Financing acquisition of a medical practice

By Lisa Wood, MBA, Senior VP, Medical Industry Specialist, IBERIABANK

Whether the goal is establishing or strengthening a position in the healthcare marketplace, acquisition of an existing practice offers a variety of potential benefits − so long as the deal makes financial sense for all parties concerned.

For a young physician, purchasing the practice of an established doctor looking to retire can provide immediate legitimacy and a patient base that might take years to otherwise acquire. In many cases the new doctor will join the practice for an agreed upon time working alongside the senior physician to provide a smooth transition of responsibility and patient interaction.

For a larger medical practice, acquisition of a medical specialty practice offers vertical integration benefits. The practice can offer a greater range of services and have a source of referral capabilities within the organization.

Larger medical practices also have greater negotiating power with suppliers, revenue resources and commercial insurance payers. A diversified medical practice has greater opportunities to generate cash flow, achieve better volume purchasing rates and consolidate overall practice expenses.

Strength in numbers is an increasingly important part of the healthcare industry. The creation of Accountable Care Organizations (ACO) is an emerging trend in which groups of doctors, hospitals and other health care providers come together voluntarily to provide quality care to patients − while avoiding unnecessary duplication of services. The ACO model encourages doctors to share financial and medical responsibility for providing coordinated care to patients.

More than 428 provider groups have already signed up for ACO status − with an indication that more consolidation will occur in the healthcare industry.

The sales price, and upon what value that sales prices is based, will be a key component of the transaction for physicians and their bankers. Prospective buyers and sellers need to be able to establish a value on what a practice is worth.

There are several ways to establish value. The cost approach addresses the value of the physical assets plus the market value of the practice’s good will. A market approach relies on the actual prices paid for comparable facilities in the marketplace. An income approach is based on earnings with a multiple applied. Multiples will vary by market. There are numerous companies that can assist with practice valuations The National Association of Government Guaranteed Lenders (NAGGL) at Template.cfm?Section=Lender_Service_ Providers&Template=/CM/ContentDisplay. cfm&ContentID=10154.

When an established doctor sells his practice to a less established one, a 20-30 percent patient attrition rate is not uncommon. Often the senior doctor will agree to a three to six month transition period. It is important that the sale agreement include a non-compete clause for the departing seller. For larger medical groups buying individual practices, it is important to know that key physicians and healthcare providers will continue their roles following the acquisition.

When meeting with your banker, they will want to review the finances of the existing medical practice, and the prospective purchase, the lender will want to know what the overall benefits of the purchase will be − including projections of what the new practice will generate in terms of cash flow and expenses. While bankers understand the logic and potential benefits of purchasing a medical practice, they will want to know specifically how the acquisition will be handled and what benefits will result from the purchase. It’s a good idea to have an overall business plan available that details projected revenues and expenses. They will also be interested in knowing about any staffing changes that are anticipated in the practice.

Under ideal circumstances, bankers will finance up to 80 percent of the acquisition cost, requiring the borrower to come up with 20 percent. Lenders will rarely finance 100 percent of the cost because they feel it is important for the borrower to have a vested interest in the success of the venture. A Small Business Administration (SBA) loan may allow a lower equity injection, with longer repayment terms, but typically has more upfront fees associated with it.

In some cases, sellers can assist in the sale by taking a note for a portion of the purchase price − or the 20 percent not covered by a bank agreement − but it is important to note that this financial arrangement must subordinated to the bank’s loan.

There are a lot of good reasons for acquiring or consolidating medical practices. It is important, however, to consult with experts to make sure the arrangements make business and financial sense.