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Legal guide for acquiring a medical practice

By Daniel M. Bernick, JD, MBA

Buying a medical practice can be the most stressful transaction that a physician ever undertakes. The dollars and obligations are big and the pitfalls are many. Here is a practical legal guide for those about to embark on the journey. It is written from the perspective of the buyer.

Consult Your Advisors Early

Line up and consult your “advisory team” before discussing price or other terms. Too often, the attorney or consultant is consulted after the basic deal terms have been discussed or agreed, making it impossible for the advisor to help on anything major. More dollars can be squandered in a split second negotiation over price than can ever be recovered when negotiating the fine print of the legal documentation.

Certainly, getting advice late in the transaction is better than getting no advice at all. It is also true that many “misunderstandings” can be worked out by closing. However, issues that are not resolved until just before closing may not be resolved in your favor; as the deal progresses you will feel more heavily invested in terms of time and money (i.e., attorney and consultant and accounting fees), and more reluctant to back out if seller “hardballs” you on a key issue at the last minute. The moral of the story is know your concerns up front, and resolve them early.

Specify All Major Deal Terms Up Front

Typically, the first item discussed and agreed is the purchase price, before such other items as structure (asset sale versus stock sale), tax allocation, payment terms, collateral and post-sale employment of seller. Yet these other issues may dramatically affect your pricing decision. Paying $500,000 for a stock sale is a lot different than paying $500,000 in an asset sale, in terms of tax write-offs. So is paying $100,000 for equipment and $400,000 for goodwill versus $400,000 for equipment and $100,000 for goodwill (again, the tax write-offs). So, an offer for the practice should be in an outline, letter of intent or other writing specifying all major deal terms.

Asset Sale or Stock Sale

First, the tax considerations. Sellers love stock sales since all the gain becomes taxable to them at capital gains rates. However, stock sales are bad for buyers because stock is not a depreciable asset. Buyers gets no tax deductions for any of the purchase price. Therefore, buyers almost invariably want to buy assets rather than stock. Depending on the tax allocation of the purchase price among the assets acquired (equipment, supplies, receivables, goodwill, consulting payments), buyers can dramatically increase the write-offs from the transaction, thereby greatly reducing the after-tax cost of the purchase. Consult your tax accountant or attorney for further details.

Another thing about stock sales: they carry with them not only the assets of the medical practice corporation, but also its liabilities. This includes not only the accounts payable, but also such latent items as not-yet-filed malpractice lawsuits and future fraud investigations into previously submitted Medicare claims. This is yet another reason why buyers prefer asset sales, in which all liabilities can be specifically excluded.

Because of these negatives for buyers, nearly all practice purchases are done as asset sales. Of course, there are exceptions, such as when the corporate entity has a valuable asset that cannot readily be transferred in an asset sale. For instance, the corporation may have a long-term space lease at a very favorable rate which can be terminated by the landlord if a seller attempts to assign it to a buyer in an asset sale. Structuring the transaction as a stock sale means that the landlord may not have the ability to terminate the lease when the practice is sold to you.

What Are You Buying?

Make sure you understand fully what it is you are buying. Frequently, buyers and sellers haggle over the purchase price and agree on a number, only to discover later, when the attorneys are preparing documents, that maybe it isn’t so clear what is being bought and sold. Thus, before you make an offer to the seller (or accept one of his), make sure that you have specified what your offered price includes and excludes.

For instance, if you agree to pay $500,000 for seller’s “medical practice,” does that mean you will be entitled to the accounts receivable? What about ancillary businesses, such as an optical shop or cosmetic skin care business? What about deposits on equipment leases and space leases? Who is responsible for refunds on previously submitted claims? It is surprising how often disputes arise on these issues, long after the parties thought they had “agreed in principle” on the major terms of the deal.

Choose An Entity

It is generally advisable in today’s liability-filled world to operate your medical practice through a limited liability entity, whether C-Corporation, S-Corporation, or limited liability company. Whatever your choice, make it early, as the legal documentation and structure of the transaction will be affected. Be sure also that your corporation or other entity is a signatory on the promissory note; otherwise, the interest you pay to the seller will be non-deductible.

Provider Numbers

Don’t negotiate to get the seller’s provider numbers. This may be tempting, since getting new numbers may delay your post-sale billings at a time when your cash needs are critical. Yet, use of a seller’s provider numbers means that Medicare and commercial payors will hold you responsible for any prior overbilling by the seller, even if this occurred well before the first day you set foot in the practice.

Therefore, if you know you are going to buy a practice, form your limited liability entity early and apply early, well before closing, for your new numbers.

Note: if you won’t get all your provider numbers in place by closing, it isn’t generally fatal. You may bill Medicare retroactively for services rendered as much as a year in arrears. Commercial payors may be more of a problem. Some require that the payor be billed within 60 or 90 days of the date of service, or not at all. Again, get those provider numbers early, and obtain a line of credit to help pay expenses if your provider numbers are not ready in time.

Financing

Sellers naturally prefer to be paid all cash at closing, even if that means you must borrow from a bank. However, it is generally preferable for a buyer to have the seller finance part of the sale. This helps ensure that the seller is cooperative after the sale, on Day 1, Day 30, even Day 180 or Day 365. If the seller gets all his or her money upfront, he or she has little economic motivation to cooperate on any little (or not so little) issues that arise post-sale.

Negotiating a Lease

Most commercial real estate leases have a clause which prohibits the tenant from assigning the lease or subletting the space without landlord’s permission. Therefore, chances are good that you will not be able to take over the old lease, particularly if it has favorable rent terms. Instead, you will have to negotiate a new lease. And, if you commence such negotiations late in the game, after you have spent big dollars on legal and consulting fees on your practice acquisition, you may have limited ability to walk away from a hardballing landlord. Get the landlord pinned down on basic terms well before you reach final agreement with the seller on purchase of the practice. Then, if landlord hardballs you, you can threaten to walk away from the entire deal.

Security and Collateral

Sellers are (with good reason) very concerned about collateral, unless of course they are getting 100 percent cash at closing. If the seller is financing a portion of the purchase price, expect a demand for a security interest in the medical practice being acquired, including its future receivables. You may also receive a demand for a second security interest in your house, collateral assignment of your life insurance policy, signature of your spouse on the promissory note, and “confession of judgment” clause. All of these are fair game in the wild and woolly world of business purchases. Consult with your attorney to determine how far you’ll go to satisfy the seller, and where you’ll draw the line.

Note: if the seller wants a security interest in your medical practice, make it clear that his or her security interest takes a back seat to any bank loans that you will be taking out, such as loans to help with the down payment on the practice, or equipment purchases, or line of credit. Banks insist on having first claim on this collateral. Without it, you won’t get any bank financing at all.

Escrows and Offsets

Your asset purchase agreement will have a long list of “Seller Representations and Warranties.” This is where the seller makes important promises that he or she has good title to the assets being sold, that there are no undisclosed liabilities, that he has paid all his taxes, that the equipment is in operable condition, and so forth. The concept is that you are buying the practice based on the seller’s assurances on these matters, and that if the goods are not as promised, the seller will make it up to you with some money back.

On the other hand, if the seller has gotten 100 percent of the purchase price in cash at closing, it can be tough for you to get that money back. Therefore, talk to your attorney about holding some of the purchase price payments back, in an escrow fund, or providing in the promissory note to the seller that you have the right to “offset” your claims for breach of representations and warranties against the purchase price payments that are still owed to the seller.

Post Sale Employment of Seller

How long do you want the seller around post-sale? This varies from sale to sale. Sometimes a buyer has been working in the practice for several years, and is therefore well-known to patients. In this situation, it may not be overly alarming to patients if the seller exits soon after the sale. This may also be desired by buyer, since longtime practice employees will probably never fully transfer their loyalty to a buyer as owner until the seller is gone. Also, there may not be sufficient patient volume to keep both buyer and seller busy, post-sale. In such cases, the seller should probably stay no longer than six months post-sale. In some practice transfers, it is desirable for the seller to exit immediately, such as when the seller is ill, is a malpractice risk, or has already cut back his involvement in the practice significantly.

In other situations, it may be desirable or necessary for the seller to stay longer. For instance, if the seller is financing the sale, he may insist on an extended post-sale employment period, to make sure that the practice stays intact long enough for a buyer to finish making the purchase price payments.

Daniel M. Bernick, JD, MBA is a shareholder in The Health Care Group and its affiliate Health Care Law Associates, P.C. in Plymouth Meeting, Pa.

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