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Healthcare Practice Strategies - Winter 2014 - To Merge or Not to Merge: It All Starts with Due Diligence

Feb 7, 2014

This article is the first in a series exploring the elements that contribute to a successful practice merger.

To reach the critical mass they need to effectively compete, more physicians are exploring strategic mergers. By joining with other physicians and physician groups, they create a larger group practice that can share ancillary services and spread the cost of cutting-edge technology, equipment and staff across a wider base.
Properly executed, such a merger — along with a solid business plan — can help boost the bottom line for years to come.

Winners and Losers

What separates the merger winners from the losers? Experts agree it centers around performing solid due diligence prior to making the merger leap.
Sure, a merger must make practical and philosophical sense to all involved. But it’s the next step that’s so critical: clearly establishing what the new entity will look like and how it will perform.

A CPA with real-world M&A experience can help “run the numbers” and perform the necessary due diligence, including a review of the following:

  • Financial trends – A seasoned CPA will take a critical look at the financial positions of all the practices involved in the merger. For example, how has revenue trended over the past three years — have the numbers gone up or is revenue declining?
  • Tax aspects – Even the most straightforward M&A transactions can have complicated tax implications. With a C corporation, for example, there may be an element of goodwill that needs to be evaluated. The key is to address these issues early on in the process.
  • Potential cost savings – Combined practices can reduce costs associated with multiple facilities, redundant equipment and duplicate services such as lab, billing and accounting. In fact, with proper planning, overhead as a percentage of gross collections can decrease. In other situations, though, overhead costs per physician may not decrease much. Rather, average income per provider increases — providing the same result of higher profitability. However, it’s important to recognize that even with a well-planned merger, significant economies of scale may not be realized during the first year while all the kinks are being worked out.
  • Negotiating leverage – Greater volume means more leverage. Here, an experienced CPA can help project out the potential impact of the new practice’s increased size and clout, analyzing payer mix and uncovering potential reimbursement increases.
  • Overhead allocation – Whether economies of scale come into play or not, overhead still needs to be allocated fairly. While there are many different ways to allocate expenses, the merging groups will need to arrive at a general allocation method that everyone is comfortable with.
  • Ancillary income – Mergers certainly increase the opportunities for generating ancillary income — from imaging and lab work to so-called “lifestyle ancillaries” like cosmetic laser procedures. But how much revenue can be expected? And how will profits be allocated?
    Just as important, what will be the investment in equipment and leasehold improvements needed to bring these new sources of income online? Finally, it’s important to identify any regulatory issues that may come into play. Stark regulations, for example, are incredibly complex and apply to many ancillary services covered by government insurance plans.

Sealing the Deal

Merger deals take time to properly structure — at least nine to 12 months, usually. You’ll need to commit man-hours to not only gathering data, but also holding regular discussions on everything from operational issues to corporate culture, values and ethics. Along the way, an experienced CPA can add value to the process by:

  1. Preparing a pro-forma. A tight pro-forma can project profit-and-loss for the consolidated group. Likewise, the data can also be used to project individual care center profitability.
  2. Reviewing operating agreements. After the group’s operating agreement is thoroughly reviewed by an experienced healthcare attorney, your CPA can review the plan and provide input on any business or financial issues that will impact the merger.
  3. Identifying working capital needs. With a solid pro-forma in place, it should be easy to identify any needs for financing and/or working capital — and easy for a lender to see the business case for extending financing. Your CPA can help with introductions to lenders and assist in any covenant negotiations.

When considering a merger or acquisition, it’s wise to surround yourself with a team of advisors who can not only make the deal happen, but also structure it most advantageously for you. Experienced advisors will typically pay for themselves in the end by helping you avoid costly mistakes.

Healthcare Practice Strategies - Winter 2014

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