Understanding Essential Documents in a Healthcare Transaction
During a healthcare M&A transaction, there are a flurry of key documents that can cause headaches among both sellers and buyers, but should be thoroughly understood because of their importance to the process as a whole. The Ambulatory M&A Advisor takes a look at the processes and rules behind Purchase and Sale Agreements, Letters of Intent, and the Acquisition Agreement. All of these documents are major landmarks that lead parties on the road to closing a deal.
Purchase and Sale Agreement
John Fanburg, Partner with Brach Eichler LLC says that when discussing a Purchase and a Sale Agreement in an urgent care setting, the number one, two and three issue is the price, price and price. A lot of factors can play into that, but usually, a physician owned surgery center is not going to be selling 100 percent, but is going to be selling a portion.
The buyer wants the physicians to stay engaged because they control the volume. In these transactions, some of the development companies or private equity firms buy as little as 40 percent, to as much as 51 percent.
“I am in the process of concluding a deal where the physicians are selling 60 percent, and will retain 40 percent, so these variables really depend on the nature of the sale,” Fanburg says.
How much is being sold and price are critical. Ways to approach these agreements are to examine how it is structured. Is it an asset sale or a stock sale? Does it have tax implications? Fanburg explains that usually, the price is a multiple of Earnings Before Interest Tax Depreciation Amortization (EBITDA), and the selling physicians want to have their accountants to come in to appropriately boost the starting off EBITDA number, and then they negotiate what the multiple of that number will be.
After discussing how much is being sold an at what price, the next area to focus on is the ongoing limitations for physicians in terms of how long they need to remain in the center. There could be a penalty involved because the purchaser expects those physicians to continue to support the center for a period of time, as well as restrictive covenant positions. Those are the main deal points even though there are other aspects involved, but those are critical.
When discussing restricted covenants in a Purchase and a Sale Agreement, Fanburg says the physician would be prohibited from having any type of financial interest in another surgery center within a geographic mileage from the center involved in the transaction. If, in fact the physician leaves the center, there would be a post- withdrawal limitation as well.
“Depending upon where it is located, the geographic limitation could be between 10 and 30 miles, and the post-termination could be 2-4 years, however, that is a negotiating point between a buyer and a seller,” Fanburg says.
Fanburg says that the terms within these types of agreements are absolutely binding because they are the contract of sale in the transaction.
On the topic of breach Fanburg says that lawyers involved always try to negotiate a resolution before charging in directly with a law suit.
“It takes a lot of time and financial resources to get to a resolution so if there is a way to negotiate out of a controversy, we try to do that, but if we can’t we send you to the courts,” He says.
Letter of Intent
Fanburg says a Letter of Intent (LOI) will lay out the key negotiated terms, and those tend to be non-binding until the deal is signed. Typically, the only thing that is binding in a LOI would be the confidentiality of the discussions, the confidentiality of the financial material that is exchanged. There may be some non-solicitation so that people are not hired away if for some reason the deal does not happen. Key terms of the contract are generally non-binding in order to give everybody the chance to go through due diligence and reassess what is happening.
Matthew Fisher, Chair of the Health Law Group at Mirick O’ Connell Attorneys at Law says that typically, when he is working on a letter of intent, for the most part, they are non-binding aspects to the overall transaction.
“The general purpose of an LOI is to set up the preliminary understandings and preliminary agreements on certain terms. You are helping to inform what will go into the definitive agreements,” Fisher says.
“I feel like over half the time when I am working on LOIs, aside from provisions such as confidentiality, or responsibility for fees, the general overarching concepts are not binding.”
After Fisher reinforces the fact that it is not typical for most terms in a LOI to be binding, he does say it is more and more common that he sees a confidentiality provision in LOIs that would preclude a party from showing that LOI to other potentially competing parties.
According to Fisher, breakup fees and no-shop clauses were, up until recently, only found in transactions involving large public companies. However, these types of binding terms have become commonplace in mid to small size ambulatory care center acquisitions.
Fisher says that in the modern transaction, these are common and expected requests from parties.
“You want to cover your damages, or your time in the deal; you want it significant enough to act as a deterrent yet from an enforcement perspective you do not want it deemed as a penalty,” He says.
As far as uncommon binding terms, Fisher says people have to be careful when dealing with these things.
“You need to make sure that the LOI is not prepared an offer letter if that is not what you are intending it to be. An LOI could be so specific about the terms and positions of a deal, and could be phrased to be characterized as an offer. If you sign on the “agree to” line you may in fact be entering into a contract,” Fisher says.
The Acquisition Agreement
Tammy Scelfo, Partner at Allen and Gooch practicing in healthcare and other commercial transactions, explains that an acquisition document is the road map to a closing and also adds to the protection of a transaction post-closing.
Scelfo explains that one of the most important aspects of the document is that it gives the parties the right to conduct due diligence, which is critical in any acquisition, but particularly so in a healthcare transaction given how heavily regulated the healthcare industry is and the severe nature of the penalties that can be assessed.
“A well-structured agreement should provide in addition to a clear road map of how the parties are to get from pre-closing matters, such as due diligence, to closing, but also how liabilities are handled after the closing should any arise. To address this, the agreement should contain reps and warranties, as well as indemnity agreements,” Scelfo says.
“The acquisition agreement is vital; it’s your protection; it’s what you rely on; and it’s what gives a party its remedies against the other party if there has been a breach of a rep or warranty or an unexpected liability arises post-closing.”
According to Scelfo, it is important that the document clearly reflects what each party’s duties and responsibilities are, and the timeline for the transaction. Scelfo explains that a typical acquisition agreement will state what the purchase price is, when the purchase price is to be paid, how the purchase price is to be allocated among the assets being acquired.
“It depends on how the transaction is structured, but the purchase price may be allocated among various assets and the parties need to agree on that allocation so that both parties consistently report that allocation for tax purposes,” she says.
If the purchase price is to be paid in a lump sum, if it’s to be paid in installments, whether there will be a promissory note, whether the purchase price will be paid by electronic transfer, bank check etc; all of this information is involved in the acquisition agreement.
“Also, an important aspect is the timeline for the acquisition. Very often you want to build in a due diligence period so that both parties can conduct their pre-transaction due diligence on the other party. Typically, the purchaser wants to make sure that there are no known or latent liabilities out there like legal judgments, liens on any of the assets being acquired. You want to build in a due diligence period and you also want to clearly spell out what happens if any problems are discovered during due diligence,” She says.
According to Scelfo, when drafting such a document one must consider these questions should a negative surprise arise: Can the parties walk away? Is there an opportunity to cure any of those issues before a party walks away?
If you would like to learn more about the concepts covered in this article, want to sell your business or discuss how Ambulatory Alliances, LLC might be able to help you out, contact Blayne Rush, (469)-385-7792, or Blayne@ambulatoryalliances.com.
If you have suggestions for future topics, email Blayne@ambulatoryalliances.com.