Are You Considering Selling Your
Imaging Center or Practice? Or
Merging With Your Healthcare
System? Part 2 of 2
Richard S. Cooper, Esq.
McDonald Hopkins LLC
600 Superior Avenue, E., Suite 2100
Cleveland, OH 44114
(216) 348-5438
rcooper@mcdonaldhopkins.com
mcdonaldhopkins.com
Kirk A. Rebane, ASA CFA
Haverford Healthcare Advisors
43 Leopard Road, Suite 102
Paoli, PA 19301
(601) 407-4024
krebane@haverfordcapital.com
haverfordhealthcare.com
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Learning Objectives
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• List the steps should be taken prior to selling or
merging a radiology business in order to maximize
the purchase price and optimize the terms obtained
in the transaction
• Outline the key issues that will need to be
addressed in connection with the sale or merger of a
radiology business
• Articulate the typical process involved in taking a
transaction from start to finish, and the most
important aspects, documents, and arrangements to
such a transaction
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Valuation Basics for
Radiology and Imaging:
Developing a Realistic
Expectation of Deal Value
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• Valuation fundamentals
– Future cash flow
– The two most common descriptors when discussing
radiology and imaging practice valuations are pro forma
and/or sustainable net revenue and EBITDA
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• Valuation fundamentals: Pro forma and/or
sustainable income statement
– Typical adjustments
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Excess officer’s or physicians’ compensation
Real property lease
Non-recurring revenue
Non-recurring expenses
Run rate in revenue
Run rate in expenses
Which referral sources or clients are at risk?
Excess professional, management and billing fees
Other personal or discretionary expenses
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• Valuation fundamentals: Value-based management
– In addition to providing assistance in selling your radiology
and imaging practice, knowledge of the factors that drive
value and knowledge of how to value a practice allows
shareholders to practice value-based management
– A good manager who practices value-based management
seeks to:
• Maximize sustainable value
• Monitor performance on a fairly real-time basis
• Understand and monitor the direct correlation between actions and
value creation
• Manage the internal factors which can be controlled
• Anticipate the external factors which cannot be controlled
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• Valuation fundamentals: Three basic approaches to
valuation
– The Income Approach
• Discounted Cash Flow Approach
– The Market Approach
• Public Market Comparable Approach
• Comparable Acquisition Approach
– The Cost Approach
• Future cash flow
– Value = Present value of future cash flows
– What factors will impact future cash flows?
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• Factors that influence value
– Management should understand the internal and external
factors which drive value
– Whether a tangible exercise listed on the manager’s to-do
list, or whether an implied responsibility within a job
description, a manager should be practicing value-based
management
– A true organizational leader should be managing a
radiology practice or imaging center operation with the
goal of creating value for the stakeholders, including equity
value for the shareholders
– Understanding the correlation between actions and valuedelta is critical to success, and can serve to optimize the
planning process
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• Internal factors that influence value
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Pro forma sustainable financial performance
Historical growth trends
Growth potential: Proactive or reactive
Size (net revenue, EBITDA, test volume of scans, number of
centers, breadth of modalities, etc.): There is a scarcity of large
acquisition targets
– Profitability and cash flow
– Stability/reputation
– Professional subspecialties and quality
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• Internal factors that influence value
– Composition of revenue
• Collected revenue per scan
• Specialty vs. routine volume mix
• Inpatient vs. outpatient vs. freestanding imaging centers
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Sustainability and quality of revenue and EBITDA
Professional/technical mix
Billing compliance, collection rates and payor mix
Location and competition
Verifiability of financial and operating data
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• Internal factors that influence value
– Customer, client and referral source relationships
– Hospital contract terms
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Exclusivity
Term and termination provisions
Compensation
Change of control
Call provisions
Quality of relationship with administration
Equipment age, functional utility and deferred CAPEX
Depth, quality and versatility of management and staff
Information technology
Corporate structure: C-corp. vs. S-corp. vs. Partnership vs.
LLC
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• Internal factors that influence value
– Deal structure and tradeoff between buyer post-transaction
transaction value
• Higher post-transaction expenses paid to seller (PC, medical
director, management fee) which implies lower post-transaction
income for buyer which implies lower transaction value
• Lower post-transaction expenses paid to seller which implies higher
post-transaction income for buyer which implies higher transaction
value
– Level of working capital or net asset value to be delivered
at closing
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• External factors that influence value
– State of general economy
• Availability of patient funds for healthcare
• Credit market for buyers
• Government stimulus plan
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Preventive medicine and diagnostics
EMR
Volume impact from broader health insurance coverage
Expiring capital gains tax rates
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• External factors that influence value (continued)
– Industry demographics
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Reimbursement trends
Paradigm shift from inpatient to outpatient setting
Rapidly aging population
Many screening tests are performed based on age
Increased incidence of cancer
Shift from prognostic and monitoring tests to preventive medicine
High growth in new technology, new test development and
implementation
• Strong fundamentals continue to attract investment from large
consolidators and private equity
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• External factors that influence value (continued)
– Opportunities for the buyer, (i.e. Synergies)
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Revenue growth from existing clients and referral sources
New marketing
New services and offerings
Subsequent “fold-in” acquisitions
An intelligent buyer will make an acquisition only if it adds to the
value of the acquiring company. Such acquisitions are said to be
accretive. Buyers can afford to pay more for an acquisition as the
relative value of their own company increases
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• External factors that influence value (continued)
– Taxation and finance theory factors
• Benefit from the lower tax rate on capital gains
• Conversion of future earnings to lump sum distribution today
• Value protection and asset diversification
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Valuation Issues Arising out
of a Transaction (Besides
the Purchase Price)
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• Governance agreements specify important
characteristics such as:
– Types and size of equity classes which exist
– Rights, privileges and limitations associated with each
class of equity
– Governance of the entity, including the voting rights and
control elements afforded to each class of equity
– Restrictions placed on the marketability of each class
– Provisions for allowing new equity holders, including
conditions, terms and purchase price
– Provisions for allowing liquidity events by existing equity
holders, including conditions, terms and purchase price
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• In a joint venture or other form of partnership, you
will need the valuation of the initial contributions and
an allocation of equity holdings
• If valuation balancing problems arise, they can be
solved using:
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Tiers of equity
Tiers of governance
Differing income allocation
Tiers of entities (via modality, professional/technical,
geography, etc.)
– Tail protection provisions
– Measurement dates for look-back provisions
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• Common valuation mistakes include:
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Using investment value instead of fair market value
Bifurcating business valuation from compensation analysis
Failing to properly analyze operating data
Failing to properly assess deferred capital expenditures
and future capital needs
– Failing to assess capacity issues
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Valuation Issues Related to
Ancillary Agreements
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• Stark law and other regulatory concerns, including
anti-kickback regulations, the False Claims Act and
the IRS, require that payments made relating to
professional compensation arrangements and
medical director agreements must be consistent with
Fair Market Value, and must be commercially
reasonable
• Whenever a physician receives compensation in
exchange for providing professional services to or
on behalf of the hospital, the physician is deemed to
have a financial relationship with the hospital. Such
a financial relationship must be compensation for
services rendered, as opposed to payment for
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referrals
• Compensation arrangements could include:
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Administrative services
Administrative, supervisory and teaching services (AS&T)
Call-coverage services
Employed physician compensation arrangements
Management services agreements
Co-management agreements
Medical director services agreements
Professional services agreements
Lease agreements for equipment, space or staffing
Billing agreements
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• Fair market rates:
– Depend on the unique facts and circumstances of a
situation
– Estimate the time and cost to perform tasks by internallyemployed personnel (cost approach)
– Collect information related to comparable agreements for
similar services, either within the particular healthcare
system in question or within the greater marketplace
(market approach)
– Analyze comparable compensation market data contained
in multiple, objective, independently published surveys
(survey approach)
– Adjust the findings for inflation, specialties, productivity,
taxes and benefits, geography, and other factors to ensure
comparability
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– Do a final sanity check on the remaining profitability of the
payor, i.e., is there a reasonable rate of return for the
employer?
– Beware of the impossible day
– Verify that compensation components from separate fee
arrangements do not overlap or provide duplicate payment
for identical services
– Compensation arrangements, and fair market opinions,
can be bifurcated into a fixed component and a
variable/incentive component
– Prudent to have certain measurement dates for look-back
provisions and to allow for periodic adjustments to the
compensation
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• Compliance programs
– Lack of compliance with regulatory concerns by a
healthcare organization can lead to large fines, disruption
of the organization, lost jobs, imprisonment, lost goodwill in
the marketplace, loss of tax-exempt status, and exclusion
from Medicare/Medicaid programs
– Therefore, it is important for the healthcare organization to
conduct a compliance review, in which all payments made
to physicians are identified, documented, categorized, and
justified
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– In a compliance review, you should check for:
• Expired or unsigned contracts
• Contracts that do not specify the exact services to be covered by
the arrangement
• Contracts that are not correlated with any and all other
arrangements between the hospital and the physician
• Contracts which specify aggregate services to be provided by the
physicians which exceed those that are reasonable and necessary
for legitimate business purposes
• Lack of legal counsel or board approval
• Lack of appropriate, or insufficient, FMV data or analysis
• Contracts that have changed fees during the term of the contract, or
in which the fee or fee formula has not been set in advance
• Contracts that contain fees impacted by the volume or value of
referrals, or other business generated by the physician for the
hospital
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• Lack of time sheets or work logs, especially for non-clinical services
• Lack of invoicing documentation
• Payments made without a contract, payments that do not match the
contract terms or payments that do not match the time sheet or
invoice amounts
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– Maintain active checklists, databases and work papers
which allow for the continuous monitoring of all financial
relationships with physicians
– FMV justification does not necessarily require the use of a
third-party appraiser. Instead, develop an internal policy as
to when outside third-party FMV opinions should be
obtained, as opposed to internal analyses
– Having a third-party appraisal does not provide full
protection from an investigation, but it demonstrates that
the organization considered relevant facts and sought an
expert opinion
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Preparing Now for this
Deal in Your Future
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• The facts
– Every radiology group/imaging facility has problem areas
• Some will be modest, others serious
– Problems can affect whether you get offers, deal value,
whether a deal gets done and deal timing and cost
– Not all problems are known. A true understanding requires
an “audit.” An audit can be done internally or through an
independent source.
– It is better to know about and correct problems or
deficiencies now rather than have them detected by
buyers or partners and have corrective measures imposed
on you
– A thoughtful, timely audit and correction of problem is less
onerous on and disruptive for management and staff
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• Be prepared for extensive and thorough
buyer’s/partner’s due diligence
– Focus areas:
• Ownership/governance
• Financials and financial trends
• Legal (tax structure, compliance, licensure, litigation, other current,
threatened or anticipated third party actions including government
actions, etc.)
• Operations
• Clinicians/management/employees
• Customer relationships and profile
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• Start thinking about a transaction well in advance of
actually beginning the process – years rather than
months is best
– A proper deal readiness approach can reduce risks
associated with selling and the negatives of fixing
problems during the transaction process (confidentiality
breaches, government intrusion into deal, distracted
management, deal fatigue/failure)
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Key Areas for Focus for the
Radiology Group/Imaging
Facility
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• Regulatory and legal compliance
– Buyers will heavily scrutinize legal compliance issues as part
of evaluation of the business. The issues are broad ranging.
Potentially the biggest risk area for buyers.
– Key areas include:
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Coding and billing issues
Fraud and abuse issues
Licensure and accreditation
HIPAA and data security
Taxes
Employee vs. independent contractor issues
Contract compliance
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• Regulatory and legal compliance (continued)
– If problems are uncovered, buyers may back out, delay
deal until fixed, or require purchase price to be reduced.
Problems detected after closing will likely constitute a
breach of reps and warranties and may hit the escrow.
– Coding and billing compliance (including fulfilling all
overpayment disclosure obligations and RAC patterns)
• Most buyers focus heavily on billing in their “due diligence” review
• Sellers should make sure their billing practices are appropriate and
will survive scrutiny
• Seller should consider doing its own audit/review prior to putting
facility up for sale – remember self disclosure obligations
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• Regulatory and legal compliance (continued)
– Referral source relationships
• Do you have business relationships with referral sources that are
less than “market rate?”
• Are you providing benefits to referral sources at a “discount” that
might be characterized as an impermissible?
• Do you have agreements in place to protect against improper use of
EMR and other equipment?
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• Regulatory and legal compliance (continued)
– Marketing activities
• Fraud and abuse laws and regulations
• Practices proscribed by OIG fraud alerts
• Review all marketing materials and products
– Consider having a Compliance Plan and HIPAA and Data
Security Plan in place
• Licensure
– Confirm that your radiologists are licensed in every state in
which they are required to be licensed
– Confirm that facility is properly licensed and accredited in
every state where licensure/accreditation is required
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• Clinician, management and key employee retention
– What is in place to retain key
clinicians/management/employees during and posttransaction
• Strength of relationship
• Incentives to stay
– Proper non-compete and non-solicitation provisions
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• Use of “standard form” employment and
independent contractor documents
– Standard form, “one size fits all” documents may not be
legally enforceable; particularly acute in sales
representative agreements
– In order to be enforceable, agreements need to be tailored
to individual state law requirements. What works in one
state may not work in another
– Agreements need to be tailored to the people being
covered (senior executives, sales reps, rank and file
employees)
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Tax Planning
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• Should start well in advance of deal-consult tax
advisor early
• Beware of common trap: Selling assets from “C”
corporation (double tax issue)
• Interplay with estate planning
• Charitable gifts: Tax savings opportunity
• Even non-profit owners may have significant tax
issues
• Section 481 adjustments
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Asset Sale by a “C” corp.
• Example of “Double Tax” on Sale of Assets by “C”
corporation
Sales Price of Business
$10.00mm
Tax to Corporation (35%)
3.50
Distribution to Shareholders
6.50mm
Tax to Shareholders (15%)
.98
Net to Shareholders
$5.52mm
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Asset Sale by an “S” corp. or LLC
• Example of Tax on Sale of Assets by “S”
Corporation
or LLC
Sales Price of Business
Tax to Shareholders (15%)
Net to Shareholders
$10.00 mm
1.50
$ 8.50 mm
Difference: $8.50 - $5.52 - $ 2.98 mm
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Common Deal Issues
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Valuation
Seller financing (seller notes & rollover equity)
Earn-outs
Control over operation of business
Employment/Consulting terms & restrictive covenants
Employee matters & benefits
Indemnification
Taxes
Consents & licenses
Transition services/integration
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• Valuation
– Not a legal concept but informs everything in transaction
– Buyer and seller expectations on issues will depend significantly
on perception of premium
– Items in deal agreements will be revised to reflect valuation
model – e.g. one-time charge v. recurring
– Typically negotiated at letter of intent stage before attorneys are
extensively involved
– Can include purchase price adjustments
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• Seller notes
– Used to bridge gap between seller and buyer price expectation
– Risk of non-payment
– Subordination and security concerns
• Equity rollovers
– Significant incentive for sellers to continue to produce positive
performance
– Upside downside risk
– Tax issues
– Stockholders agreement (governance, puts, calls, etc.)
– Tie to employment/consulting agreements
• Earn-outs
– Used to bridge gap between seller and buyer price expectation
– Also can be significant incentive for performance post-closing
• Capital gains and ordinary income treatment
• Regulatory considerations
– Potential for significant conflict post-closing regarding operation of the
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business
• Control of operations
– Before closing, buyer will want some visibility and control
over operations. Seller will be willing to provide visibility, but
must be able to maintain control and operate as business
needs arise.
– After closing, buyer will expect complete or near complete
control over operation of business
– Can cause expectation problems for sellers
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• Employment terms
– Professionals can be key driver of the value of the business being
acquired
– Employment terms can also represent significant portion of value
for sellers
– Key terms include: duration, termination triggers (for cause and
good reason), duties, vacation, benefits
– Note that benefits packages likely will change post closing and
often are not as generous
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• Restrictive Covenants
– Three main Covenants
• Non-competition
• Non-solicitation (customers, employees, referral sources)
• Confidential information of the business
– Purchase agreement Covenants
• Will be based on snapshot of business at closing
• Will run for fixed period of time from closing
– Employment agreement Covenants
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Will resemble purchase agreement Covenants
Will change with changes in business over period of employment
Will address exceptions to non-competition/non-solicitation restrictions
Outcomes depend on determination of “for cause” and “without cause”
terminations
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• Employee matters
– In addition to seller employment agreements, compensations for
employed physicians and other will change as well
– Prospect of partnership for up-and-coming physicians/employees
will disappear – may require additional compensation to offset
– Diminished control over bonuses
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• Indemnification
– Promise of seller to make buyer whole for:
• Breaches of representations and warranties
• Breaches of Covenants
• Anything else agreed to by the parties
– Promise buyer to make seller whole for:
• Breaches of representations and warranties
• Breaches of Covenants
• Post-closing Covenants and operation of the business
– Is effectively a purchase price adjustment for the business not
being in the condition promised
– Gives teeth to all of the other provisions
– Watch impact on applicable insurances
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ASRT Code:
VAD0052059
AAPC Code:
26342QJTAB
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