Physician Practice Merger Considerations

With the ever-evolving reform of the U.S. healthcare industry, comes much uncertainty for private practice physicians.  While some practices are content with no organizational changes and some have decided to be acquired by hospitals, others have gone the route (or are pondering) of merging with another private practice (either same specialty or different specialty).  For those that are considering merging with another private practice entity, there are many things to strategize about vice just assuming there will be a windfall of benefits by consummating a merger.

Physician owners must have a clear rationale for a transaction or truly understand a deal’s impact on their practice’s long-term financial future.  Too often, however, there’s a misguided sense of why the merger should take place at all, and there’s far too little time spent defining how the merger enables them to beat competitors and increase organizational value.  For a merger to be successful, it is critical in the pre-deal phase to carefully identify, capture, and price the potential cost and revenue synergies.  While valuing synergy requires assumptions about future cash flows and growth, the lack of exactness in the process should not be a deterrent.  With due diligence, it is possible to obtain an unbiased estimate of value.  Moreover, when assessing a deal’s assigned value (market value plus the premium) it is important to understand that pricing should be set based on the impacts that are both operational (e.g. cost savings and economies of scale) and financial (e.g. lower cost of capital, higher return on investment potential, and potential for a lengthier growth period from increased competitive advantages).

It is also important to understand synergies and valuation, because there is a potential for reducing the cost of operations in many mergers.  In general, it is much easier to cut costs than to attempt to increase the revenue of a practice on its own.  When similar practices merge, they are presented with an opportunity to improve savings through expense reduction strategies like optimizing operations and lowering redundancies.  Skillful cost cutting measures and combining redundant departments can reduce training and turnover expenses while also helping to promote employee loyalty.  Arguably the biggest error in planning mergers is overconfidence in projected revenue synergies.  It is difficult to project revenue synergies because in most cases they are matters of speculation, and manifest themselves in so many different ways.  Ideally, the merger should help improve market reach and better negotiations with payers.  The new practice now encompasses a larger catchment area, where revenue increases can be realized by increased patient volume, which in turn can boost provider productivity in the long run.

Despite these benefits, projected synergies must be carefully considered and priced before any transaction, as overly rosy visions of the combined practices’ future can lead both physician owners and managers astray.  To be sure, there will always be uncertainty surrounding future synergies. However, qualified healthcare consultants should attempt to make the best estimate of how much value cost and revenue synergies will be created in any merger before advising the parties to proceed.

Performing this synergy valuation is significant even though doing so requires the consultant and practice owners to make assumptions about an uncertain future.  Failure to perform the lengthy due diligence will result in mergers that are dead on arrival, no matter how they are managed after the deal is complete.  Realizing these future synergies requires significant management actions, and thus the core driver of a merger must be a marriage of sound management philosophy and the implementation of projected synergies. Without both, there is no foundation for the merger.


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What is my medical practice worth?

The purchase or sale of a practice will be one of the largest and most complex transactions a physician will ever undertake.  Understanding the factors that go into pricing a medical practice can help ease the process, and ensure that both buyers and sellers feel they receive a fair deal.  Estimates of value may differ significantly, depending on the purpose of the appraisal, the acumen of the appraiser, etc.  To help determine the value, there are some important questions to consider.  What is the value of the practice for purchase or sale?  What is the value of a practice for merger?  What is the value of practice assets for joint venture with a corporate partner?  What is the value to establish buy-in or buy-out arrangements for partners?  What is the value of practice assets for purchase or sale, apart from ongoing operations?

Needless-to-say, there are many, many considerations that go into a medical practice valuation. In short, however, a medical practice’s tangible and intangible assets can be grouped into two broad categories: physical assets and non-physical assets. Examples of physical assets include real estate, medical records, leaseholds, medical equipment and furnishings, and accounts receivable (A/R). Examples of non-physical assets include goodwill, restrictive covenants, buy/sell agreements, managed care contracts, and an assembled workforce.

For most practices, the value of the furniture, equipment and other assets is small and may not amount to very much.  On the other hand, supplies inventory may have significant value and is usually valued at the historic cost of each item.  Other tangible assets include prepaid expenses such as malpractice insurance (which may be quite significant).  Additionally, if the physicians own their office building, it will be need to have a current (within two years) appraisal.  Any mortgage balance will be subtracted from the building’s fair market value in order to determine the equity interest of the physician owners.

Accounts receivable is often one of the largest assets of a medical practice.  Since physicians never collect 100% of what there are owed, an adjustment is taken into account when valuing practices.  A common method to deal with this discrepancy is to use a historical collections rate and apply it to outstanding accounts receivable.  This also becomes a point of negotiation because a buyer’s collections success may differ from the seller’s collections success.

Intangible assets are by far the most subjective elements of a medical practice valuation.  What is the value of restrictive covenants?  What is the value of the existing medical practice staff?  Valuation considerations here should also take into account the payor mix, patient demographics, level of competition, and the geographical location of the practice.  And as disheartening as this may be for practice owners to hear, goodwill may be zero in some instances.  That is, it may have very little value depending on whom the practice is being sold to.


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Competitive Analysis Considerations

For healthcare organizations, a competitive analysis is a means to assess who your competitors are, what value they provide, understanding their (and your) strengths and weaknesses, and where your practice fits in.  A good competitive analysis is a scouting report of the actual market terrain that your practice must navigate in order to be successful.  While analyzing the competition is an essential component of your strategy, most medical practices don’t conduct this type of analysis systematically enough.  However, a thorough competitive analysis is indispensable.

First, begin by compiling a list of your practice’s competitors.  Most of the time, such a list is comprised of who your practice considers to be its chief competitors.  However, there may be other healthcare organizations that indirectly compete with yours, perhaps ones outside of your catchment area that offer services such as telemedicine or niche treatment modalities that are aiming for the same patients.  You will also want to include information on healthcare entities that may be entering your market in the coming year.  Once you have compiled the list, you can highlight those practices that will be the greatest challenge.

Second, analyze the competition’s services in terms of features, value, and target patients.  How do they market them?  How do patients see your competition?  How do referring physicians view your competition?  Take an honest look at their offerings.  Is your quality commensurate?  Do you have similar offerings?  What is the unique value you provide that competitors don’t or can’t?  Emphasize these benefits in your marketing.

Third, compile a list of competitor strengths and weaknesses and remember to be objective.  You’ll do your practice no good if you allow bias toward your own physicians, staff, and services to cloud your judgment.  Try to see the competition’s practice as though you were them.  What makes their practice so great?  If they are growing rapidly, what is it about their practice that’s promoting that growth?

Fourth, observe how your competitors market themselves through advertising, collateral material, and perhaps the use of physician liaisons.  You will have to go to many different sources to get a complete picture.  It takes practice and a little shrewdness on your part to piece together a complete picture of strategies and objectives, so the use of a qualified consultant may be to your benefit.  Focus on the facts, be persistent, and trust your intuition to help you.

Fifth, what are the market demographics for your practice like now?  Is it growing?  If so, then there are likely quite a few patients left to go around.  If on the other hand the market is flat, then the competition for patients is likely to be fierce.  Your practice will find itself scrambling to win market share.  The outlook portion of your analysis may seem like forecasting, but it’s really a measure of trends.  By the time you’ve done most of your research, you’ll have enough information to determine what the outlook really is.

By evaluating yourself against your competition, you’ll likely find new ideas for your practice.  While compiling a competitive analysis is an interesting piece of work, it can indeed be challenging.  Consequently, you may want to seek the help of a healthcare consultant to guide you through this process.  You’ll learn a lot about your market and in the process become a more valuable resource for your patients and referring physicians.


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U.S. Physicians’ Perspectives

As healthcare reform in the United States continues to evolve, many are assessing the experiences and perspectives of those on the front lines . . . the physicians.  It has been well-documented that many physicians are experiencing decreased morale and are struggling to adapt to the various facets of healthcare reform while also trying to provide patients with reasonable access to care.

Physicians Foundation recently concluded their biennial study examining practice patterns and perspectives of U.S. physicians.  The examination was based on a survey of over 17,000 U.S. physicians, with a margin of error less than 1%.  Here are a few highlights:

80% reported being overextended or at capacity, with no time to see additional patients

72% state third-party intrusions detract from the quality of care they can provide

63% are pessimistic about the future of the medical profession

54% rate their morale as somewhat or very negative

49% state they are either often or always feeling burnt out

48% reported their intentions to cut back on hours, retire, take a non-clinical job, switch to “concierge” medicine or take other steps that will further limit patient access

36% reported they do not see Medicaid patients, or limit the number they see

27% reported they do not see Medicare patients, or limit the number they see

Half of the physicians surveyed stated they would not recommend medicine as a career to their children and nearly one-third claimed they would not choose to be physicians if they had their careers to do over.  Walker Ray, M.D., President of the Physicians Foundation and chair of its Research Committee, noted:

“By retiring, taking non-clinical roles or cutting back in various other ways, physicians are essentially voting with their feet and leaving the clinical workforce.  This trend is to the detriment of patient access.  It is imperative that all healthcare stakeholders recognize and begin to address these issues more proactively, to support physicians and enhance the medical practice environment.”

Regarding Electronic Health Records (EHRs), only 12% indicated the use of EHRs has improved patient interaction, while the remaining 89% say it has had little or no impact or has detracted from patient interaction.  Regarding Accountable Care Organizations (ACOs), the percent of physicians that agree ACOs are likely to enhance quality and lower costs decreased, while there was an increase in physicians who feel ACOs are unlikely to increase quality or decrease cost.

Although 74% of respondents list the patient relationship as the most satisfying aspect of their job, they also indicated that they spend 21% of their time on non-clinical paper work duties.  Physicians note that issues such as a lack of clinical autonomy, liability concerns, struggle for reimbursement and decreased patient face-time can all negatively impact the patient-physician relationship – thereby undermining physician satisfaction.


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Physician Practice Acquisitions

U.S. hospitals acquire physician practices in order to expand their networks, which they hope will in turn boost their revenues. However, in doing so, they also incur the costs associated with physician (and employee) salaries, benefits, office space, and necessary upgrades to IT infrastructures. Nevertheless, hospital systems across the country continue with diligent searches in attempts to acquire physician practices. Their goal of doing so is to be better prepared with healthcare reform that reimburses based on quality of care, outcomes and cost control rather than the traditional fee-for-service system.

Recently, Avalere Health conducted a study on behalf of the Physicians Advocacy Institute (PAI) analyzing hospital ownership of physician practices. In looking at data from 2012 – 2015, the study showed that the number of physician practices owned by hospitals/health systems rose 86% during this timeframe. Other key facets of the study include:

  • By mid-2015, 38% of U.S. physicians were employed by hospitals and health systems.
  • There were 95,000 hospital-employed physicians in 2012 and more than 140,000 hospital-employed physicians in 2015.
  • As of mid-2015, one in four medical practices was hospital-owned.
  • From 2012 to 2015, hospitals acquired 31,000 physician practices.

Unfortunately this is extremely bad news on many fronts, including the cost of healthcare.  Call it misaligned incentives or unintended consequences, but the influence of the Affordable Care Act which drives such acquisitions is impacting healthcare costs. As Kelly Kenney, PAI executive vice president, correctly states:

“Medicare spends less when patients receive treatment in a physician’s office, yet the number of physician-owned medical practices is rapidly shrinking. The shift toward more physicians employed by hospitals could mean higher costs for the entire health care system.  For patients, it impacts both where they receive and how much they pay for care.”

The study also showed that hospitals’ employment of physicians rose approximately 59% in the South; 58% in the Northeast; 49% in Alaska and Hawaii; 44% in the Midwest; and 33% in the West.

Recently however, from what I have seen across the U.S., it appears that this frenzy has slowed some. In its place, I see much activity in the form of mergers amongst private practices (either same specialty or multispecialty).


Contact ABISA for healthcare consultancy support or speaking engagements.