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What Physicians Should Know Before Selling Their Practice to a Hospital

By Lucia Francesca Bruno, J.D., LL.M., M.B.A.

For a long time, third-party reimbursement allowed most private practice physicians to go it alone and earn a decent living from insurance carriers and government-sponsored health programs; regrettably, that is no longer the case.

In today’s ever-changing world of healthcare reform, bundled payments, and Accountable Care Organizations, many private practitioners have come to the stark realization that private practice may soon be a thing of the past.  Most are convinced that the best way to stay ahead of the pack is to sell out to a hospital, health network, or other alternative healthcare system.

Motivational Factors for Selling Out

Common motivational factors that drive practice sales are: quality of life issues; job security; access to additional resources and state-of-the-art equipment; assistance with administrative and staffing needs; and higher reimbursement rates.

While the plethora of benefits appears to outweigh the disadvantages, sellers are forewarned that all that glitters is not gold.  The process of selling out is time and labor intensive, and requires significant planning to secure an arrangement that is both personally rewarding and financially advantageous.

Form of Purchase

The acquisition of a practice can be accomplished through the purchase of stock or the purchase of assets.  The purchase of stock is commonly used when an employee of the practice seeks to become a full or partial owner.  In a stock purchase, the buyer not only acquires the assets of the practice, but its liabilities as well, e.g., contractual obligations to employees, accounts payable, and malpractice actions.  Conversely, the purchase of assets is more prevalent when the seller wishes to close the practice and retain the accounts receivable, but the buyer does not wish to take on the liabilities of the practice.[1]

Structure

While the complexity of the transaction varies with the size and specialty of the practice, there are several ways to structure the acquisition: (i) The hospital acquires the assets of the practice, with the physicians and staff remaining employees of the practice, and the practice retains its identity as a separate entity; (ii) The hospital acquires the assets of the practice, with the physicians and staff becoming employees of the hospital, and the practice ceases to exist; and (iii) A hybrid model, where the staff becomes employees of the hospital, but the physicians remain with the practice which retains a separate existence.[2]  Since there are tax implications unique to each structure, parties to the acquisition are encouraged to consult with a tax advisor in order to ensure fair results for both sides.

Saleable Assets of a Practice

Medical practices have only three elements of value: hard assets; accounts receivable; and intangible assets.  Before contemplating the sale of a practice, sellers are encouraged to identify their assets and have a realistic expectation of their worth.

Hard assets include items such as diagnostic and laboratory equipment, examination tables, desks, computers, and drug inventory. The value of hard assets varies amongst practices and is driven by liquidity.  Liquidity is the measure of how fast an asset can be converted into cash in the current market, i.e., the harder an asset is to sell, the lower its liquidity.

Accounts Receivable is the uncollected revenue for services rendered and billed by the physician.  Patient copayments, coinsurance, and deductibles make up a growing percentage of the total dollar volume of a practice’s receivables that can remain on the books for months before payment is received.

Intangibles assets, commonly referred to as goodwill, is the biggest component of a practice’s value.  Goodwill consists of the profitability and economic soundness of the practice, location, reputation, staff and systems in place, and patient-payer mix.  Not surprising, the saleable nature of goodwill continues to be controversial.  Nonetheless, payment for goodwill has been found to be appropriate where the amount did not exceed fair market value, and did not account for the value of referrals.

Valuation Methodologies

Practice valuation is a complex and time-consuming process.  When referring to the valuation of a practice, it is important to distinguish between “value” and “price.”  Value is determined; whereas, price is the actual dollar amount for which the practice sells.

There are three general approaches to valuing a practice:  (i) Asset-based, commonly referred to as the cost approach; (ii) Income-based, also known as the discounted cash flow method; and (iii) Market-based.  Irrespective of the methodology, all valuations should be supported by written documentation clearly identifying the formulas used so non-expert readers can follow the appraiser’s reasoning and verify the numbers.

Hospital Employment and Compensation

In most instances, the purchase of a practice is contingent on the partners of the practice becoming employees of the hospital for a designated period of time, usually one year.  Although state and federal anti-kickback laws require physicians to be compensated at fair market value, most hospital employment agreements allow for an income guarantee period consistent with the physician’s practice earnings from the previous year.

Unfortunately after the income guarantee period ends, compensation is comprised of a base salary reflective of compensation data published by the Medical Group Management Association or the American Medical Group Association, plus an additional payment for productivity measured by total Relative Value Units (“RVUs”), which accounts for all the physician does, or work RVUs based on patient-physician encounters.

The biggest danger hospitals face in a practice acquisition is the risk that newly-employed physicians will fall short of critical economic and service-related goals.  If productivity targets are missed, physicians aren’t likely to lose their jobs; however, take-home pay will undoubtedly be on the low side.  Physicians should be on the lookout for hospital employment agreements that contain clawback provisions permitting a percentage of compensation be withheld if RVU targets are not met.

Finally, physicians may also be eligible to receive a quality incentive bonus for achieving the organizational and service goals of the hospital, e.g., improving patient satisfaction, adherence to best practices, core measure compliance, and outreach participation.

Regulatory Compliance

There are a plethora of compliance issues which must be addressed when structuring the sale of a medical practice.  Parties to the acquisition must ensure that the transaction is compliant with state and federal anti-kickback laws, self-referral legislation, anti-trust laws, as well as state-specific corporate practice of medicine laws, and certificate of need laws.

Anti-Kickback Statute

The federal Anti-Kickback Statute, 42 U.S.C. §1320-a7(b), governs a vast array of transactions in the healthcare industry.  In the most simplistic terms, the Statute prohibits payments or remuneration to any person in return for the referral of patients covered in whole, or in part, by Medicare or Medicaid.

Amongst the 23 safe harbors promulgated by the Office of the Inspector General (“OIG”), several are applicable to the sale of practices: (i) the equipment rental or office space safe harbor; (ii) the employment safe harbor; (iii) the personal services safe harbor; and (iv) the sale of physician practices to hospitals in underserved areas safe harbor.

It is important to note that failure to comply with a safe harbor doesn’t necessarily mean that the transaction violates the Statute.  Instead, each transaction is subject to examination, on a case-by-case basis, to determine whether any portion of the payment was disguised as remuneration for the inducement of referrals.

STARK

The Stark Law (“STARK”) prohibits the making of referrals or the billing for payment for certain designated health services (“DHS”) covered by Medicare or Medicaid if there is a financial relationship between the referring physician (or an immediate family member of the physician) and the entity receiving payments for DHS, unless the relationship comes within one of the many enumerated exceptions.  Unlike the Anti-Kickback Statute, STARK requires strict compliance with each exception.  Any arrangement that does not meet each element of an exception constitutes a violation of STARK.

In a practice acquisition, payment of the purchase price creates a “financial relationship” between a physician-seller and the hospital-buyer.  While physician services are not DHS under STARK, it is important to consider whether such services are involved, either from the seller or buyer’s perspective, in order avoid penalties under the law.[3]

Fair Market Value v. Commercial Reasonableness

Fair market value (“FMV”) is a business valuation concept that has significant implications for transactions involving healthcare providers.  FMV is the price at which property would change hands between a hypothetical willing and able buyer, and a hypothetical willing and able seller, acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.[4]

Commercial reasonableness is a separate analysis beyond that of fair market value.  Several exceptions to the general prohibition under STARK require that arrangements be “commercially reasonable.”[5]   Whether a transaction is commercially reasonable requires a look into the underlying economics of the transaction, without taking into account the potential for referrals between the parties.

An arrangement will be considered ‘‘commercially reasonable,’’ in the absence of referrals, if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope and specialty.[6]

Tax Exempt Issues

In a practice acquisition, either the seller or the buyer or, in rare instances, both may be tax exempt under Section 501(c)(3) of the Internal Revenue Code.  To qualify for 501(c)(3) status, the agency must be organized and operated exclusively for exempt purposes, and none of its earnings may inure to any private shareholder or individual.[7]

Accordingly, a non-for-profit hospital may acquire the private practice of a physician provided that such acquisition is consistent with the charitable purposes of the hospital, such as providing a community benefit, and the hospital pays no more than fair market value for the practice.  Compliance with tax exempt requirements is essential to avoid losing 501(c)3 status as a result of the transaction.

A Word of Warning

Despite valiant attempts to remain compliant, copies of relevant documents should be retained by both parties to the acquisition in the unlikely event that the transaction is scrutinized by the OIG or IRS.  Relevant documents include: (i) the Asset Purchase Agreement and Employment Agreements; (ii) copies of valuation reports describing the methodology used to determine fair market value; (iii) all financial records indicating the amount of remuneration, the method of payment, and whether the amount was based on value or volume of referrals; and (iv) any documents which satisfy the requirements of an Anti-Kickback safe harbor, STARK exception, or 501(c)3 exemption.

Conclusion

Selling a medical practice is no easy task.  It is often difficult to give up the autonomy of a private practice and work under the direction of a large organization.  Since the sale of a practice is for all intents and purposes irrevocable, physicians are encouraged to think long and hard before signing on the dotted line.  It is important to hire an experienced healthcare attorney, accountant, and financial advisor to oversee the acquisition process.

 

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Lucia Francesca Bruno, J.D., LL.M., M.B.A., is Principal Shareholder of Physicians’ Legal Group, LLC (www.physicianslegalgroup.com). She can be reached at Lbruno@physicianslegalgroup.com.


[1] Carol W. Phillips, “Buying and Selling Medical Practices,” 2009.

[2] Dennis J. Alessi and Constantina Koulosousas, “Issues to Consider in Selling or Leasing a Medical Practice to a Hospital” (August 2011) at http://www.eisneramper.com/medical-practice-sale-lease-0811.aspx.

[3] Carol W. Phillips, “Buying and Selling Medical Practices,” 2009.

[4] International Glossary of Business Valuation Terms, The Institute of Business Appraisers, at : http://www.go-iba.org/glossary.php

[5] 42 U.S.C §1395nn(e)(1)(A)(v).

[6] 69 Fed. Reg. 16,093 (March 26, 2004).

[7] IRS Exemption Requirements – Section 501(c)(3) Organizations at http://www.irs.gov/charities/charitable/article/0,,id=96099,00.html/.

One comment

  1. Great article, especially explaining some of the legal concerns.

    At U.S. HealthWorks, we have acquired 50+ practices (mostly occupational medicine and urgent care clinics) over the last few years. We gained a great deal of insight and perspective while working with different sellers all over the country. Based on this experience we put together some tips for sellers from a buyer’s perspective that can help make an complicated transaction a bit smoother.

    The link is below and hopefully it can be as helpful as Lucia’s article:

    http://www.ushealthworks.com/Docs/US%20HealthWorks_Tips%20for%20Selling%20Your%20Practice.pdf

    Scott Witter
    Director of Business Development
    U.S. HealthWorks

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