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5 Pitfalls to Avoid in Hospital Mergers and Acquisitions

With a growing emphasis on value-based purchasing and ACO-style reimbursement, many providers are considering new transactions and joint ventures to align their facilities with others and jointly provide high-quality services.

Recognizing this, experts from law firm Drinker Biddle & Reath in Chicago recently hosted a webinar titled "Hospital Mergers & Acquisitions: Transactional, Labor, Employment and Benefit Issues" that discussed many considerations for hospitals and systems looking to buy, sell or merge with a competitor.

Here are five ways to avoid common pitfalls in hospital transactions, as discussed in the webinar.

1. Know what you want. There are plenty of affiliation models hospitals can choose when they enter into an agreement with a competitor, but each carries a different level of gain and risk. Before signing a binding agreement, Doug Swill, JD, a managing partner and chair of the healthcare practice group at Drinker Biddle, urges hospital executives and board leaders to know what they hope to gain from a merger.

Considerations the board of directors and senior management should be making include what infrastructure would be made available from the proposed affiliation, or whether the parties have the technology capabilities to realize their goals. If the affiliation is driven by a desire for more capital, a board must be certain acquired liabilities wouldn't cancel out the desired benefits of a merger.

Because mergers and acquisitions are highly complex and permanent, Mr. Swill says joint ventures have become increasingly popular among providers hoping to streamline care because of their relative ease to arrange and disaffiliate.  This can certainly be advantageous, but it can be done poorly as well, he warns. "It's not as clean as just merging one hospital into another hospital," he says.

2. Get the people part right. Many systems are considering affiliation to capitalize on the rewards for better managed and integrated care, says Mark Nelson, JD, a partner in Drinker Biddle's labor and employment practice group, but "the people part of it is getting less attention than it does in other industries."

Compatible cultures between affiliating systems is a crucial element in determining whether a transaction will be successful. Their mission and values must be in sync, but so must the preferred leadership styles, goals and time horizons. Even staff preferences for individual versus team recognition are factors that must be managed along all stages of the integration process.

"It requires analysis and in-depth review, and organizations have found trying to meld these is a much different process and cultural reality than they ever would have imagined. It's a tremendous barrier, and while it doesn't necessarily kill the deal, it does make it more challenging," Mr. Nelson says, adding that many in the initial stages of affiliation talks have decided "marrying" the two cultures would be too difficult or too costly.

To help ensure the integration process doesn't impede the success of the transaction, Mr. Nelson recommended a chief integration officer be appointed and granted authority over the process for a defined period of time. Otherwise, work can become too diffused for a huge team without defined leadership.

Mr. Nelson says that leadership is critical but often lacking in the integration process, making operational failings common. Staff identified as key leaders should be granted retention agreements for a period of time after the transition to stabilize the organizations as they begin to meld.

3. Involve HR early. Melissa Junge, JD, an associate in the firm's employee benefits and executive compensation practice group, says a common error she sees hospitals make is not engaging their human resources departments in initial transaction discussions and due diligence efforts, and little concern or analysis is given to existing employee benefit packages from an affiliating system.

"HR is too often left out of the mix until too late in the process, which can be costly as benefit packages are now binding for the acquirer," Ms. Junge says. "Too often HR is not given sufficient involvement in this process, or a sufficient leadership voice. Or if it does, it's too late in the process."

Due diligence should look closely at employee benefit plans, checking to see if plans are compatible. For-profit 401(k) plans, for example, are not compatible with non-profits' 403(b) plans. Also, if not hammered out in advance, each organization's 401(k) plan may not be able to be terminated, requiring the new managing entity to operate two separate 401(k) plans. And the 404(c) status, which determines whether employees can make independent stock decisions on their 401(k) plans, has big impacts on the hospital's liability, Ms. Junge cautions.

Don't forget about executive benefit packages, too. "Sometimes we'd like to think C-suite executives know what plans exist, but sometimes they don't," Ms. Junge says. In some cases, that can be a major source of frustration for executives and physicians with generous for-profit 451 plans that would no longer be valid if the company were acquired by a non-profit system.

Sick days, vacation time, leaves of absence and severance are just a few things that should be handled and agreed upon long before the deal is inked, and HR can help that happen smoothly.

4. Avoid Unwanted Liabilities. The structure of an affiliation carries with it protections and vulnerabilities from both internal and governmental influences, Mr. Swill says. The structure a hospital system selects may depend on how it wants existing or future debt to be handled, as well as the governmental process necessary to execute certain types of deals.

It's also possible to simply purchase only the assets of a system, without needing to also acquire employees or liabilities. This, when available, can be a desirable way to safely build a hospital's assets quickly, Mr. Swill says.

However, be sure retirement benefits won't break the bank. Defined benefit pension plans, Ms. Junge says, "just exude liability." If the acquired organization has one, its funding status is a major consideration because many pension plans today are underfunded.

5. Do due diligence thoroughly. So much has to be considered in due diligence that it's easy to let smaller things slip by, but that could end up costing buyers.

Among the many things that must be closely examined in this phase are whether there are outstanding benefit plan liabilities or losses. For 401k plans, it's important to make sure there have been timely contributions of employee deferrals, employer contributions and nondiscrimination testing. "It needs to go a little bit further into operation to ensure compliance," Ms. Junge says.

Additionally, it's important to remember due diligence is a two-way street. Mr. Swill says clients doing internal due diligence sometimes find unattractive information and are reluctant to report it. Those things will be found eventually, he says, and it's much better to disclose them. "Otherwise you may have adverse trust issues that could impact agreements or end them entirely."

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