Avoiding practice merger traps

By Vasilios J. Kalogredis, J.D. & Michael R. Burke, J.D.

There are a multitude of factors driving physicians and groups towards greater integration in health care: skyrocketing costs, federal and state legislation, the impact of managed care, etc. Solo practitioners and smaller group practices are finding it increasingly difficult to compete in this environment. In response to changing times, physicians, attorneys and consultants have been developing new models for delivering health care that are in tune with the changing environment. While various options exist, including having a physician sell his or her practice to a hospital or health system, or joining an independent practice association (IPA) or physician-hospital organization (PHO), physicians will have the ability to retain an equity interest in the practice and the most autonomy and flexibility in larger doctor-controlled practices, which can be accomplished through mergers and acquisitions. This article will first discuss the advantages of practice mergers, and then will point out the disadvantages to such mergers and the traps to avoid in pursuing them.

Advantages

Increasing size is the biggest advantage of a practice merger. Increased size strengthens the group practice’s negotiating position with hospitals, employers, insurance companies, managed care organizations and other third party payors. This may enable a physician to participate with a third party payor who had not even considered contracting with the physician or smaller group prior to the practice merger.

Forming a larger group practice enables merged practices to maintain and/or strengthen their market share in the area. The merged practice will be able to offer more full service care and greater continuity of care for patients. In today’s environment, with patient satisfaction being key, providing more to patients is what the business of medicine is all about. In addition, the size of a larger group will enable the physicians within the practice to provide better coverage for one another, most likely in a more favorable (and hopefully more cost-efficient) manner than what was previously accomplished.

The resources that a larger group possesses may allow the physicians within the merged group to attain goals and advance their practices beyond what would have been attainable prior to the merger. The increased financial resources of the group may allow the group to purchase major medical equipment, recruit higher level management, offer additional ancillary services and recruit additional physicians.

With proper planning, the size of the group should also allow for economies of scale in the use of its space, equipment, staff, supplies and ancillary services. A larger group practice can save money through the elimination of duplicate services. For example, in the merger of four practices, instead of having four billing systems, four attorneys and four accountants, the merger of group practices will lead to only one individual providing each of the aforementioned functions, thereby saving the merged group money. Group purchasing and marketing activities may also be handled more cost-effectively.

A large group practice should be able to tap its resources to obtain the computers needed to access information that is increasingly important to managed care entities. As information related to patient satisfaction, peer review, quality assurance and utilization management become increasingly important, those practices who have this data available will have a better chance to succeed. This will also make the merged group more attractive to such payors, possibly enabling the physicians to obtain better payment rates than they received prior to the merger.

Finally, having a larger group practice provides each individual physician with financial protection in the case of death, illness or disability. Whereas a sole practitioner might have had to have a “distress” sale upon death or disability, he or she will now have a definitive purchaser for his or her interest in the group and the backing of the resources of the group in such a purchase.

Disadvantages

As you can see, there are many benefits to a successful merger. However, there are also obvious disadvantages to a group practice merger, and certain issues that should be highlighted in the discussions leading up to the merger and in the formal merger documents.

The hardest factor to deal with for most physicians who are merging into a larger group is the diminishment of control and autonomy. It is sometimes hard for a physician who has had control of his or her own sole practice, or who has been the leader of the small group in which he or she was a partner, to now work as part of a team towards the greater good of the group, as opposed to promoting the physician’s own needs. It is a must that these issues be handled in the legal documents prepared to memorialize the merger (to be discussed below). These documents will need to set forth the power that each individual has within the group.

Linked to the concern of diminishment of control is that individual physicians will now have to deal with the management structure inherent in larger organizations. If a physician wants a new copier, in most instances he or she will not be able to simply go out and purchase one for his or her office. There will be a hierarchy that the physician will have to go through in order to make such an equipment purchase. This may be a dramatic change for a physician who never had to report or “answer” to anyone.

Another disadvantage of a group merger is the possible cross-purposes regarding markets and patient population. It is integral in initially examining a merger to determine whether the end goals of each of the physicians and groups participating in the merger are “similar” (they do not have to be exactly the same) in serving markets and patient population. If each of the groups has a different expectancy as to what the merger will accomplish in expanding their practice and approaching third party payors, the parties will be disappointed as to the results of the merger after it takes effect.

Another major concern in a group practice merger is the possible incompatibility of the physicians and practices merging together. This incompatibility can take many forms. For example, one physician group may be from the “old school,” where physicians were expected to work eighty hour work weeks, whereas another group may consist of physicians who place more value on spending time with their families. In addition, the “leaders” of each group that is merging may disagree in making major decisions on behalf of the group. We have also seen that there are sometimes one or two physicians in a larger group that disagree with almost everything that the group decides to do, and this is often a difficult problem to deal with. The problem of incompatibility is often seen in multi-specialty practices where the desires of each of the different specialists may not necessarily coalesce into a uniform whole.

Group practice mergers take time, effort and money. From the start of initial discussions to signing final documents, the practice merger may take anywhere from between six to eighteen months. The physicians must expend a lot of effort during this time, as they will be the principals in negotiating the deal and attempting to mold their discussions into agreements that embody the terms that form the basis of their deal. Practice mergers require capital to fund the legal, accounting and consulting fees that are expended in bringing the group together and in capitalizing the group to move forward into the future. However, these are necessary expenditures that must be made to make sure that the practice merger is done properly.

Traps To Avoid

It is the job of the physicians, attorneys, accountants and consultants, working together, to accentuate the advantages and minimize the disadvantages of a practice merger. This must be done in the structural development of the group practice and in the legal documents. The following list contains specific issues that should be addressed in the legal documents associated with a practice merger:

• Ownership. Many disputes arise as to how ownership of the merged practice will be divided among the merged physicians. Please note that the percentage ownership interest that a physician has in the entity does not necessarily have to correspond to the voting power of the physician in governance issues. For example, where two groups are merging together, a value can be placed on each individual group, and the ownership interests can be based upon these valuations. However, this does not necessarily mean that the physicians will not have equal voting power, because different methods can be used (such as having voting and non-voting stock in a professional corporation) to make sure that the capital and voting issues remain separate.

• Governance. Although the bylaws may look tedious and boring, it is important to understand voting rights and the issues that need to be approved by the officers, directors and/or shareholders, respectively. Key issues such as amending the bylaws, acquiring other practices and selling all of the assets of the practice should be made by the shareholders. Other major issues, however, may be decided upon by the directors, and the basic day-to-day issues should be left to the officers. It is also wise in many instances to create sub-committees of the board of directors to deal with specific issues, thereby attempting to get everyone in the group involved. Also, deciding what issues need a mere majority vote, unanimity, or something in between is very important.

• Compensation. Obviously, each physician involved in the practice merger will want to know what the practice merger will mean in terms of income. There are a variety of physician compensation formulas that address the division of income, and it is beyond the scope of this article to go into each one of them here. Please be aware that such compensation structures must be developed with both the tax impact and the fraud and abuse/Stark II consequences in mind.

• Liability Issues. It is important that the respective parties entering into a practice merger agree to indemnify one another for liabilities that arise which predate the merger. These liabilities should not be imposed upon the merging parties due to the practice merger.

• Fraud and Abuse. It is important to examine the various arrangements possessed by each of the physicians entering into a practice merger to ensure that these arrangements abide by federal and state fraud and abuse laws. It is important that competent legal counsel be engaged to ensure that compensation and ownership structures comply with the Stark II legislation, federal Anti-Kickback Statute and state self-referral laws, if applicable.

• Reimbursement. It is important to work on establishing assignment accounts and contacting managed care payors to notify them of the changes brought about by the merger once the deal has been agreed upon (before the actual closing, if possible), so that the merged practice gets a head start on receiving proper reimbursement. It is also important to examine the managed care agreements that each solo practice or group has, and how these different agreements may affect the merged group if one party is getting reimbursed less than one of the other members of the group. If there is a commitment to full integration, one profile would be established. It is important to emphasize reimbursement more than fees. A combined profile will help a practice whose fees are not competitive (too low). In addition, the group will have to decide how decisions as to negotiating new and continuing existing managed care contracts will be made. Do it right from the start!

• Taxation and Benefits. It is important to attempt to structure the merger in such a way so that there is little, if any, tax impact on the merging parties. This will be part and parcel of the decision as to how to best accomplish the merger and whether to make the new entity a partnership, professional corporation (S-corporation or C-corporation) or a limited liability company.

• Benefits Issues. There will not be separate practices anymore; there will be one unified group. All employees (physician and non-physician) will be employed by one entity. It is important to analyze the different benefit plans that each solo practice and group provides before the merger so that decisions can be made as to what will be continued after the merger. In addition, in one of the more highly contested issues of a group merger, the decision as to which retirement plan will continue must be made. Disposition of the predecessor plans also needs to be addressed.

• Antitrust. It is important to analyze the Agreement from an antitrust perspective, as there are potential price fixing, boycott and monopoly issues that might arise. These issues depend upon the number of physicians that are included in the practice merger, the geographic areas involved, the patients served, etc.

• Office/Personnel. In some instances, the merged practice may not need all of the locations or personnel that existed prior to the merger. This can be the subject of heated debate, and if a decision is made to keep all of the offices and personnel, it is important that the merged practices understand how these issues can be changed in accordance with the terms of the governance documents.

As you can see, a group practice merger is not something that is to be taken lightly. It is like a marriage. It takes time, effort, commitment and money for it to work. But when it does, it results in something successful and long-lasting. Our advice to all physicians is to keep your eyes open—there are a myriad of issues that must be addressed in order to attempt to make the parties comfortable as they enter into the merger and to ensure the group’s success after the merger. The physicians entering into the merger must expect and anticipate that changes will occur. Although the merged practice will be different, it does not necessarily mean that it must be worse than prior to the merger. Time, effort and commitment to a practice merger will result in a group practice that is poised to meet the health care challenges of the next century.

Vasilios (Bill) Kalogredis, J.D., C.P.B.C., C.F.P., is a health care attorney and consultant. He is president and founder of Kalogredis, Tsoules and Sweeney, Ltd., and Professional Practice Consulting, Inc., both in Wayne, PA. Michael Burke, J.D., is an associate health care attorney with Kalogredis, Tsoules and Sweeney, Ltd., and a consultant with Professional Practice Consulting, Inc.