Buy and Employ Transactions: Part 1
Hospitals are increasingly entering into “buy and employ” transactions with key physicians as part of their strategy to provide high quality patient care and grow market share. This buy and employ model is where the hospital acquires the medical practice and then employs the physician(s) – generally under some type of productivity based compensation arrangement. Although these transactions often make good business sense for both the hospital and physician(s), there are a number of important issues that must first be addressed in order to successfully achieve the desired outcomes. Some of the more significant issues include:
- Structuring the deal
- Performing financial and operational due diligence
- Determining the “fair market” value of the physician’s practice
- Assuring the transaction is commercially reasonable to the hospital
- Structuring the physician’s post acquisition employment arrangement
Deal Structure
Of the above list of issues, the deal structure will normally be the simplest with which to “deal.” Generally speaking, acquisition transactions are structured as either “stock” (i.e. equity) or “asset” transactions. With stock transactions, the acquiring hospital buys the outstanding shares of the practice entity and gets everything owned or owed by it (known or unknown); whereas, with assets transactions, the buyer acquires only agreed upon assets and assumes only agreed upon liabilities.
Sellers normally prefer stock transactions due to the tax benefits (capital stock is considered a capital asset subject to the 15% capital gains tax as opposed to the much higher ordinary income tax rates that would likely apply to the underlying assets). Buyers on the other hand usually prefer asset transactions because 1) there is usually less risk of inheriting undisclosed/unknown liabilities of the seller, and 2) the ability to “step up” the tax basis in the underlying assets for future depreciation purposes.
However, aside from these general preferences, the ultimate deal structure will be significantly influenced by the organizational structure of the acquiring hospital and physician practice. For example, if the acquiring hospital is organized as a non-profit entity, it probably won’t be very concerned about the additional depreciation deductions available from the stepped up tax basis of the assets, and therefore may be more willing to do a stock deal.
Another concern from the physician practice perspective is the possibility of double taxation that can result from asset transactions when the practice is organized as a corporation. Asset acquisitions, in such cases, should generally be structured such that the hospital acquires only certain assets (e.g. the tangible fixed assets). The physicians would retain the remaining assets (including accounts receivable) and, to the extent possible, distribute the net proceeds as compensation.
Obviously, there are many other factors that will need to be considered in connection with structuring the transaction; however, the point is that the deal structure can have a significant impact on the ultimate outcomes from the transaction, and therefore, should be planned accordingly.
We’ll take a closer look at the other issues over the next several posts.
