TOP 10 CONSIDERATIONS WHEN SELLING OR PURCHASING A PHYSICIAN PRACTICE

1. TOP 10 CONSIDERATIONS WHEN SELLING OR PURCHASING A PHYSICIAN PRACTICE Thomas N. Hutchinson Krieg DeVault LLP Heather F. Delgado Barnes & Thornburg LLP

2. BACKGROUND • Recent increase in sale of physician practices to hospitals. • Reasons for physician practice sales: • Decreasing reimbursement • Increasing operating costs • Lifestyles • Retirement • Physician supply • Call coverage • Regulatory environment • Security • Quality initiatives • Economic environment • Cost of technology

3. 1. Structure of Transaction

4. Transaction is typically structured as stock purchase or asset purchase • Both arrangements have advantages and disadvantages

5. Stock Purchase Transaction • Transaction where buyer purchases shares or stock of physician practice • All assets, receivables and liabilities are transferred to buyer • Uninterrupted cash flow because contracts with third party payors remain intact • Can assume existing provider numbers, licenses and contracts in most cases • Risk that buyer will be responsible for future malpractice suits and other complaints not yet filed at the time of sale

6. Asset Purchase Transaction • Transaction where buyer purchases certain designated assets of practice • Liabilities can be excluded from transaction • Purchase can include both tangible and intangible assets • Buyer will have to obtain new provider number in most cases which may not be available on closing date • Need permission to assign existing agreements • Buyer will not be responsible for any liabilities or overpayments due back to any payor due to buyer’s new provider number

7. 2. Purchase of Assets

8. More common to purchase assets rather than stock of physician practice • Assets purchased in accordance with Asset Purchase Agreement • Asset Purchase Agreement should address: • Acquired Assets • Excluded Assets • Purchase Price • Representations and Warranties of Buyer and Seller • Malpractice and Other Insurance • Consents • Financial Statements • Accounts Receivables

9. Contracts • Litigation • Title to Assets • Taxes • Licenses and Permits • Compliance with Laws • Patient Records • Labor and Employment Matters • Environmental • Indemnification • Limitation on Liability • Costs • Governing Law

10. Asset Purchase Agreement should address both tangible and intangible assets being purchased (i.e. goodwill, medical records, trade names)

11. 3. Corporate Practice of Medicine

12. Indiana has statutory prohibition against corporate practice of medicine (IC25-22.5-1-1.1(a)(1). • Prohibition does not apply to hospitals

13. 4. Valuation

14. Agreed upon valuation date should be set forth in purchase agreement • Cost Approach • Aggregate value of the assets, net the liabilities of the business, may be indicative of the value of the equity in the business • Identify and adjust the reported value of tangible assets and liabilities to their estimated fair market value • Approach does not usually recognize personal and professional goodwill

15. Income Approach • Value of a business is directly related to the present value of all future cash flows or earnings that the business can reasonably be expected to produce • Discounted Cash Flow Method is the most common application of the income approach in the valuation of physician practices. Revenue and expenses are projected over reasonable periods of time • Single Period Capitalization Method is another method under income approach where an analyst determines a base level of annual earnings and then determines a multiplier appropriate to that earnings expression

16. Income approach requires identification of a normalized cash flow on a stand-alone basis • Uses MGMA Survey and other benchmarking tools • Market Approach • Uses a variety of methods that compare the subject with transactions involving similar investments • Goodwill Registry good source of comparable transactions for medical community • Method should not be used if appraiser cannot obtain current transaction data

17. Qualified, professional, independent party appraise the practice value • After valuation, seller should have good idea of true value of practice’s tangible and intangible assets, including the value of the property owned, accounts receivable, and the perceived value to the community and their referring physicians • Different valuation guides can be used as guidance including, but not limited to: • MGMA Survey • AMGA Survey • Sullivan-Cotter Survey

18. American Society of Appraisers Business Valuation Standards • Exempt Organizations Continuing Professional Education Technical Instruction Program-1995-Valuations of Medical Practice • General Rules for Valuation • Written documentation to support written valuation • Based on current data • Purpose of the valuation should be the sale of physician practice • Should reflect (have adjustments for) physician compensation, benefits, family members, one-time expenditures, etc.

19. Income and market approach should incorporate working capital adjustment • Qualified independent third party appraiser should do valuation • Fair Market Value

20. 5. Restrictive Covenants

21. Buyer may require seller to have restrictive covenant not to compete with buyer in certain defined restricted area. • Non-compete covenant must be reasonable in length of time and geographic scope • “Blue pencil” clause • Buyer may want liquidated damages clause that provides that any seller in violation of the non-compete covenant shall immediately pay to buyer certain amount of money • If a physician practice has current employees, then buyer should review enforceability of any existing non-compete

22. Non-compete covenant may be included as part of practice appraisal if economic effect can be reasonably estimated and it has a finite duration (See Schulz v. Commissioner, 294 F.2d 52 (9th Cir. 1961), aff’g 235 (1960) • 3 types of non-compete covenants to evaluate: • Between individual employee physician and the selling practice as physician’s employer • Between the individual selling physician and the buyer • Between the selling medical practice and the buyer • Non-compete covenants can have varying terms and conditions

23. 6. Employment

24. Buyer may purchase practice and employ seller (usually occurs in hospital purchase of physician practice) • Employment may be of short duration in case of retiring physician who is transitioning practice • Written employment agreement should set out terms of employment (i.e. restrictive covenant, benefits, compensation, productivity incentives) • 2 most common employment models • Stock/Asset Purchase Agreement and buyer employs selling physician • Physician Managed Employment Model where buyer does not purchase assets but obtains infrastructure from former practice entity under a lease/management agreement. Physician then employed by practice entity

25. Hospital employment of physician should meet Anti-Kickback Safe Harbor and Stark Law employment exception or fair market value exception • Direct hospital employment v. hospital affiliated group practice employment • Purchase agreement should address various practice employee issues: • Continuation of employment • ERISA • Benefits • Paid Time Off • Vacation • Seniority • Drug testing • Termination of certain employees

26. 7. Fraud and Abuse

27. Purchase should comply with fraud and abuse laws • Purchase of physician practice must be fair market value (FMV) • IRS defines FMV as: “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

28. Stark law defines FMV as: “The value in arms’ length transactions, consistent with the general market value means the price that the assets would bring as the result of a bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, on the date of the acquisition of the assets. Usually, the fair market price is the price at which bona fide sales have been consummated for assets of like type, quality, and quantity in a particular market at the time of the acquisition, where the price has not been determined in any manner that takes into account the volume or value of anticipated or actual Medicare/Medicaid Designated Health Services referrals (as defined below) by physicians of the Practice to the entity that employs them or to other related entities.”

29. Anti-Kickback Statute defines FMV as: “where the price or compensation has not been determined in any manner that takes into account the volume or value of anticipated or actual referrals.” • FMV should be a value that is commercially reasonable • Arm’s length transaction • Anti-Kickback concerns • Seller purchasing practice as a source of referrals which can increase costs • Purchase of intangible assets (i.e. goodwill, noncompete, patient list, patient records) may be payment for referrals • OIG Advisory Opinion 09-02 held that employment of mental health practitioner after building purchase did not violate Anti-Kickback Statute

30. Anti-Kickback Statute doesn’t prohibit hospital purchase of practices and employment of physicians • Required referral provision in employment agreement is not prohibited • Do facts and intent analysis for Anti-Kickback Statute violation

31. Stark Law • Isolated transactions exception • Commercial reasonableness • Physician employee can have compensation from bona fide employer conditioned upon referrals if compensation is set in advance, FMV relationship meets an exception and in writing • McLeod Settlement where hospital overpaid for practices and physician compensation • Tenet Settlement for excess compensation • Good idea to obtain written valuation of both acquisition payment and employment compensation

32. 8. Licenses

33. Transfer or terminate • DEA registration • Return to DEA • Destruction of controlled substances • Drug samples • Prescription pads • Retain narcotics ledger for 2 years • Software licenses • Business licenses • Laboratory License (CLIA) • Tax Identification Number • OSHA

34. 9. Tax Exempt Considerations

35. Payments in excess of FMV may result in IRS determinations of private inurement or impermissible private benefit • Intermediate sanctions law • Tax-exempt organization should establish a rebuttable presumption of reasonableness with respect to the transaction • No excessive benefit conferred on physician • IRS has issued guidance for the following: • Office space • Equipment lease • Purchase of physician practices • Incentive compensation

36. 10. Medical Records

37. Purchase of medical records • Sale may include an agreement that buyer will store and maintain all medical records and have unlimited access to such medical records • Seller may want to retain a right of access • All medical records should be documented prior to sale • Record retention requirements • Value of medical records • Intangible asset v. tangible asset • Value may be cost to avoid copying charges for medical record transfer • Electronic health record system value

38. Patient notification of transfer • Indiana law currently has no notice statute • HIPAA/HITECH Act concerns • Psychotherapy notes

39. QUESTIONS