The Second in a Four-Part Series
How are medical groups responding to healthcare’s increasingly complex billing and collection landscape, the high costs of technology, the challenges of business development, rising expectations of patients and the increasing challenge of recruiting and retaining top clinicians? More and more often, the answer is by considering mergers.
Like it or not, independent physician groups are business owners. They may not have appreciated the mountain of nonclinical tasks involved in practice management when they graduated medical school. The reality is that to be successful in today’s environment a practice needs to focus extensively on the administrative side of the house. However, these are not skills that are taught in medical school and many practices are already operating with tight margins so they are faced with the dilemma of sacrificing their own compensation if they hire seasoned business managers. Many practices are looking to partner externally to help solve these challenges through mergers and acquisitions (M&As); whether it be selling to their local hospital system or merging into a regional or even national mega-practice. [Insert stat on rate of consolidation between physicians groups].
Medical professionals do not generally know where to start when it comes to beginning to evaluate a potential M&A strategy. Many groups begin their process by meeting with potential suitors, when in reality the first step should be an internal assessment of the goals and objectives of the group. Physician-owners must engage in clear planning and self-assessment, including several concrete steps discussed in more detail below.
Long-Term Business Planning
Without a doubt, the most important first step in considering any variation of M&A is to put together a substantive business plan that covers at least the next three years. Regardless of whether profit is part of the organization’s mission—which may center instead on providing care—this business plan must be based on a detailed set of historical and projected financials to convey an accurate, comprehensive financial profile.
Most practices operate on a cash basis since cash is easy to measure. However, cash may be the best basis to determine the practice’s future potential. Due to the complex reimbursement model, practices typically wait 60-90-120-150 days from when a patient is seen until when the cash is collected. However most expenses all need to get paid within 30 days so there is a natural lag between revenue and expenses in “cash basis” accounting. The practice must match revenue and expenses in the same period (“Accrual accounting”) to show an accurate picture of the health of the practice.
To complete a thorough business plan the owners must access all the factors that could potentially impact revenue and expenses over the next three years, including:
• the potential impact of likely reimbursement changes (increases or decreases)
• the potential impact of changes in patient volume (new sites, terminations, etc.)
• staffing adjustments (new hires, promotions, benefit cost changes, etc..)
• changes in administrative costs (back office support, billing, technology, personnel, etc.)
• the costs of required IT projects or upgrades.
Forecasting must be completed at the individual expense line item level i.e., looking at each administrative cost individually and modeling out the potential changes (i.e., rent, billing, technology, etc.). Once completed, this will help owners answer the critical question, “Are things going to get better or worse materially over the next three years?” In other words, where does the organization fall in the business life cycle (i.e., bottom, middle or top of the growth curve)? Does the business require additional infrastructure investment and what is the ROI on that investment? The only way to determine whether a buy-out or merger is even desirable is to be able to answer this question first.
Once a clear-eyed self assessment of the short- to medium term is established, different options can be evaluated. What are the group’s different possible paths, and what are the pros and cons of each one? How do they compare to the business objectives of the organization? (Often, this type of rigorous self-assessment can guide present actions as well as future ones: what investments can be made now to improve the organization competitively, strategically, and operationally?)
This business self-assessment will lead physician-owners to one of four main options:
1. Take advantage of a positive status quo and do nothing.
2. Merge with another practice in a pure equity merger (i.e., no cash changing hands).
3. Take in investor capital (a private equity transaction, typically 51-80% of the company is sold).
4. Pursue a full buy-out (the “strategic sale”).
For all options, the next step is to define your business vision.
Preparing A Business “Vision”
Regardless of whether the practice is looking to stay the course as independent or consider a potential sale, there should be a clear vision that defines that strategy and culture of the practice. Whether looking to recruit new doctors, win a new hospital contract or pitch a potential buyer, the president of the practice needs to be able to articulate what is unique about this group and answer “why”.
This vision starts with a story: the story of the business’s intrinsic value and growth.
What has attracted top physicians to join the group and why have they stayed? What has attracted top physicians to join the group and why have they stayed? Why is this medical group a real platform group? How does this practice compare to other groups across the country? Is it the scalability of its technology, the efficiency of its operations, its clinical expertise? Is it the result of relationships with C-suite executives? What is it that makes this practice a best of breed platform that an investor or purchaser can put their logo next to and say, “We are partnering with one of the leaders in this space and we’re willing to give it a premium valuation because there is a scarcity of practices like this.”
Identifying and Targeting the Best Potential Partners
The group’s story and vision help inform the next step: asking who are the right partners. Especially in pure equity mergers, the goal is to find partners who share a similar culture—a similar “vision”—and who will work toward mutual satisfaction.
The most successful mergers (or acquisitions or private equity transactions, for that matter) typically start with a field of five to ten potential partners. Exploratory meetings may become information-sharing exercises when a partnership comes to seem mutually beneficial. The key at this stage is recognizing that capital isn’t the only factor here—culture is critical.
Culture is so important because of the unique nature of medical practices. Medical practices are professional services where the main assets are the people themselves. The business case for acquisition or merging is thus intimately tied to the leadership of the physician-owners and the performance of the staff. If those people—which constitute the group’s value—cannot integrate with the new owners or partners, the venture will fail. Respect, curiosity, and flexibility are watchwords here: can each partner learn from the other? If this is the case, the money may follow. On the other hand, focusing exclusively on economics without considering cultural fit makes the partnership unlikely to succeed.
Bringing in Strategic Investment Advisors
Only after conducting a careful business self-assessment, determining the best range of options, articulating a vision about and for the business, and identifying the best set of potential partners can a medical group begin to think through issues like valuation and specific transaction terms. Too many times medical groups launch into such complexities without real preparation in a business sense.
If lack of preparation and self-awareness is such an Achilles’ heel for physician owners, might strategic advisors be of use? If so, when should they be brought in?
Each of the above steps is a demanding process that can benefit from expertise on the business side. Advisors can help medical practitioners at each stage—by framing the necessary three- to five-year budget, for instance, and by helping evaluate the possible options. Even if the best decision is to stay with the status quo, a professional advisor (or investment banker) can help group owners reach (and trust) that choice. The common misperception is that a practice decides to sell first and then brings in an advisor to do the deal. Very often, that is the wrong order. Financial advisors’ knowledge may be most useful in the decision-making process. Consider the example of assessing market potential. Someone unfamiliar with this exercise can skew the calculation with a simple misapplication of a multiple, leading to false conclusions about growth potential. Thinking a business is worth $100 million when it is better valued at $50 million will inevitably dictate a different course of action. Time that may have been wasted searching for interested buyers could be put to use growing the practice, for instance, and revisiting an acquisition later.
Practicing physicians should seek counsel from market experts who traffic in M&A just as those experts would come to them for questions about an injury or medical procedure. In M&A as in medicine, context and expertise are essential prerequisites for success.