Reed Tinsley, CPA

Another take on physician practice merger due diligence

By now the merger committee has the due diligence process underway. The merger team has been interviewed and assembled. The initial funding for this due diligence process has been estimated and funded. The treasurer responsibilities have been assigned for reporting of these premerger costs. The merger committee has established its methodology for communications and established a meeting schedule for the committee as well as the merging entities. Individual physician members have been interviewed or surveyed in reference to the benefits they hope to derive from the merger as well as any issues, which are of concern for them. The merger facilitator has compiled this information and communicated it to the merger committee, which is utilizing this information to not only assess the viability of continuing with the merger but hopefully to develop its vision or mission statement. The committee has drafted and executed a letter of intent in reference to the merger, which outlines basic responsibilities for everyone. The information requests have been sent to each merging entity with instructions and timelines for submission. The committee is scheduled to complete the assessment of premerger legal issues in reference to the merger and will be reviewing possible organizational structure options with legal counsel and the CPA. As information begins to be assembled, the merger committee will prioritize the common deal killers to be addressed early on in the due diligence process.

The issues incident to a merger are for the most part very similar, regardless of the number of physicians or merging groups. However, the greater the number of entities that are party to a merger, the more difficult, costly, political and lengthy the merger process will be. When more parties are involved, it requires getting resolution on more issues by more decision-makers.

The merger committee must take this into consideration during the due diligence process. For example, it might appear to be very beneficial and even seem practical to merge six practices at one time. However, close scrutiny should be made as to what this will do to the complexity of the merger, the reasonableness of doing this all at once and the significant change in culture that will occur. It may be more advisable to take the two or three medical practices which share the most common culture and important attributes to be the first entities merged with the other medical practices being merged in at an agreed upon later date. The merger model established with the initial practices helps facilitate the latter mergers, which can be more difficult if there are more significant differences between the groups. This is an option, which the merger committee must always consider. Sometimes it can be too daunting of a task for management and the merger team to facilitate a merger of numerous groups all at once. Another option that is available to the merger committee in these types of situations is the ability to negotiate and execute the merger for a large number of groups; however, the actual implementation and consolidation of operations occurs over an extended period of time.

The merger of your practices may be very practical and offer some extremely attractive benefits; however, as we have stated several times, this is a very complex process and the critical issue of completing a thorough due diligence process rests solely upon the merger committee’s shoulders. If your merger committee members are not truly prepared to invest the time, money and effort into this due diligence process, your chances of seeing a successful merger are very, very slim. Never discount the importance of writing and continuously reviewing your vision statement to keep the merger process on track and focused toward the benefit that started the process initially.

How Does a Physician Merger Process Typically Work?

Merger processes involve a number of discrete yet inter-related steps. The general process is typically one of: 

Getting comfortable with each other

Understanding each others philosophy of practice

Due Diligence

Discussion and negotiation of key merger issues

Developing agreements in principle

Closing the merger

Implementing operational integration plans 

The specific steps of the merger effort are generally as follows: 

Friendship and courtship: Prior to substantive discussions, the groups likely have made contact with each other via informal means. 

Commitment to move forward: At some point, the groups agree that they should "get down to brass tacks" and look at the merger in a more formal manner. 

Antitrust review: Depending on the local market, a first step for many groups is to engage an attorney to conduct an antitrust review. While the details of such a review are beyond the scope of this document, the group should seek experienced legal counsel in this area if there are any concerns about creating significant market power. 

Merger Committee appointment and empowerment: Unless the practices are very small, it wise to appoint a Merger Committee to do the bulk of the discussion and negotiation effort in the merger. It is desirable that the rest of the physicians empower this group to discuss and negotiate on the key merger issues. Typically this Committee includes one to three individuals from each of the groups. 

Hire a Merger Facilitator: This is a vital part of the process. You need an independent person doing your due diligence, asking the hard questions, identify critical issues that must be resolved so the merger can take place, and basically acting as a referee during the merger process. 

Confidentiality, non-competitive use, "no-shop" agreement: In order to protect their rights and the confidentiality of information, the groups should have their attorney draft a letter in which each group agrees to (a) Keep the other group's information confidential, (b) Use the information only for the purposes of merger negotiations and (c) Not seek or negotiate offers with others for a period of time. While this last point is optional, it can be important if the groups are going to expend significant resources during their negotiations. 

Initial data gathering: In order to improve the efficiency and effectiveness of the merger discussions, a significant amount of information must be gathered from each group. Such information may include practice documents and financial information. In addition, it is typically appropriate to have each physician and administrator interviewed or surveyed to identify any merger concerns that they may have. 

Perform due diligence: During this effort, the facilitator, attorneys and accountants review a number of practice related documents to identify any issue that might impact the merger from a legal perspective. 

Merger Committee meetings/retreat to review data, discuss and resolve issues: Using the information gathered in step 6, the Merger Committee meets to discuss, negotiate and reach agreements in principle related to the key merger issues. There are two alternatives in how this process may be conducted: 

a. For groups who have already had significant discussion or are very knowledgeable about each other, a Merger Retreat (typically 2 to 2 1/2 days) can be used to finalize agreements in principle. 

b. For groups who have the need for more in-depth discussion and negotiation, a series of meetings are held during which agreements in principle are made. During this effort other professionals (such as accountants, attorneys, benefits consultants, etc.) are involved as needed. 

Reach agreement in principle and execute Letter of Intent: Once most of the key decisions have been made, the groups execute a Letter of Intent under which they agree to merge under agreed upon terms unless certain events occur. This authorizes the groups to move forward with step 9. 

Create merger documents: Once agreements have been made, the attorneys will draft:

Merger Agreement (primary purpose is requiring each group to make full disclosure about its activities). 

New Entity Corporate Documents

New Entity Shareholder Agreement (Buy-sell)

New Entity Physician Employment AgreementsOther needed documents 

At the same time, the accountants will be developing the financial information needed to close the merger. 

Perform due diligence: During this effort, the attorneys and accountants review a number of practice related documents to identify any issue that might impact the merger from a legal perspective. 

Develop post-closing operational integration plan: The work I have discussed up to this point is focused primarily on the legal and organizational aspects of the merger. Once the groups are on track to merger an operational integration plan must be developed. 

Merge ("Day 1"): The day that the papers are signed and all are committed to move forward. 

Implement post-closing integration plan: The operational integration plan is implemented.

The Costs and Risks of Merging Physician Practices

While there are benefits to be gained, there are also costs/risks: 

-      Putting a merger together requires a significant amount of time from both the physicians and their administrative staff. Mergers often take six to twelve months to complete, and there are many issues to be discussed and decisions to be reached.

-      Professional costs (attorneys, accountants, consultants) are not insignificant. While professionals will seek to provide "ballpark" estimates at the beginning of the process, these estimates can change depending on the ability of the merger participants to negotiate and reach conclusions.

-      Many significant changes will (should) be required by all involved. It is not feasible to merge and keep everything the way that it was. Some level of operational integration will be required and this requires compromises by all involved.

-      It might not work. Anecdotal evidence indicates that 50% of all merger processes do not end in a merger. In some instances, this is a positive development as groups may not have the same long-term goals. In others, the lack of a disciplined effort to reach a decision results in people becoming frustrated with the lack of progress and dropping out.

-      External stakeholders might be uncomfortable with the merger. For example, hospital management may not be enthusiastic about a merger between hospital-based physicians. 

Even with these costs and potential negatives, many physicians have experienced that the benefits outweigh any risks. So move forward with your merger process and take control of your future.

Why Physicians Should Consider a Merger – A reposting

Since I’m up here in New York this week facilitating a merger between two orthopedic groups, this week’s posts will revolve around practice mergers. When I talk to the physicians this week, I’m going to be asking the question: “Why do you want to merge?” Although the specific benefits of merging are different for each different specialty, location and group, the following are some of the typical reasons groups seek to merge: 

• Job security, income stabilization.
• Increased negotiating clout.
• Additional coverage, specialties or sub-specialties to strengthen competitive advantage.
• Develop critical mass to initiate new programs.
• Continue to have access to patients where such access is threatened.
• Survival of the group in light of physician retirements.
• Secure system referrals.
• Attract capital.
• Improve ability to compete.
• First step in a plan for further integration.
• Economies of scale.

These are some of the answers I want to here this week. If I don’t, I will wonder where the “glue” is to create this new group. At the beginning, it is of key importance that all involved understand what the groups are trying to accomplish with the merger.

Questions every physician should ask before entering a practice merger

As the consolidation trend sweeps over the healthcare industry, many medical groups are considering strategic mergers with other groups in their region and/or specialty. In our experience, many physicians do not want their organizations to grow into larger entities (because of the increase in complexity, loss of autonomy, etc.). However, more and more groups recognize that in today's marketplace, bigger is often better in terms of providing cost-effective care and creating negotiating clout with managed care companies. 

Typically merger efforts begin with friendly and general discussions about shared interests and possibilities. Unfortunately, the merger effort often bogs down because either the groups do not know what to do next, or because of the lack of an organized effort. 

In order to be successful, physicians that embark on a merger effort should always make sure they get the answers to the following questions: 

• Why should we consider a merger?
• What are the costs and risks associated with merging?
• How does a merger process typically work?
• What are the key issues usually addressed in a merger process?
• Who participates in the merger process?
• How do we get started?

Developing a Merger Team for a Physician Practice Merger

Well, the first date turned out to be a good one and everyone wants to move forward.  The physicians have decided to form a merger committee, participants from the respective medical practices have been selected and everyone is raring to get started.  What’s next?  One of the first things the merger committee needs to do is to implement a merger team.  This merger team will be composed of legal counsel and the merger consultant and/or CPA (Certified Public Accountant).  One of these team members, usually the merger consultant, will facilitate the entire due diligence and merger process.  

This merger team member should be very familiar with medical practice mergers and operations.  The merger facilitator not only has the responsibilities for providing a formal structure to the merger negotiations and helping the groups adhere to a defined timeline but he or she will also have the responsibility to ask the difficult questions.   A facilitator with experience in health care and specifically, medical practice operations knowledge, will know what questions to ask and will understand potential solutions to some of these difficult issues.  Many of the critical issues to be debated and decided over the next few months require an in-depth knowledge of medical practice operations and the internal culture of medical practice groups.  The more knowledgeable the facilitator is of this, the smoother the merger process and due diligence will be.  It is very common for the potential facilitator to actually attend the first group-to-group meeting and assist the physician leaders with communicating the merger process, due diligence and necessary resources to all the physician members.   This also allows the prospective leader of the merger team to be involved in the process from the very beginning.   Having this experience on hand will help to eliminate some of the initial questions and concerns, which might arise during this initial meeting. 

Sometimes the question is raised: “Should the administrators or office managers serve on the merger committee or merger team?”  My experience shows that it is not advisable to place them on either team, although they will play critical roles throughout the process.  Merging groups tend to find better solutions when using an objective outside facilitator to assist in this difficult decision making process.  Obviously, these key management personnel will have significant input into the entire planning process.    They will attend and even help plan certain meetings and make recommendations to the committee and the merger team. It will be vital to keep them informed and included in the entire process.  Their approval of the merger plan needs to be gained at every phase of the process.  However, it is not advisable for them to be permanent members of either the committee or the merger team.  There will be times that the merger team and merger committee will need to address issues which will be hard for the respective administrators to be objective about.  

Each merging medical practice should then receive from the merger team a merger planning information request.  This type of information is needed for planning, creating, and implementing a successful merger.  The process of gathering this information needs to begin as soon as possible after formation of the merger committee.  

After the merger team and its responsibilities are established, the committee should set the communication protocol.  This protocol needs to outline which documentation will be retained and who will be responsible for taking meeting minutes.  Most importantly, the committee decides what information will be distributed to the physician members and when this distribution will occur.  My recommendation is that the actual minutes from the merger committee meetings be finalized, typed and distributed the very next day to all physician members.  There may be times when the merger committee needs to go into executive session for very controversial discussions; however, this should be the exception rather than the rule.  Also, the minutes of the meeting should only outline the eventual resolutions and agreements rather than documenting all discussions on the issues.  It is extremely important that the committee have good communication to all the physician members and that this communication is prioritized for timely receipt by everyone involved in the merger.  This will significantly enhance the entire process and increase the chances that the merger will be successful. 

Next, the committee needs to set its meeting schedule.  In order to keep most mergers on track; it is almost necessary to meet once a week.  Initially, it may be feasible to meet every other week for the first few weeks, but soon after that the committee will need to commit to a weekly meeting.  Weekly meetings are extremely important to keep the process on task.  Remember, the merger process is typically very long and a very difficult grind that requires extensive discussions in order to resolve the many issues that will arise.  My experience reveals that many parties harbor the misconception that their merger can be accomplished with just a few meetings and very short timeline.  Remember the merger process will take, in most cases, six months and sometimes even a year.  

If decisions are going to be made timely and the process moved forward, it will require regular meetings.  The merger committee also needs to set the dates and intervals for overall group meetings where all physician members will convene to review the merger process and confirm decisions made by the merger committee.  These meetings are extremely important to keep everyone apprised of the progress and decisions as they develop.  Commonly, all-physician meetings should occur at four to six week intervals.  Initially, they may be staggered a little further apart but when the merger due diligence is nearing completion and compromises are being made, all-physician meetings will need to occur more frequently.  Employees and staff should be kept apprised of the discussions.  This is best handled by individual clinic meetings to keep them apprised of the progress.  It is not necessary to get all staff together for these updates.  There will be plenty of rumors and uncertainty throughout all of the respective staff and this must be dealt with proactive communication and inclusion. 

Finally, the merger committee will need to meet with legal counsel and the merger facilitator to discuss how and why they want to merge and to discuss and review all of the legal issues to ensure there are no significant issues, which would prohibit the merger from moving forward with the due diligence process. Medical practice mergers are now back in vogue………..if done right, a merger is an excellent strategic move for many physicians now looking at their future.

Don’t Just Sit There Doctor – Start Merging

There is a myriad of strategic options for physicians who want to increase their capability to address and control what is occurring in today’s healthcare market. One “scared” option is to run towards hospital employment. But I believe a better option is to expand the size of your practice by merging with another practice and/or medical group. Physicians who merge their practices usually hope to gain a number of benefits. These often include many of the following: 

• Improved negotiating power with managed care organizations and hospitals;
• Preservation of clinical autonomy;
• Freedom from handling the “business aspects” of their practices;
• Increased access to capital needed to expand services;
• Access to human capital and management expertise to improve performance;
• Increased opportunities to collaboratively manage patient care;
• Enhanced lifestyle with better call coverage, scheduling, and support services; and
• Improved opportunities to increase sources of revenue through expansion of services such as ancillaries and the use of physician extenders.

However, I find that market realities are typically the major impetus for most practice mergers. Physicians merge their practices to improve their position in a market that is changing or that they anticipate will be changing. Practice mergers generally improve the practices’ positions in the market by providing the size, geography, and infrastructure necessary to compete more effectively. The increased size and clout gained by a medical group as the result of a merger can also influence relations with hospitals and other organizations in the community. But even on a more basic level, a group is more likely to survive managed care’s continued shakedown on physician reimbursement simply because it has greater clinical, operational, and management capabilities than a solo practitioner or small group. 

The technical and legal aspects of a medical practice merger, while not always easy to resolve, can often be worked out. My experiences have shown me that failed mergers resulted from an inattention to the “process” aspects of the merger – it must be done right and hard decisions need to be made. Paying attention to process ensures that expectations and input are appropriately managed and that sufficient time is taken to address the key issues associated with the merger. 

If you are contemplating a merger with someone else, keep in mind that one of the major concerns in medical practice mergers is the management of physician expectations. The merger process is often hampered by a lack of knowledge on the part of physicians of the time and effort involved in such an enterprise. A serious concern in this regard is that physicians in the merging groups often do not take the time beforehand to get to know each other’s practice styles, values, personalities, philosophies, and guiding principles. This is particularly true when physicians are reacting to fear or market pressure rather than out of recognition of a shared opportunity. 

There is often a delicate balance between taking enough time to work through some of the early issues in a merger and taking too long in attempting to address every conceivable concern that arises. Some physicians want to “cross every t and dot every i” before making a commitment to moving forward with a merger. This is unrealistic, since most mergers are works in progress that may take years to accomplish fully. 

A medical practice merger is akin to a marriage. It takes time, commitment, and capital to work. A successful merger is the result of a convergence of factors: demonstrated physician leadership; management of process and expectations; consideration of customer-related issues; and recognition of a common vision and goals. Mergers can also provide opportunities for improving patient care by expanding services and expertise and by the development of “best practices.” When done for the right reasons, practice mergers can provide physicians with opportunities to gain efficiencies and market strength, positioning them to meet the competitive challenges that will continue to affect their futures in the years ahead. 

So I end this article with a simple question for you: “What is your strategic vision for your medical practice?” Think about it.

Hospital acquisition & physician malpractice tail issue

When a new doctor or a group of doctors are considering selling out to a hospital will the practice be forced by the hospital to purchase an expensive “tail” for their malpractice insurance policy or will they be allowed to keep their retroactive coverage without buying a tail? 

Hospitals and doctors looking to become hospital employees undoubtedly have two different perspectives on this issue.  Hospitals prefer not to purchase retroactive coverage for the doctors they purchase for a number of reasons.  The first is the decreased expense of a first-year claims-made policy versus a more expensive policy that includes mature retroactive coverage. The second reason is that hospitals do not want the doctors’ previous practice risk exposure to potentially harm the claims record of the hospital should a purchased doctor have a claim that is a result of his or her previous practice.  Third, if the hospital does allow doctors to join them with their previous practice’s retroactive coverage intact then it could become a Stark issue if the whole package is considered over that undefined edge.  Additionally, hospital insurers or their captives’ reinsurers have started to strongly suggest, and in some cases require, that hospitals force doctors to purchase tails before a purchase is finalized.  Finally, hospitals need to be very concerned about the differing “triggers” in malpractice insurance policies as serious and expensive gaps in coverage can be created on this front.  

The only reason a hospital would ever want to purchase retroactive coverage for a new doctor is to make its recruitment efforts easier since doctors often balk at the high cost of malpractice insurance “tails” but hospitals will inevitable learn that cheap can become expensive quickly on this coverage.  

In short, many hospitals are taking the position that they do not want to insure what they cannot control, such as doctors’ past malpractice exposure so are forcing doctors to purchase tails before practicing for the hospital.   

As always, I recommend that you contact your practice advisor and malpractice insurance carrier for detailed advice and assistance with these issues.  

Article submitted by Matt Gracey, CEO of Danna Gracey, The Malpractice Insurance Experts. www.dannagracey.com

Compensation planning suggestions for hospitals who employ physicians

Assure that the reasons for the compensation arrangement are appropriate (such as benefiting the community) and not suspect. Be particularly careful with incentive compensation as poorly crafted incentives can incentivize employees in ways that are detrimental to the charity and the public interest.

Assure that compensation does not exceed reasonable compensation (such as by reference to compensation surveys or other data).

It's useful to have contemporaneous support to justify compensation (reasonableness, mission, reviews and approvals, and arm’s length negotiations).

Compensation should be determined by independent persons.

It's useful to have independent board designated committee review and approve executive compensation and other arrangements that might be suspect (such as incentive compensation plans and recruitment incentives).

Desirability of complying with intermediate sanctions presumption of reasonableness at least where compensation is paid to disqualified persons.

Remember importance of adopting and following a conflicts of interest policy (prevents conflicts and assures proper review/handling of conflicts).

Non-cash compensation, particularly personal use of charity assets, is more suspect. Extra scrutiny is critical in such valuations.

Caps useful with contingent compensation. In some situations, caps are not practicable (e.g., some percentage of gross revenue plans). A provision such as the following might be considered:

Employee acknowledges that employer is a nonprofit corporation that is described in Section 501 (c)(3) of the Internal Revenue Code and as such is prohibited from paying total compensation (including benefits) to any person in excess of that considered reasonable under Section 162 of the Code or that is of a type that my not be paid by such an organization. While the parties believe that the compensation and benefits provided pursuant to this Agreement are well within the range of reasonable and are otherwise allowed to be paid by an organization described in Section 501(c)(3) of the Code, employee agree that in no event will employer be required to pay employee total compensation in excess of that considered reasonable under Section 162 of the Code or compensation of a type that may not be paid by an organization described in Section 50l(c)(3) of the Code.

Consider an audit program or other safeguards against illegal or improper compensation.

Critical that all compensation be reported properly (employee/independent contractors, Forms W-2 1099, Form 990).

Remember The Smell Test: Think about how it will look on the front page of the paper, because it may appear on the front page of the paper.

More thoughts about physician practice mergers

The technical and legal aspects of a medical practice merger, while not always easy to resolve, can often be worked out. My experiences have shown me that failed mergers resulted from an inattention to the “process” aspects of the merger – it must be done right and hard decisions need to be made. Paying attention to process ensures that expectations and input are appropriately managed and that sufficient time is taken to address the key issues associated with the merger.

If you are contemplating a merger with someone else, keep in mind that one of the major concerns in medical practice mergers is the management of physician expectations. The merger process is often hampered by a lack of knowledge on the part of physicians of the time and effort involved in such an enterprise. A serious concern in this regard is that physicians in the merging groups often do not take the time beforehand to get to know each other’s practice styles, values, personalities, philosophies, and guiding principles. This is particularly true when physicians are reacting to fear or market pressure rather than out of recognition of a shared opportunity.

There is often a delicate balance between taking enough time to work through some of the early issues in a merger and taking too long in attempting to address every conceivable concern that arises. Some physicians want to “cross every t and dot every i” before making a commitment to moving forward with a merger. This is unrealistic, since most mergers are works in progress that may take years to accomplish fully.

A medical practice merger is akin to a marriage. It takes time, commitment, and capital to work. A successful merger is the result of a convergence of factors: demonstrated physician leadership; management of process and expectations; consideration of customer-related issues; and recognition of a common vision and goals. Mergers can also provide opportunities for improving patient care by expanding services and expertise and by the development of “best practices.” When done for the right reasons, practice mergers can provide physicians with opportunities to gain efficiencies and market strength, positioning them to meet the competitive challenges that will continue to affect their futures in the years ahead.

So I end this article with a simple question for you: “What is your strategic vision for your medical practice?” Think about it.