Four Deal-breakers in Hospital Imaging Transactions and How to Avoid Them
When the hospital is the buying party in an imaging joint venture, there are four potential issues that could terminate the transaction, all of which stem from due diligence. These issues include one or both parties failing to understand the distinction between fair market value and strategic value, conflicts surrounding how professional payments are determined after the transaction, collection irregularities or other problems with revenue recognition, and management and governance issues for the newly joint-ventured or acquired imaging center. All four of these transaction deal-breakers, however, can be avoided through understanding, preparation, commitment to communication, and setting expectations. Fair Market Versus Strategic Value Too often, one or both parties in a transaction will fail to understand the difference between strategic value and fair market value. A seller might have preconceived notions regarding the value of its business based on discussions with other industry participants or on local market conditions, giving the seller expectations regarding the value of the business. In addition, sellers often anticipate the proposed purchase price of their businesses to include the characteristics and strengths of the buyer, such as economies of scale, purchasing power, or higher reimbursement levels. Strategic value often reflects the added value of the buyer post-transaction and is not the standard of value relied upon in health-care transactions. Health-care facility transactions typically take place at fair market value, which does not include post-transaction buyer benefits in value, but rather is calculated based on the ideas of a typical willing buyer and typical willing seller. Owing to this difference, fair market value is often lower than strategic value. This means that the seller is often disappointed by the buyer’s offer, particularly if the seller was unaware that the buyer would be engaging an appraiser or valuation expert to determine fair market value. Buyers should be transparent about their use of appraisers, and sellers should expect to receive fair market (not strategic) value for their businesses. Professional–Technical Revenue Split The second common hurdle is disagreement about how professional-component payments will be delivered following the transaction. Radiology groups that own outpatient imaging centers often bill and collect for both the professional and technical components. Under this arrangement, the professional component is built into the current expense profile of the businesses, based on a per-exam rate or percentage of global collections. The treatment of the professional component is important to consider if the acquiring party is purchasing a controlling interest (51% or more of the business) because this would require billing to be brought under the buyer’s provider number. As a result, the radiology group would no longer dictate the percentage going back to the group and would have to enter into negotiations on the professional fees remitted for professional services rendered. It is important to consider that the payment from the new joint venture to the radiology group should follow the standards of fair market value. Deals can deteriorate when the professional–technical split becomes less advantageous to the radiology group, if it is seeking a percentage that is too high for the buyer. Financial and Operational Review Financial and operational irregularities are a third area that can result in the breakdown of a potential deal. Irregularities might include problems with revenue recognition, receiving revenue early or overstating revenue, or neglecting required capital expenditures needed to maintain current technology standards. In addition, a buyer must understand the target referrals of the business and determine whether referral patterns can be sustained and improved after the transaction. Buyers can be discouraged by apparent accounting missteps, surprises regarding the cost of future investments necessary to continue the business, and the potential loss of referral sources if the business changes hands. Both buyer and seller should be aware that appraisers and valuation experts are not auditors; they make their assumptions based on the accounting information provided by the seller. Therefore, financial irregularities will inevitably come to light at some point in the process. Sellers would be wise to address these irregularities as early as possible; otherwise, they risk derailing a deal into which they have already invested much time and effort. Management and Governance A final factor that can derail a potential imaging transaction is a disagreement over how management and governance will be handled, going forward. If a hospital or health system is acquiring 100% interest in an imaging center, the hospital will implement management to maintain the day-to-day operations. Generally, these functions are performed by the centralized administration of the hospital or health system; however, disputes can arise if the seller has expectations of contracting for the management services after the transaction. Governance is also important to discuss up front. If the hospital and owners of the imaging center are entering into a joint venture, a common concern is where the owners of the imaging center fit within the corporate governance/ownership structure. It is critical to have a baseline understanding of whether the sellers have equal voting rights and access to management decision in a new joint venture. Further, under the scenario of a 100% buyout, what noncompete agreements will the buyer put in place? Setting transparent expectations for these topics will help keep transactions on track. Summary Problems that derail transactions boil down to lack of communication, lack of due diligence, or both. Buyer and seller should be transparent and communicative with each other, and the should set expectations on all four of the potential problems. Determining whether one or more is a source of disagreement is best done early, so as not to terminate a transaction in which both parties are already significantly invested. Too often, deal-breakers arise as the result of last-minute discussion points. Buyer and seller should remember that these transactions can—and often, should—take time. Allowing ample time to work through issues as the deal moves forward creates an environment of trust while minimizing risk. Establishing and agreeing to target timelines can help each party meet the other’s needs while managing its expectations. Engaging an experienced attorney as early as possible is critical. As a result of the transaction process, all deals, typically, are reviewed by outside counsel to ensure compliance with legal guidelines. Excluding attorneys early in the transaction process will create undue delays down the line. Experienced attorneys can help eliminate conflict and facilitate conversations, and they will help both parties avoid these common transaction deal-breakers. Clinton Flume is a manager at VMG Health, a national health-care transaction and advisory company.