• Jason Ruchaber, CFA, ASA

When Physicians Opt Out

2017 was a busy year for acquisition activity in the healthcare industry, with major deals announced in nearly every vertical. As consolidation and acquisition activity continues at a fervent pace, attractive acquisition targets are becoming increasingly scarce, the competition for these deals is fierce, and the deal structures are becoming more creative and complex. For acquisitions involving large physician medical groups, the challenges for a successful acquisition are even greater with increased regulatory compliance considerations, complicated and widely-varying compensation models and professional service relationships, and perhaps most importantly, the differing personalities, opinions, and motivations of the individual physicians.

It should come as no surprise that the continuity of providers plays a major role in medical group acquisitions. For large practices, gaining consensus among physicians across the myriad of negotiable deal terms is not easy. This is especially true when the target practice resembles a loose affiliation of individual sub-practices, or when the practice operates in “pods” divided by office location, medical specialty, or hospital affiliation. So what happens when one or more physicians or physician pods believe the proposed acquisition is not in their best interest? Should they oppose the acquisition and potentially kill the deal? Or is it possible for this sub-set of physicians to opt out and pursue an alternative? Here are five value considerations when physicians opt out of the deal.

1) The value of a group practice is not linear – a common misconception is that the value of a group practice varies proportionately with the number of physicians participating in the deal. Under that construct, if 10% of the doctors opt out, the value of the practice would be reduced by 10% (or conversely the value of the physician pod opting out is equal to 10% of the total). In many instances this construct does not hold true and the sum of the parts does not equal the whole. Large group practices benefit from economies of scale, including shared overhead costs, higher utilization of practice assets, intra-group collaboration/increased productivity, sharing of ancillary profits, etc. Because of this, when a group of physicians opts out of a deal, the cost structure and profit sharing of the parent practice may not change proportionately. This may result in a disproportionate decline in value or offer price. Similarly, when a pod seeks to separate from the parent, the revenue and cost structure associated with operating the smaller sub-group practice may be much different than that associated with functioning as part of the group, resulting in a lower valuation on a standalone basis.

2) Motivations of the Physicians – The catalyst for a practice sale can come in many forms, but a driving force behind many sale discussions is the desire for senior physician leadership to monetize an exit or pursue a path to retirement. For a large group practices, this can create friction among the physician partners and have a significant impact on the underlying valuation metrics. Deal consideration is directly impacted by the post-acquisition physician compensation model, and some physicians may seek to lower post-acquisition compensation in favor of higher upfront purchase consideration (or vice versa). Senior physician partners will typically seek to minimize a reduction in post-acquisition compensation to maximize their upfront buyout, whereas younger and mid-career physicians may be more interested in compensation models that opportunities for higher levels of future compensation. The potential for near term retirement of physicians can also have an impact on the valuation simply by virtue of the uncertainty associated with maintaining the patient base and revenue stream, but also the costs associated with identifying, hiring, and training replacement physicians. Both of these factors will have a direct downward impact on the valuation of the practice all things being equal. When the disparate motivations of the physicians lead to a splintering of the group, the valuation metrics that apply to the two groups may also be very different.

3) Motivations of the Potential Buyers - The motivations of the selling physicians may also play a role in the type of buyer or alignment partner sought. There are generally three categories of buyers in the physician market place, hospitals and health systems, managed care players, and large public companies and private equity groups, each of which are driven by different objectives and offer different integration models. Hospitals and health systems are generally motivated by increasing market share, securing the continued service of physicians, and sustaining revenues. For these buyers, the acquisition model generally favors younger physicians with higher, productivity-driven compensation models, and lower upfront purchase prices. For-profits and managed care players are generally motivated by reducing costs and controlling services across the continuum of care to generate profits. This model generally utilizes a fixed salary plus incentive model, which may work for either senior physicians or their younger counterparts. The large publics and private equity backed deals tend to focus on deal synergies, including ancillary utilization and/or “creating” a margin on professional services through a reduction in compensation. This model will generally favor those seeking higher upfront purchase consideration in lieu of future compensation. Aligning the motivations of the buyer with those of the seller may lead some physician to opt out in favor of a different model, and the valuation metrics applicable the alternative model could be significantly different. This can also lead to confusion when attempting to compare offer prices from different buyers, as the underlying valuation metrics and economic drivers do not align.

4) Ownership of the Pod – Physicians considering whether or not to participate in a proposed acquisition may believe they are entitled to sell their “practice” to an alternate buyer. Depending upon the organizational structure and legal rights of the parent organization relative to the pod or individual physician (such as ownership of assets, leaseholds or other real property, non-compete and or non-solicit provisions, etc.), the departing physicians may have no economic claim or legal right to sell their practice independent of the parent organization. In such cases, the parent would have to approve the sale and may be entitled to receive some or all of the purchase consideration received. The organizational structure of the parent may also impact the how the pod is valued, which may be as simple as determining the value to buy out the non-competes of the departing physicians. When the pod is operating as a business within a business, with its own financial reporting and direct ownership of assets, it may be appropriate to value the pod as if a going concern, however, the appraiser should be careful to fully account for any assets or liabilities excluded from the deal, as well as any shared overhead costs that should be burdened to the pod.

5) Considerations for Physician Partners – In addition to the ownership considerations above, shareholder physicians should carefully review their shareholder and/or employment agreement to determine what, if any, impact an opt-out may have on the purchase price for their shares. In some instances, shareholder agreements contain contractual provisions for the buy-out of shares under certain conditions, which could be materially below the proposed deal price. Shareholder physicians should also carefully review and understand how the proposed deal price is determined, particularly if determined based upon a multiple of earnings resulting from reduced shareholder compensation (as discussed above). This valuation model is re-emerging as a vehicle to capitalize the practice, particularly with private equity buyers, and understanding the underlying valuation mechanics and value drivers behind the offer price is critical to properly evaluating the proposal. Shareholder physicians opting out of a deal to avoid a reduction in compensation may not be entitled to any purchase consideration otherwise associated with their ownership in the Practice.

A successful physician practice transaction requires careful consideration of many legal, regulatory, economic and qualitative factors. Physicians evaluating a proposed acquisition or looking to explore opt out alternatives should seek the advice of an experienced health lawyer and healthcare valuation professional to fully understand the legal and economic implications of the various options on the table. Opting out of a proposed practice acquisition is challenging, but doing so may result in an alternative alignment model that is better suited to the practice patterns and preferences of the physicians, and the economic interests of all parties involved.

#physicians #fairmarketvalue #acquisitions

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