How to Get Your Hospital or Health System “Transaction Ready” in a Challenging Market

by Davis Wright Tremaine LLP

Health care providers are competing in a dynamic environment with a host of challenges and opportunities. With the population aging, reimbursement rates declining, and government regulatory efforts expanding, health care providers are struggling to adapt, survive, and succeed. In response to such challenges, hospitals, medical groups, and other health systems are attempting to align their competitive positions and build economies of scale. Affiliations, mergers, and sale transactions will continue to be a significant trend, particularly with help from the enactment of the Patient Protection and Affordable Care Act.

Any organization considering a merger, sale, or affiliation in response to this challenging market environment should prepare diligently. Here we provide an abbreviated guide to how a hospital or health care system can strategically prepare itself for executing a successful transaction in today’s dynamic health care market. For the complete expanded version of this guide, click here.

Build a strategic plan – where do you want to go?
A hospital or health care system should identify its well-performing, core assets and its underperforming, non-core assets (which could be medical office buildings, ASCs or commercial real estate) in its strategic plan. Only after an organization has clearly and honestly defined its objectives and strategies for the future, can it determine whether an affiliation, sale or merger will further these objectives.

If the strategic plan calls for the sale of any non-core assets or the sale of the entire system as a going concern, then the plan should also:

  • Build a justifiable valuation of the business (as a whole) or of the specific assets being sold;
  • Identify and vet potential buyers or partners;
  • Explore various deal structures for the proposed transaction (and the accompanying tax implications of each); and
  • Identify any regulatory hurdles that may impact the time in which it takes to close a deal.

Assemble your “A team”
Health care transactions are more complicated than other sale transactions because of the extensive regulatory environment in which they operate and the serious consequences of regulatory non-compliance. Thus, it is critically important to assemble your “A team” of advisors and consultants that have a track record of successfully negotiating and closing health care deals.

Moreover, the tone set by a counsel can also be important to the success of the negotiations. A combative style is not preferred when one is trying to bring entities together. Prior successful dealings are one indicator of counsel’s ability to work with others.

Should you create a special committee?
If your board has many members or is composed of directors with conflicting interests in the transaction, then it is often advised to create a special committee with the full authority to negotiate the transaction and to hire deal advisors. A smaller group focused on the deal points would bring the fully negotiated definitive agreement back to the full board for approval. In appointing such a negotiating committee, the aim should be to find experienced businesspersons and forceful representatives of the various constituencies (i.e., the medical staff, administration, employees, etc.).

“Spring” cleaning. . . at any time of the year
Before you start looking for prospective buyers or partners, make sure you do a thorough pre-sale assessment of your business to identify any regulatory, legal or business deficiencies that will likely arise in the buyer’s “due diligence” so that you can get ahead of the curve and quickly address such deficiencies or create a plan to resolve them.

Let’s make a deal
A hospital or health care system looking for an affiliation partner will find a variety of interested entities, and it will need to understand and sort through the strengths and weaknesses of each.

The next step is to consider the type of deal structure to pursue with a prospective buyer or partner. Three main types of transactions are:

  • Affiliation transaction where a member (or members) of a nonprofit corporation relinquishes its membership in the nonprofit to another member (usually a nonprofit health system parent).
  • Stock sale transaction (a structure usually preferred by sellers), where the company’s stockholders sell their equity interest in the company to the buyer and, as a result, all of the assets and liabilities remain part of the company—the company simply has changed owners.  
  • Asset sale transaction (a structure usually preferred by buyers), where a buyer will “cherry pick” and acquire certain key assets of the seller and will only assume certain liabilities of the seller—unwanted assets and liabilities are left with the seller to manage and liquidate after the closing. This structure is also favored by the buyer because it gives the ability of the buyer to receive a “step up” in the basis in the assets, which is not usually the case in a typical stock sale.

Each transaction comes with unique issues, so seek the advice of your advisors. Finally, it is important to identify the regulatory hurdles you’ll face throughout the transaction process. If the buyer proposes an earnout or other contingent payment (based on future performance of the business), then such arrangements should be carefully scrutinized to ensure that such arrangements do not run afoul of regulatory concerns, such as the state and federal anti-kickback statutes. 

Timing is everything
Set a reasonably aggressive timeline for completing the sale and try to stick with it. The longer the “deal period,” the more time there is for the surfacing of tangential issues or questions that may distract the parties or disrupt productive discussions. For instance, a seller may start to lose key managers who take other jobs, key physicians may start to refer elsewhere (resulting in the loss of business), or the senior management team can lose focus on running the business by prioritizing the deal over running the operations. Set a reasonable timeline and get all parties, including each party’s advisors, to agree to use their best efforts to meet the dates in the timeline.

Delivering the goods – the due diligence process
Before the parties engage in the due diligence process, they will need to enter into a confidentiality agreement protecting the information shared between the parties. Often, such confidentiality agreements will contain other provisions, including a buyer’s agreement not to solicit your employees for a certain period of time (so-called “no raid” provision). At this time, the parties should also decide whether they want to set forth the principal terms of the deal in a non-binding letter of intent or rather move to definitive agreements. Early in the process, the selling party needs to review a due diligence request list so the magnitude of the project is clear.

We suggest starting with the following:

  • Gather all of the contracts and amendments. The contracts aren’t always neatly organized and located in one location in the hospital. Find the contracts, organize them, and put them in one place.
  • Make sure all contracts with referral sources are up to date, including fully executed and not expired.
  • Gather all licenses, permits, and accreditations, and make sure they are not expired.
  • Identify and address significant liabilities on retirement and benefit plans, since a buyer will focus on the financial status of such plans.
  • Catalogue any regulatory deficiencies for disclosure and, to the extent you can, plans of corrections or other corrective action taken.

Most buyers will not assume contracts they have not reviewed for fear of assuming potential legal issues. Most transactions today will have a closing condition tied to amending contracts to more closely align with applicable regulatory requirements.

Your staff need support too
Organize your due diligence efforts. Appoint a gate keeper for all requests and require the buyer to identify one person to make the due diligence requests on behalf of the buyer—otherwise there is no prioritization of information requests and duplicate requests are commonplace.

All requests for information should be in writing and responses documented and catalogued. Verbal interviews will be a part of the process, but all document requests should be in writing or at least confirmed in writing.

Reoccurring contract diligence issues we see include:

  • Not providing the most current version of a contract that has been amended;
  • Not being able to find a contract—so the terms cannot be confirmed by the buyer;
  • Not having a contract, where an ongoing business relationship is evidenced by other documents, such as a review of payments reflected on an IRS Form 1099;
  • Having more than one contract with a party, but only providing one; or
  • Providing expired licenses, without explaining where the organization is in the renewal process or providing the new license.

If you are thinking about a deal, prepare diligently. Dust off the strategic plan and make sure you know why a deal makes sense and what your organization needs out of a deal. Assemble a strong team of advisors with a proven track record of success. Organize your corporate records and get your corporate house and documents in order. Be ready to respond promptly and accurately to due diligence requests. Figure out how to support your staff with additional resources. Being prepared will allow your management team to keep the business intact and your team to stay focused on successfully completing the deal.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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