Acquiring Physician Practices Brings Risk Along with Benefits

Authors: Alan Gracie, Ryan Grady, Shawn Frier

The number of hospitals pursuing acquisitions of physician practices is on the rise. Why? Because they hope it will help improve care, cut costs and boost profits. However, such transactions aren’t without risk and they require comprehensive due diligence. On the financial side, a hospital should perform due diligence in these areas in particular.

Sustaining revenues

The sustainability of the practice’s revenues is key to its value as well as the eventual success of the transaction. But revenues can be inflated because of overdependence on either a limited number of referral sources that could dry up, or a small number of providers who might depart.

Moreover, trends in reimbursement rates may also distort revenue. If rates for one of the practice’s primary services are dropping, the services might bring in less revenue down the road.

Practice revenues and the distribution of procedure codes both should be compared to appropriate benchmarks to determine reasonableness. The facility should also determine each physician’s age and estimate how long he or she might remain with the practice.

Another area to scrutinize is the revenue cycle. Ask yourself how long it should take to convert a procedure into revenue. Also consider the patient flow process, collections and denials, and billing and documentation practices.

Understanding expenses and capital requirements

Do you anticipate any major expenses on the horizon, such as increased rent for more space, supplies or costly equipment? If so, prepare a list of all incurred but unpaid accounts payable and accrued expenses as of your balance sheet date. Next, compare operating expenses, overall and by category, with appropriate benchmarks.

It’s likely that physician compensation is the source of any substantial jumps in expenses. Make sure you review every physician’s employment agreement and compare their compensation with benchmarks. If you find any significant discrepancies, get further explanation.

You should also think about the practice’s future capital requirements. For instance, will significant investment be necessary to implement needed technology upgrades for electronic health records (EHRs)?

Consider other financial obligations

Your facility should gather copies of all outstanding debt agreements and summarize the relevant terms, including covenants, repayment terms and assets pledged as security. Also confirm that no loans are in default.

Some hospitals decline to assume a practice’s debt as part of the transaction. But there may be similar obligations lurking out there in the form of commitments or contingencies that don’t appear on the balance sheet. Your hospital should be aware of any change-in-control payments that could be triggered by a transaction, for example. And a self-insured practice might have incurred, but never reported, a medical malpractice claim that may come back to haunt the hospital.      

Do your due diligence

Comprehensive due diligence requires all hospitals to consider many other areas that will affect both the practice’s value and the success of the transaction.

Make sure you engage legal and consulting advisors who are experienced with hospital purchases of physician practices. They can help you navigate all of the compliance, legal, and transition matters that must be addressed.

If you have any questions about due diligence or any other issue pertaining to hospitals, give us a call at 716.847.2651, or you may contact us here.

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