AVOIDING COMMON PITFALLS AND MAXIMIZING LAB VALUE · Regulatory and legal compliance –Buyers will heavily scrutinize legal compliance issues as part of the evaluation of the business

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AVOIDING COMMON PITFALLS AND MAXIMIZING LAB VALUE

Richard S. Cooper, Esq. McDonald Hopkins LLC

600 Superior Avenue, Suite 2100 Cleveland, OH 44114

Telephone: (216) 348-5438 Email: [email protected]

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Pre-Deal Planning

Pre-planning goals:

– Attract as many interested buyers as possible

– Enhance value

– Increase the probability of a successful closing with minimal business interruption

Reasons – Reduces risk of problem areas/exposures negatively impacting the number of interested buyers, the deal price, the timeframe for completing the deal, owner/management distraction and deal fatigue, government or other third party “intrusion” into the deal, and deal failure

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Pre-Deal Planning

The Reality

– Every lab has problem areas that should be corrected pre-deal. Could include:

• Financial status or trends issues

• Compliance and regulatory issues

• Operational issues

• Personnel issues

• Management issues

• Customer relations and retention issues

• Non-compete, trade secret, data security issues

• Payer issues

• Tax planning/structure issues

• Accounting/financial reporting/control issues

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Pre-Deal Planning

The Reality (continued)

– You will be subjected to extensive and thorough buyer due diligence

• Focus areas:

– Ownership

– Financials

– Legal

– Operations

– Regulatory compliance

– Clinicians/management/employees

– Customer relationships and profile

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Pre-Deal Planning

What does this all mean regarding pre-deal planning?

– Some problems are modest, others serious. Focus primarily on the serious, “deal killer” issues.

– Not all problems are known. A comprehensive understanding of the type and scope of problems requires an effective audit.

• Can be internal or independent

• Needs to include representatives from all key areas

• AUDIT DISCOVERIES OF OVERPAYMENTS LIKELY REQUIRE DISCLOSURE TO THE APPLICABLE PAYER

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Pre-Deal Planning

What does this all mean regarding pre-deal planning? (continued)

– Some problems have a long time horizon to correct, so the earlier you act, the better

– As a general rule, it is better for you to find and correct problems pre-deal, than have a buyer discover them and impose their “correction plan” or price adjustment on you

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Key Areas for Focus for the Group/Lab

Focus areas:

– Regulatory and Legal Compliance

– Operational Excellence

– Financial Reporting and Controls

– Strength of Customer Relationships

– Licensure

– Clinician, Management and Key Employee Retention

– Use of “Standard Form” Documents

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Regulatory and legal compliance – Buyers will heavily scrutinize legal compliance issues as part of the

evaluation of the business. The issues are broad ranging. Potentially the biggest risk area for buyers.

– Key areas include: • Coding and billing issues

• Fraud and abuse issues

• Stark/anti-kick back issues (referral relationships)

• Licensure and accreditation

• HIPAA and data security

• Taxes

• Employee vs. independent contractor issues

• Contract compliance

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Regulatory and legal compliance (continued)

– Coding and billing compliance (including fulfilling all overpayment disclosure obligations and RACs)

• Most buyers focus heavily on coding and billing in their “due diligence” review

• Sellers should make sure their coding and billing practices are appropriate and will survive scrutiny

• Seller should consider doing its own audit/review prior to putting lab up for sale – remember self disclosure obligations!

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– Referral source relationships

• Do you have business relationships with referral sources that are less than “market rate?”

• Are you providing benefits to referral sources at a “discount” that might be characterized as an impermissible?

• Do you have agreements in place to protect against improper use of EMR and other equipment?

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– Marketing activities

• STARK violations (referrals from physicians with remunerative interest)

• Medicare/Medicaid anti-kickback regulations

• Practices proscribed by OIG fraud alerts

• Review all marketing materials, products, and practices

– Consider having a written Compliance Plan and written HIPAA and Data Security Plan in place

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Regulatory and legal compliance (continued) – Contracts

• Keep well maintained and executed records

• Use standard “terms and conditions” where appropriate

– Litigation • Manage and disclose outstanding litigation

• Settle outstanding matters if appropriate

– IP Matters • Protect intellectual property in advance

• Use “work for hire” agreements

• Know your software and technology license rights

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– Ownership and corporate governance:

• Have you properly registered with the appropriate jurisdictions?

• Are you active and in good standing?

• Have you maintained a corporate record book that is clear and up-to-date

• Who holds equity rights?

– Clarify types and classes of securities

– Issue stock certificate where appropriate

– Maintain records of options, warrants and other incentives

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Operational excellence

– Well-managed, efficient operations will command more interest

– Keep growth initiatives in place

• Now is not the time to cut back – don’t sacrifice growth or disrupt growth trends for cost reductions just for the sake of cost reductions

• Look for other achievable strategic growth opportunities

– Geographic expansion

– Service menu expansion

– Significant new customers/strategic partnerships

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Operational excellence (continued)

– Build/retain quality management team

• Especially important for financial buyers

– Meaningful cost-cutting is appropriate

• But don’t look for short-term band-aids (Buyer will figure it out)

– Buyers want to see:

• Strong brand/reputation

• Strong customer relationships

• Strong, scalable and adaptable I.T. Systems/Connectivity

• Updated facilities and equipment

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Financial reporting and controls

– Accurate financial reporting is a must – make sure your source of accounting services has kept pace with your growth and complexity

– Financial controls/systems must be sound – Are your systems outdated?

– Accounting methods must be consistent

– Buyers want feeling of confidence and certainty, not surprises

– Financial projections should be realistic

– You should have the ability to deliver accurate standard and “drill down” reports within reasonable time frames

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Strength of customer relationships

– Number, size and type of customers

– Length of relationship

– Exclusivity of relationship

– Long-term expectations – protections, threat of loss

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Licensure

– Confirm that your pathologists are licensed in every state in which they are required to be licensed

– Confirm that lab is licensed in every state where licensure is required

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Clinician, management and key employee retention

– What is in place to retain key clinicians/management/employees during and post-transaction

• Strength of relationship

• Incentives to stay

– Proper non-compete and non-solicitation provisions

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Key Areas for Focus in the Group/Lab

Use of “standard form” documents

– Standard form, “one size fits all” documents may not be legally enforceable; particularly acute in sales representative agreements

– In order to be enforceable, agreements need to be tailored to individual state law requirements. What works in one state may not work in another

– Agreements need to be tailored to the people being covered (senior executives, sales reps, rank and file employees)

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Tax Planning

Should start well in advance of deal-consult tax advisor early

Beware of common trap: selling assets from “C” corporation (double tax issue)

Interplay with estate planning

Charitable gifts – tax savings opportunity

Even non-profit owners may have significant tax issues

Section 481 adjustments

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Tax Planning

Asset Sale by a “C” corp. Simplified example of “Double Tax” on Sale of Assets by

“C” Corporation

Sales Price of Business $10.00mm Tax to Corporation (35%) 3.50 Distribution to Shareholders 6.50mm Tax to Shareholders (15%) .98 Net to Shareholders $5.52mm

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Tax Planning

Asset Sale by an “S” corp. or LLC

Simplified example of Tax on Sale of Assets by “S” Corporation or LLC

Sales Price of Business $10.00mm

Tax to Shareholders (15%) 1.50

Net to Shareholders $ 8.50mm

Difference: $8.50 - $5.52 - $2.98 mm

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During the Deal

Have a deal process in place-centralized, assigned responsibilities, confidentiality protections

Have a deal timeline and party responsibilities list agreed to with buyer

Be responsive and timely to questions and information requests

Be accurate and complete in responses

Push the buyer to stay on course and prioritize your deal

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During the Deal

Have frequent deal status and open issue discussions with buyer

Recognize if a deal is headed off course or in wrong direction and act accordingly

Understand key timing matters such as payer and licensing agency notifications