generate ancillary income — from imaging and lab work to so-called “lifestyle” ancillaries like cosmetic laser procedures. But how much revenue can be expected? And how will profits be allocated? Merged practices need to determine the level of investment needed in equipment and leasehold improvements to bring these new sources of income to fruition.

It is also important to identify any regulatory issues that may come into play from the merger. Stark regulations, for example, are incredibly complex and apply to many ancillary services covered by government insurance plans. For example, practices that refer patients for imaging scans may face regulatory restrictions related to the compensation earned for scans performed at their own imaging centers.

You’ve Decided to Merge. Now What?

With an understanding of key items that can make your merged practice successful, it is important to now focus on the information-gathering process and prepare a comprehensive business plan for the new practice. Key action items include:

Preparing a pro forma. A tight pro forma can be created to project profit-and-loss for the consolidated group. Likewise, this information can also be used to project individual care center accountability and profitability.

Reviewing operating agreements. After the group’s operating agreement is thoroughly reviewed by an experienced healthcare attorney, it is important that the plan is analyzed to determine business or financial issues that can impact the merger.

Identifying working capital needs. With a solid pro forma in place, it should be more transparent to identify financing and/or working capital needs (and build a more substantial argument for a lender to buy into the business case for extending financing). Your consultant can help with introductions to lenders and assist in any covenant negotiations.

Make It Work

It takes time to properly structure a deal — generally, at least nine to 12 months. A commitment to man hours for gathering data and holding regular discussions on everything from operational issues to corporate culture, values, and ethics will be critical to the merger’s success.

Consider designating a representative from each medical group to drive the due-diligence process. Ideally, this should be a detail-oriented person who can compile the necessary documents and data while also managing the day-to-day interaction with your consultant. To keep the process moving, the internal resource can designate committees to address specific issues (e.g., how to handle pension plans and fringe benefits in the combined practice).

At the same time, don’t get so consumed with the merger that practice performance starts to slip. By engaging experienced consultants who can tackle due diligence requirements for the merger, you and the other partners of the merged medical practices can focus on running your practices.

With appropriate due diligence, there is less of a risk that the merger results in costly mistakes — mistakes that could result in being saddled with debt and significantly lower profitability.

Don’t Go It Alone

Avoid the temptation to go it alone. “Entrepreneurial physicians are often accustomed to working solo,” notes Puzo. “But, when it comes to a merger or acquisition, it’s wise to surround yourself with a team of advisors who can not only make the deal happen, but also structure it most advantageously for the partners.”Puzo adds, “In the end, medical practices generally find that the cost to enlist experienced advisers typically pays for itself as the partners are much better able to anticipate and avoid costly mistakes.”


What Does CohnReznick Think?
With increased size comes increased opportunity. Yet, while the potential benefits of a medical practice merger can be captivating (lower overhead and an increased patient base to name a few), the complexity of actually combining disparate financial statuses and operations could put a merger at risk of failure. “Physicians contemplating a strategic merger are well advised to have a consultant with merger and acquisition expertise on their side,” says Puzo. “Experienced consultants can help private medical practices successfully navigate the unknowns of a merger and plan for a greater likelihood of success.”


Contact:

For more information, contact Richard Puzo, Partner and Medical Industry Practice Leader, at 973-228-3500 or visit our webpage.

 

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