private equity transactions in healthcare: navigating...

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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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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


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


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


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



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



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



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


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


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



■ 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



■ 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


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


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


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



Starting Structure

Legacy Medical

Group

MD MD MD MD

Assets

and

Employees

17



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



■ 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



■ 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



■ 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



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



■ 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



■ Legacy Tax Issues

− Impact of S Corporation Status on Rollover Equity

− Amelioration of Negative Tax Consequences

24


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


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



■ 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


■ 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


28


■ 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”


29



■ 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


■ 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


31


■ 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


■ 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


■ 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

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