Eight Potential Issues to Address (Long) Before Selling Your Practice

We are in the middle of an active market for physician practice acquisitions in a variety of specialties such as anesthesiology, dermatology, dentistry, oral surgery, ophthalmology, orthopedics, urology and others. While there are a variety of acquiring parties, including private equity, health systems, managed care organizations, private investors and other strategic buyers, practice acquisitions — regardless of the buyer — share many similarities in terms of pricing, structure, etc.

Below are eight common issues that you should consider addressing in advance (in some cases, well in advance) of engaging a broker, soliciting bids or otherwise negotiating or pursuing a sale transaction:

1. Optimal Corporate and Tax Structure

Whether it be an asset or equity deal, the corporate and tax structure of your practice could greatly impact the tax liability of/financial return to the owners. For example, “C” corporations might find it advantageous to elect “S” corporation status in advance of pursuing a deal. This election may offer more benefits with long-term foresight. However, certain types of entities including both “S” corporations and professional corporations/associations, have restrictions on the types of individuals or entities that can be owners, thus limiting the pool of potential buyers and often rendering equity deals more difficult.

2. Optimal Size, Revenue and Financial Performance

While buyers vary, buyers and their valuators tend to value practices similarly.  Whether the valuation is based on discounted cash flow, multiples of gross revenue or net earnings, or other financial metrics, the revenues and expenses of your practice will matter (a lot). Therefore, it is important to take advantage of any revenue-enhancing and/or cost-saving measures well in advance of a transaction in order to establish a track record of financial performance (which could exponentially impact the purchase price).

It is also important to optimize the size of your practice (i.e., in terms of number of providers, locations, etc.) not only because it will impact financial performance (and purchase price), but certain buyers are strategically targeting specifically-sized practices. For example, a strategic investor new to a geographic area may be willing to pay a premium (e.g., higher multiple) for a large foundational practice on which to build a portfolio.

3. Voting and Approval Thresholds

Pay close attention to what your entity’s governing documents say in terms of voting and approval rights as they relate to a sale transaction. If unanimous approval is required, you might want to consider reducing the threshold and/or adding drag along provisions to prevent a small minority of owners from blocking a deal favored by a majority. You might also want to evaluate removal and/or buy-out rights in case it is desirable to buy out certain owners in advance of the transaction (i.e., those that do not wish to participate).

4. Lingering Buy-outs/Buy-ins or Options

While well-intentioned, phased buy-in or buy-out provisions can complicate a sale transaction. Make sure any phased buy-outs (e.g., retiring owners) are structured so that it is clear whether the owner being bought out can participate in the deal and whether the buy-out can be accelerated in a sale transaction. On the flip side, buy-ins or options should be drafted carefully to account for what might happen if a sale transaction occurs before the buy-in or option is triggered or completed. Buyers will want all of these lingering issues cleaned up before closing. Related to #1, note also that the tax impact of these buy-in, buy-out or option provisions could change materially once a purchase offer is received (i.e., the reportable value of the practice or its equity might increase considerably).

5. Proportional vs. Disproportional Ownership

While it has been the norm in many physician practices for owners to all have equal ownership percentages, often times owners do not believe that sale proceeds should necessarily be shared equally. Though it may be difficult to change ownership percentages at the 11th hour in anticipation of a sale, with the benefit of longer foresight, your practice may be able to adopt a tiered ownership structure whereby sale proceeds might be distributed more in accordance with the owners’ expectations, tenure, etc.

6. Restrictive Covenants

Restrictive covenants such as non-competes and non-solicitation clauses can enhance the value and attractiveness of your practice as they deter key employees from leaving (keeping your business intact) and preserve your business in case some decide to leave in any case (by restricting departing employees from taking business with them). In anticipation of a sale, it makes sense to review the duration and scope of your restrictive covenants, to whom they apply, and whether they apply after any termination/resignation event (or just some subset).

7. Liens

It might make sense to order a lien search on your practice in advance of any sale discussions to determine any outstanding liens on the assets (the results might surprise you). Based on the results you could contact lenders to clean up expired/outdated liens and plan on how to pay off any outstanding debt in order to ensure your assets are free from encumbrances and ready for sale.

8. Affiliated Entities

A variety of issues arise when practices have affiliated entities. Affiliated providers such as surgery centers, laboratories or imaging centers might be included in the sale and may enhance the value of a transaction. As a preliminary matter, such affiliates should likewise consider the other seven issues discussed above. Other affiliates, such as real estate entities or administrative service providers, might be excluded from the deal, so it is important to ensure that any inter-company agreements are on acceptable terms assuming they will be retained as part of the deal.

As a final note, do not forget that the changes discussed above may involve other legal, tax or financial considerations that must also be evaluated before implementing changes.