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Legal guide for selling a medical practice

By Daniel M. Bernick, JD, MBA

Earlier this year we presented a legal guide for buyers of medical practices. This article reviews the sales transaction from the seller’s perspective.

Specify All Major Deal Terms Upfront

In the earlier article, we advised buyers to specify all major deal terms (asset sale versus stock sale; tax allocation; payment terms; collateral; and post-sale employment of seller) upfront. The same advice applies doubly to sellers, since it is customary for seller, not buyer, to “go first” in terms of putting an offer on the table. While this puts the onus on you as seller to pin down all of the many variables (price, terms, etc.), treat it as an opportunity, not a burden. You have the opportunity to control the transaction and the way in which your business of 20 or 30 years and your transition to retirement or a new career is handled. Of course, what you want and what you can get may not be the same. That is where your advisors come in. They help you arrive at a price and deal terms that will attract buyers, yet meet your objectives.

Asset Sale or Stock Sale

As indicated in the earlier article, stock sales are more advantageous for you, from a tax perspective, but buyers generally prevail in getting the asset sale structure. One potent argument that you can use in favor of the stock sale is that it ensures uninterrupted cash flow. If buyer buys assets, he or she will have to get new provider numbers, and depending on timing, these provider numbers may not be available on post-sale day one. Medicare numbers can take six months or more to obtain. And although Medicare permits retroactive billing, once the provider number is obtained, many commercial payors do not. If there is a one or two month delay in obtaining a commercial provider number, buyer will have to see those patients for free, until the new provider number comes through.

Another advantage of the stock sale that you can market to the buyer is that it may enable buyer to continue your long term, favorable space lease. With an asset sale, the landlord will almost surely, under the terms of the lease, be able to terminate it and negotiate a new lease with higher rents.

Buyer may remain concerned, based on conversations with his health care lawyer, that use of your provider numbers (particularly the Medicare number) via a stock sale, is a bad idea. Medicare or the commercial payor will hold buyer’s newly acquired corporation responsible if there are any overpayments due back to the payor. The overpayments will be deducted from any new claims submitted by buyer. What you can do to address this concern is offer to leave some money in escrow, or allow offsets against the purchase price installment payments, if such liabilities come to fruition.

What Are You Selling?

In a stock sale, all corporate assets will transfer to buyer. In an asset sale, only assets enumerated in the asset purchase agreement are sold, but frequently buyer’s attorney will want all-encompassing language that sweeps in anything and everything of value. Therefore make sure in the documentation that you explicitly remove from the transaction all assets that have personal or nostalgic value, including (potentially) office artwork or your office furniture. Also try to exclude, if you can, deposits on your equipment and space leases, so that these amounts come back to you rather than to buyer.

What about receivables? Should these be included? They will automatically be included in a stock sale, but not necessarily in an asset sale. Generally, I leave them out in the initial presentation, as this makes for a smaller asking price, with a notation that if buyer wants the receivables they can be purchased, for an appropriate additional fee.

Financing

We normally recommend that seller demand at least 50 percent of the purchase price upfront, in cash. This helps out the “tire kickers” early. It also makes sure that buyer has some “skin in the game,” and will not walk away from his payment obligations to you if he or she has a rocky start. Get the remainder of the purchase price as quickly as you can, within 24 to 60 months, with interest at prime plus one to two percent.

Security and Collateral

Unless you are getting 100 percent cash at closing, you need collateral or other security to ensure that you get what is owed to you. Getting at least 50 percent cash as recommended above is the first step that you should take to protect yourself. Other valuable protections, listed from most protective to least protective, are as follows:

Second security interest in buyer’s house, with spouse’s personal guarantee of purchase note. Realistically, if buyer defaults, you may not be able to recoup much from the house, since the mortgage lender has priority. Nonetheless, the fact that you have the second security interest is a great “motivator” for buyer; if he defaults on his payments to you, you can trigger foreclosure of the home, even if buyer has managed to keep up with his mortgage payments.

Spouse’s personal guarantee (but no second security interest in house). This enables you to get a judgment against bank accounts held jointly by buyer and spouse.

Confession of judgment. If buyer defaults on his or her payments to you, the confession of judgment clause allows you to obtain a judgment and start levying on buyer’s assets without having a prolonged legal battle with buyer about whose fault it is that buyer defaulted. (Without the confession of judgement, you must bring a “regular” lawsuit in which buyer can defend himself by claiming that the money that he has failed to pay you is offset by the damages that buyer has suffered from your “misrepresentations” in the asset purchase agreement or from your other breaches of that document.)

Collateral assignment of policy on buyer’s life (buyer should pay the premiums, not you).

Security interest in all practice assets, including equipment, goodwill and accounts receivable (including accounts receivable generated by buyer after the sale date). This is a standard clause in practice sale agreements. However, it has limited value if buyer must borrow significant monies from a bank to fund his or her downpayment on the practice purchase or provide initial working capital. Such a lender will insist on first priority in all practice assets, so you will be in a distant second place, with little or no equity on which to foreclose.

On the more innovative side, talk with your attorney about a “sweep account” mechanism. This is not often seen in small practice sales, but it has been frequently employed by management companies in their relationships with physician practices. An arrangement is set up where buyer’s practice receipts are deposited in a pre-designated “lockbox” account. By pre-existing arrangement, the deposited funds are instantly swept into an account controlled by seller. Seller deducts a pre-agreed percentage (to be credited against the fixed dollar amounts owed to seller by buyer), then seller remits the rest back to buyer. In this way, seller assures that he or she is paid before buyer or buyer’s employees! This is a tough sell to buyer in most instances, but if you are taking a small downpayment it may be essential to ensure that you are in fact paid what buyer owes you.

Representations and Warranties

As explained in the earlier article, your asset purchase agreement will have a long list of “Seller Representations and Warranties.” Make sure that these provisions state that buyer is buying your equipment “as is.” Avoid language providing that your financial statements “fairly represent” the past performance of your practice, since buyer may use this later to say that he bought your practice in reliance on financials that turned out to be “false.” Wherever possible, avoid statements that “there are no liabilities” associated with your practice (reimbursement, tax, employee relations, environmental, etc.); this language makes you strictly liable if such liabilities come to fruition, after the sale. Instead, say “to the best of your knowledge” these liabilities do not exist; then if you in fact had no prior knowledge of the liability, you cannot be held responsible for it, once the sale is complete.

Post Sale Employment

Generally, it is not a good idea for seller to continue with the practice, post-sale, as buyer’s employee, for more than a month or two. Buyer will often want to make changes in the office, and put his or her imprint on the new acquisition. Most sellers resist such changes; they have been running their own show for too long to submit to changes made by someone else.

The exception is where seller is continuing with the practice for the express purpose of managing it. Buyer may not have great management skills, so if seller wants to make sure that he gets his purchase price payments, he needs to run things until the debt is paid off. In this event, seller should get explicit rights in terms of ability to make management decisions. This is a tricky area; buyer will likely resist your request for iron clad management rights. He will likely feel that as the new owner he (not you) should have the ultimate right to make the key management decisions.

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, Pennsylvania.

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