Investment in a health care provider, especially one intended as a “platform” for future growth, usually involves extensive diligence and compliance review.
Post-closing, recently formed or acquired “platform” companies are typically tasked with one mission above all others—growth—and that growth can be accomplished de novo (i.e., through establishing new locations from the ground up), or by a much faster method, especially for a company with a recent influx of capital, which is by acquisitions.
These transactions, often called “add-ons”, “bolt-ons”, or “tuck-ins”, are generally smaller than “platform” acquisitions. During this aggressive growth phase, it’s important to develop “right-size” compliance and diligence structures to ensure ongoing compliance.
These smaller acquisitions pose some delicate diligence problems. Often, speed is a key factor, as is maintaining lower costs. Traditional detailed document reviews are impractical (or impossible). From a practical standpoint, the risks posed may be low enough to justify an abbreviated process.
So what are some key points for an abbreviated add-on diligence process?
Don’t Neglect Health Regulatory Diligence
It is all too easy when faced with a rapid-fire series of add-ons, to simply skip over health regulatory diligence. The target is obviously running OK (that’s why you’re buying it) and you have asked if the target is aware of any open investigations or audits. You can probably skip the rest, right? Especially since you’re just buying the assets? Not unless you are OK with negative surprises.
Sellers are (surprise) not always forthcoming about how they do business. Even if you are leaving provider numbers behind, there are other potentially negative consequences that can follow. As an example, we have worked on matters where a government investigation or licensure complication arose not because of anything the new owners did, but because the purchased assets shared a physical address with the previous practice that had a reputation for non-compliance.
Similarly, reputational risk—the risk that the bad actions of previous owners will be imputed to the new owners—is an ongoing concern even where legal liability doesn’t technically follow.
Further, if your add-on, like many, will leave most operations and key employees in place and involve essentially “changing the name over the door”, bad compliance practices that existed before you took over are likely to continue after closing. You can keep the process efficient and focused on the most significant risks, but skipping health regulatory diligence is a gamble likely not worth the savings.
Understand Your Risks
Most health care companies share some risk areas—fraud & abuse and privacy & security spring to mind—but every specialty has its own unique issues. Dermatology, Orthopedic and other physician practices that perform “designated health services” need to be concerned with Stark law compliance. Dental practices need to ensure services delivered are necessary and appropriate, especially when dealing with Medicaid populations.
This list could continue for much longer than this article has space, but the key message is that effective add-on diligence will require understanding the unique risks that are most prevalent in the target company’s particular specialty.
Mitigate Those Risks
Some key mitigation strategies will apply in many, if not all, transactions.
Billing and Coding: In most health care transactions, fraud & abuse risks are going to present the greatest possibility for significant financial loss and reputational damage. A billing and coding audit, focused on those risk areas most likely to give rise to problems in your industry, should be a standard part of every deal. Small, targeted audits can significantly reduce the risk of potentially improper billings (both in terms of regulatory and reimbursement compliance risk and in terms of artificially inflated EBITDA numbers).
Even in an asset purchase, where provider numbers may be retained by the seller, the existence of bad practices can indicate pricing problems, lack of compliance oversight, bad management, or even a need to replace certain employees.
Financial Relationships: Similarly, focusing on how the company develops and maintains business (including where they exist and financial relationships with referral sources) as well as how it compensates marketing staff will provide valuable information about the company’s compliance knowledge and practices.
If a target’s business has been built around questionable relationships with referral sources or is driven by an improperly incentivized marketing or business development staff, it is worth thinking carefully on how that culture will need to change and what that change will mean to the viability of the business.
Carefully Consider Structure: Will the add-on be structured as an asset or a stock transaction? If so, what assets and liabilities will be assumed by the acquirer and what will be retained by the seller? Will ancillary services be provided by a management company following the add-on, thereby possibly impacting compliance with Stark’s in-office ancillary exception? How the new add-on company will be integrated into the existing enterprise structure is a key consideration and will have a significant impact on how risks need to be addressed.
Think Carefully About Indemnification: From a buyer’s perspective, strong indemnification provisions are key, especially where the scope and time for diligence will be limited. At the same time, in a competitive, time-sensitive transaction, pushing too hard on indemnification issues may result in losing the deal.
For smaller transactions, it’s important to keep in mind who is providing or standing behind the indemnification—will they even have financial wherewithal to back the obligation? If the seller is staying on as an employee, can the company afford to become adversarial with them? Thus, in some circumstances, even if a buyer is successful in getting strong indemnification protection, it may be not be beneficial from a practical perspective. In that circumstance, other risk mitigation strategies such as escrows, holdbacks, or representations and warranties’ insurance, may be more favorable to a buyer.
Focus on your Team: Industry specific knowledge, especially knowledge about the company and its existing needs and structures, is going to cut down on educational time and therefore costs. Trusted advisers who know the industry can key in more quickly on critical risk areas and are more familiar with alternative risk mitigation strategies.
Correct Identified Problems Prior to Close: It can be easy to put potential issues identified in diligence on a back burner and move on to the next transaction. For exactly that reason, consider correcting known issues at or prior to closing.
Whether the fix requires changes in billing practices, a government or payor refund, or self-disclosure, getting it accomplished prior to closing can help ensure a “clean slate”, eliminate the need for potentially divisive indemnification negotiations, eliminate any potential liability for buyers who knew about but did not correct the issue, and ensure the target company is in the right frame of mind to move forward with a compliant structure.
Sunk Costs Fallacy: Don’t be afraid to walk away. While it can sometimes feel like the competition is fierce in every type of space, many health care provider industry sectors remain highly fragmented. There will be other deals. Moving ahead in the face of substantial or unquantifiable risks may threaten your entire enterprise. Walking away may only mean a slight delay until you’re able to move to another opportunity.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Joshua J. Freemire is a member of the firm in the Health Care and Life Sciences practice in the Baltimore office of Epstein Becker Green. His practice is primarily focused on counseling private equity companies and other health care investors and their portfolio companies on a broad spectrum of health regulatory concerns, including fraud and abuse, privacy law, licensing, reimbursement, multi-jurisdictional practice and entity structuring, compliance, and disclosures.
Anjana D. Patel is a member of the firm in the Health Care and Life Sciences practice in the Newark and New York offices of Epstein Becker Green and serves on the firm’s National Health Care and Life Sciences Steering Committee. Her practice focuses on health care transactions and regulatory compliance counseling and she represents a diverse group of health care providers, venture capital and private equity funds, and various other health care industry service providers and businesses.