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Presenting a live 90-minute webinar with interactive Q&A
Private Equity Transactions in Healthcare:
Navigating Stark, AKS, and Other
Regulatory and Compliance Challenges Negotiating Purchase Price, Restrictive Covenants, Indemnities, Equity Rollovers and More
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
THURSDAY, MAY 12, 2016
John C. Riddle, Managing Director, Brown Gibbons Lang & Company, Chicago
Roger D. Strode, Partner, Foley & Lardner, Chicago
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©2016 Foley & Lardner LLP • Attorney Advertising • Prior results do not guarantee a similar outcome • Models used are not clients but may be representative of clients • 321 N. Clark Street, Suite 2800, Chicago, IL 60654 • 312.832.4500
May 12, 2016
Private Equity
Transactions
in Healthcare
Roger Strode
Foley-Chicago, IL [email protected]
John Riddle
Brown Gibbons Lang-Chicago, IL [email protected]
©2016 Foley & Lardner LLP
Agenda
■ Current Capital Market Conditions
■ Physician Practice Transaction Landscape − Practice landscape taxonomy
− Transaction considerations
■ Deal and tax structuring − Corporate practice of medicine
− Impact of designated health services
− Impact of legacy tax structures
■ Regulatory and Compliance issues − Stark Law and AKS Issues
− Issues related to billing and coding compliance
■ Common deal terms and indemnities − Representations and warranties
− Caps/baskets/survival periods/insurance
6
©2016 Foley & Lardner LLP
Favorable Capital Markets
Transaction Volume and Value (Middle Market) • As healthcare becomes an ever larger component of the
American economy, transactions in the healthcare space
continue to increase as a percentage of overall market
transaction activity
• In the fourth quarter, provider services acquisitions
increased over 15% from third quarter activity and 29%
higher than the fourth quarter of the prior year
• Scarcity of quality assets to meet demand for
acquisitions
Strong Healthcare Deal
Flow 3,567
5,119 6,104
7,027 6,382
6,935 7,236
$0
$150
$300
$450
$600
0
2,500
5,000
7,500
10,000
2009 2010 2011 2012 2013 2014 2015
Transactio
n V
alue
Tran
sact
ion
Vo
lum
e
Transactions Transaction Value
Private Capital Availability Remains Robust
• Aggressive private equity investors with dry powder
• Ample financing available for high quality companies
• Large amount of capital that needs to be deployed in the
next six to eighteen months
• Excess investable capital being drawn down
Sources: Capital IQ, Thomson Reuters, Pitchbook
Aggressive Private Equity
Investors
7
©2016 Foley & Lardner LLP
Leverage Markets Holding
• Increased competition from non-traditional sources,
paired with a lack of demand for loans, has created a
highly competitive dynamic in the marketplace
• Issuances directed strictly to leverage buyouts have
returned to pre-crisis levels, at 10.4% of total issuance
over the last twelve months
• Debt multiples for middle market LBOs continue to be
stable at 5.3x in 2015, reaching the highest level since
2007 when debt multiples averaged 6.2x
• 2015 experienced continued momentum from 2014 and
favorable leverage ratios remain prevalent
• Increasing number of loans are coming due in 2016,
which will compete for new debt used for M&A and
growth initiatives
Leverage Increasing in Deals (Middle Market LBOs)
Middle Market Loan Issuance ($US in billions)
3.3x
4.2x 4.3x4.5x
4.8x5.3x 5.3x
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
6.0x
2009 2010 2011 2012 2013 2014 2015
Tota
l Deb
t /
EBIT
DA
8
©2016 Foley & Lardner LLP
Valuations Above 5-Year Average
10.0x
7.3x6.1x
10.7x
0.0x
2.0x
4.0x
6.0x
8.0x
10.0x
12.0x
14.0x
16.0x
18.0x
Specialty PhysicianGroup
Hospital Management Imaging Services ASCs
Me
dia
n N
TM E
V/E
BIT
DA
12.1x
8.1x 7.4x
10.7x
0.0x
2.0x
4.0x
6.0x
8.0x
10.0x
12.0x
14.0x
16.0x
18.0x
Specialty PhysicianGroup
Hospital Management Imaging Services ASCs
Me
dia
n L
TM E
V/E
BIT
DA
1.1x1.0x
1.3x
2.5x
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
3.0x
Specialty PhysicianGroup
Hospital Management Imaging Services ASCs
Me
dia
n N
TM E
V/R
eve
nu
e
1.4x
1.1x1.3x
2.8x
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
3.0x
Specialty PhysicianGroup
Hospital Management Imaging Services ASCs
Me
dia
n L
TM E
V/R
eve
nu
e
Average Forward Looking Enterprise Value to Revenue Average Enterprise Value to Revenue
Average Forward Looking Enterprise Value to EBITDA Average Enterprise Value to EBITDA (Proxy for Cash Flow)
= 5-Year Market Cap Weighted Average
9
©2016 Foley & Lardner LLP
Valuations Above 5-Year Average
0.0x
0.5x
1.0x
1.5x
2.0x
2.5x
3.0x
3.5x
Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15
His
tori
cal E
V/R
even
ue
Specialty Physician Group Hospital Management Imaging Services ASCs Total 5-Year Average
0.0x
2.0x
4.0x
6.0x
8.0x
10.0x
12.0x
14.0x
16.0x
18.0x
Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15
His
tori
cal E
V/E
BIT
DA
Specialty Physician Group Hospital Management Imaging Services ASCs Total 5-Year Average
Comparable Public Companies Historical Median LTM EV / Revenue
Comparable Public Companies Historical Median LTM EV / EBITDA
10
©2016 Foley & Lardner LLP
Physician Practice Landscape
■ Practice Taxonomy
− Four sectors with significant activity
Facility-based specialties (e.g. anesthesia, radiology,
ED, hospitalists)
Retail medicine (e.g. dental, dermatology, IVF)
Disease-state specialties (e.g. gastro, orthopedics)
Primary care strategies
11
©2016 Foley & Lardner LLP
Physician Practice Landscape
■ Core Drivers of Consolidation
− Benefits of scale
Leverage IT, scheduling, revenue cycle
Access and optimize ancillaries
Deploy physician extenders and specialize
Manage care strategies
− Capital availability
Investors increasingly understand potential in clinical
services
12
©2016 Foley & Lardner LLP
Physician Practice Landscape
■ Core Drivers of Consolidation
− Secular trends
Healthcare reform
Employer and payer strategies
− Physicians increasingly interested in a transaction
Desire to establish long-term practice continuity
Aging physician base in ownership
Capital requirements
Wealth diversification
13
©2016 Foley & Lardner LLP
Transaction Considerations
■ “Platform” vs. “Bolt-Ons”
− Platform attributes
− Valuation differences
■ Compensation and Value
− Trading compensation for liquidity
− Tax considerations
■ Ownership Dynamics
− Broadly held vs. consolidated ownership
14
©2016 Foley & Lardner LLP
Transaction Considerations
■ Post Transaction Physician Relationship
− Employment terms important to get right
− Maintain culture and clinical operations
− Ensure ability to continue to recruit and retain new
physicians
15
©2016 Foley & Lardner LLP
Deal and Tax Structuring
■ Corporate Practice of Medicine
− Most states have some form of “corporate
practice of medicine”
− Influences structure
− Generally requires the use of a “friendly” or
“captive” professional entity
− Economics captured in Management Company
through management fee
16
©2016 Foley & Lardner LLP
Deal and Tax Structuring
Starting Structure
Legacy Medical
Group
MD MD MD MD
Assets
and
Employees
17
©2016 Foley & Lardner LLP
Deal and Tax Structuring
Ending Structure
“Friendly”
Medical Group
MD Limited
Clinical
Assets
(DHS)
Clinical
Employees
Management
Company
MD
Rollover
Entity
MD
MD
MD
MD
Sponsor
Management Services
Management Fee
Assets
and
Employees
18
©2016 Foley & Lardner LLP
Deal and Tax Structuring
■ Corporate Practice of Medicine − New York state settlement with Aspen Dental Management
− Many states have some form of CPOM concept and fee-splitting prohibitions
− Significant risks can arise when a non-professional vendor is engaged to manage or consult a licensed professional or an entity comprised of licensed professionals.
− New York State AG alleged that ADMI did not simply provide business support and administrative services but subjected its managed dental practices to extensive “undue control”
19
©2016 Foley & Lardner LLP
Deal and Tax Structuring
■ Corporate Practice of Medicine − AG determined that
Practices were individually owned in name only, and ADMI was acting effectively as a de facto owner
Management fee captured a percentage of the practices’ revenue,
ADMI exercised control over bank accounts, advertising and marketing practices, decisions involving patient care and treatment plans, and clinical staff employment matters
− Significant fine paid and restrictions agreed to by ADMI
20
©2016 Foley & Lardner LLP
Deal and Tax Structuring
■ Corporate Practice of Medicine
− Who is really in control of the practice, not just in control of clinical decision making?
− How are management fees determined? Are they consistent with FMV?
− Can the manager unilaterally discipline/fire licensed professionals?
− What do the non-competes look like?
− What impact does a loosening of control/restrictions and renegotiation of management fees have on purchase price?
21
©2016 Foley & Lardner LLP
Deal and Tax Structuring
Impact of DHS
“Friendly”
Medical Group
DHS Assets
(Lab)
(Imaging)
(PT)
Management
Company 3. Management Services
4. Management Fee
Payers
Including
Medicare
1. Bill for DHS 2. Reimbursement
22
©2016 Foley & Lardner LLP
Deal and Tax Structuring
■ Impact of Designated Health Services − Implicates the Stark Law
− Stark prohibits certain referrals by a physician for so-called “designated health services” (DHS) including lab and imaging reimbursed by Medicare unless the structure meets an exception
− Requires a structure that preserves the so-called “in office ancillary services” exception
− Failure to meet IOAS exception will make illegal physician referrals for DHS
− Successfully meeting the IOAS exception obviates the need to meet other exceptions
23
©2016 Foley & Lardner LLP
Deal and Tax Structuring
■ Legacy Tax Issues
− Impact of S Corporation Status on Rollover Equity
− Amelioration of Negative Tax Consequences
24
©2016 Foley & Lardner LLP
Regulatory and Compliance Issues
■ Impact of AKS and Stark Law
− FMV payments still a concern
− Stark Law DHS issues
■ State Law CPOM and Licensure
■ Compliance Issues in Diligence
− Billing and coding (“up” coding and incorrect use of modifiers)
− Improper billing for physician extender
− Billing when charting is incomplete
25
©2016 Foley & Lardner LLP
Hot Diligence Issues
■ Anti-Referral Issues − Violations of Physician Anti-Referral laws (Stark) remain
a significant concern
− OIG Fraud Alert (June 2015)
Emphasized the need for FMV payments to MDs for bona fide
services
Problematic arrangements include (i) those above FMV, (ii)
compensation that takes into account v/v of referrals, (iii) MDs
failing to provide contracted services and (iv) affiliated health
care entity paying for physician office staff
Shot across the bow to physicians who sometimes believe they
won’t be targeted for abusive situations
26
©2016 Foley & Lardner LLP
Regulatory and Compliance Issues
■ Anti-Referral Issues − Physician compensation, particularly stacking of compensation that
leads to high aggregate compensation amounts
− Focus on FMV, including the selection of benchmarks and the quality
of reports
− Focus on the accuracy, reliability and completeness of information
provided to advisors
− Questioning of commercial reasonableness of compensation
arrangements when reasons for the arrangement are not well
documented
27
©2016 Foley & Lardner LLP
■ Anti-Referral Issues
− North Broward Settlement
$69MM settlement for FCA and Stark law violations
(including a 5 year CIA)
− Adventist Settlement
$115MM to settle Stark law and Medicare coding
claims
Regulatory and Compliance Issues
28
©2016 Foley & Lardner LLP
■ Anti-Referral Issues
− Employment Safe Harbor (AKS) is not bullet proof
and doesn’t give you cover under the Stark Law
− If you have high compensation relative to MGMA
percentiles, have good documentation to support
the compensation
− Watch use of internal reports, related to physician
use/referral to ancillaries—regulators will use it to
“connect the dots”
Regulatory and Compliance Issues
29
©2016 Foley & Lardner LLP
Regulatory and Compliance Issues
■ Finalization of 60-Day Overpayment Rule
− Statute set the 60-day rule stating that the overpayment must be reported and returned by the later of:
the date which is 60 days after the date on which the overpayment was identified, or
the date any corresponding cost report is due, if applicable
− By statute, overpayments retained after the deadline for reporting and returning an overpayment become an “obligation” under the Federal False Claims Act, subject to treble damages and per claim penalties
30
©2016 Foley & Lardner LLP
■ Finalization of 60-Day Overpayment Rule
− Does the target have an overpayment policy?
− What are the target’s document retention
policies?
− Evaluate processes for conducting internal
investigations
− Evaluate overpayment training
Regulatory and Compliance Issues
31
©2016 Foley & Lardner LLP
■ Due diligence continues to be critical to most deals getting done—We are seeing a heavy emphasis on diligence matters − Often due to the fact that Friendly PC retains its
provider number(s) and NPIs
− In certain situations, agreements to self disclose prior to closing, or immediately after closing, are common
■ Valuations appear robust—Not unusual to see 9-12x (sometimes greater) multiples on TTM EBITDA for platform companies in the private equity space
Common Deal Terms and Indemnities
32
©2016 Foley & Lardner LLP
■ Escrows of 10%-15% of transaction value not
uncommon
■ Seeing some reduction of escrows when R&W
insurance is used
− Beware of carve outs for certain issues, such as
“health care compliance” reps and warranties
− Sellers should be prepared for a second round of
diligence from counsel
Deal Term Updates
33
©2016 Foley & Lardner LLP
■ Survival Periods (R&W) − General: 12-18 months
− Fundamental: Unlimited
− Taxes/Benefits: SOL + 60-90 days
− Health Care: SOL = 60-90 days or 3-5 years (depending upon negotiations)
■ Caps − Can be lowered through use of R&W insurance (as low as 5% of
transaction value in some cases)
− No cap, generally, on breaches of covenants or breaches of fundamental R&W
− Higher caps, generally, on breaches of health care R&W
■ Baskets
Deal Term Updates
34