In the specialty medical practice space, roll-up acquisitions—where smaller medical practices are acquired and integrated into larger practices—have become increasingly popular with private equity firms. However, this investment strategy comes with its own challenges, and understanding the acquisition and post-acquisition obstacles can help alleviate risks and improve the chances for a successful transaction and a smooth transition.
Writing a Clear Letter of Intent
It is critical that the buyer and seller agree to the purchase structure and how the initial indication of the practice’s value is determined. In the medical roll-up space, the legal and tax structure of the selling entity often poses challenges with the purchasing entity structure. When the seller does not understand how the value is derived during the negotiation process, they may ask to be paid for additional items not in the letter of intent and deals can fall apart. It is also important to consider post-acquisition compensation or equity ownership and the impact on value they may have, along with the need for reverse due diligence.
Due Diligence Obstacles
After parties agree to a letter of intent, the due diligence process creates its own set of obstacles. Small medical practices often lack a full-time accountant and going through the due diligence process can be overwhelming. Many times, the quality of the financial information makes it difficult to support the true financial results. In one recent acquisition, the doctor-owner of a $2 million practice maintained the general ledger in a checkbook. Unsophisticated financial controls and significant personal expenses make it easier to commit fraud, which can get missed during due diligence if the scope is not designed appropriately.
It’s important to be on the lookout for other sources of risk. For instance, some practices still use paper medical records that pose HIPAA risks. An operational review needs to identify equipment that lacks the latest technology upgrades, and revenue recognition and days sales outstanding are often impacted by insurance reporting and realization.
Working capital is often the most contentious area of a transaction. A working capital target to protect the buyer is typically calculated using a trailing 12-month average, but difficulties can arise in calculations because medical practices often use cash-basis accounting. In many of these acquisitions, working capital is difficult to predict due to inventory, receivables and payables not being accounted for properly—if at all.
Challenges may surface while integrating the new roll-up, even after acquisition. These challenges can arise from insurance contract credentialing, integrating an electronic medical records system, implementing management software and ensuring the physicians are happy with post-acquisition transitions.
Being aware of obstacles and risks in a specialty medical practice roll-up strategy—and planning accordingly to address them—will ensure success for a PE firm.
This story originally appeared in the May/June print edition of Middle Market Growth magazine. Read the full issue in the archive.
Bryan Graiff has more than 25 years of C-level experience and has led over 100 buy- and sell-side transactions from both sides of the desk.
Ron Present has over 35 years of health care industry experience. He helps clients prepare and implement solutions for value-based purchasing and care.