Buying and Selling a Medical Practice
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This article gives a quick overview of buying and selling a medical practice. I discuss the deal from due diligence, through deal terms, to the definitive deal documents. Finding the Deal - The first step is to find a deal. Talk to people in the industry. Find out if a physician is looking to sell and retire, or if an up-and-coming associate is looking to buy.
If you have a longer timeline, consider hiring an associate and grooming him or her to take over (from the buyer’s side, consider being that associate). If that doesn’t work, hire a broker who specializes in medical practices. Lastly, remember that for most medical practices, only someone licensed in CA as a physician may buy and own the practice.
Due Diligence
Both the buyer and the seller should go about the due diligence process in a business-like manner. Most buyers of a medical practice have experience in the profession and understand what to look for, so I won’t belabor the issue. At a minimum, (1) check the seller’s medical license for a history of complaints or litigation, (2) review the practice’s financial statements and tax returns for the past three years, (3) analyze whether the seller’s relationship with referral sources and patients can realistically be transferred to you (conversely, beware if the relationship is so intensely personal that it can’t be separated from the seller), (4) beware of prior employee / contractor misclassification in the practice, and (5) check for liens, unpaid back taxes (including sales taxes), unpaid workers compensation, unpaid trust fund taxes, unpaid vacation liability, unpaid bills, and current and potential lawsuits.
Deal Terms
The first deal document is a letter of intent, also called a term sheet. The parties use a letter of intent to confirm basic deal terms. The letter of intent should not be binding on the parties, except for such matters as due diligence procedures and perhaps a lock-up or exclusive period within which the seller may not field other offers.
Purchase price is the primary deal term. Be sure to take taxes into account, because it’s the after-tax price that counts. Payment terms are almost as important as the total purchase price. For medical practices, usually you use some combination of cash, promissory note, and earn-out (which is money that is paid over time based on the practice’s post-closing performance). Sellers love cash and buyers love earn-outs. Also consider who collects the accounts receivable that were booked before the closing date.
IMPORTANT: Make sure that you have an attorney analyze the payment terms for compliance with the CA and federal Stark and Kickback laws.
Another deal term is legal structure – will it be a stock or asset sale? As a rule of thumb, buyers want to buy assets and sellers want to sell stock.
◦ Stock Sales. Here the buyer takes the entire medical corporation, leaving all contracts, assets and liabilities in place for the buyer. The buyer gets a carry-over basis, while the seller pays taxes on the appreciation in their shares (with no double-tax). This is why sellers love stock sales.
◦ Asset Sales. Here the buyer takes the assets of the practice but not the liabilities (except those that the buyer agrees to assume); also the buyer gets a stepped-up basis in the assets. This is why buyers love asset sales. The seller keeps the un-assumed liabilities, and might incur the dreaded double tax (if the seller uses a C corporation), that is, the corporation pays taxes on the asset sale, then the shareholders pay taxes again when the corporation dividends the remaining purchase price to them.
Fixing Prior Defective WorkAll of us (even lawyers) make mistakes. When buying a medical practice, the deal terms should include the fix-up of the seller’s prior defective work (if this makes sense given the nature of the practice). For patients who stay on, usually the buyer will re-do, for free, defective work done by the seller. Hence the buyer and seller need to allocate the responsibility and costs for the re-do work + the time period for doing the work, for example, for the first year after closing, the buyer might do the fix-up work then charge the seller some agreed-to fee for the work.
Also address the purchase of tail insurance by the seller. For more information on malpractice tail policies, see Leaving a medical practice / closing a medical practice.
Deal Documents
Once the parties agree to the basic deal terms, they move on to the deal documents including the purchase agreement. In the purchase agreement, the seller makes representations about the practice. This allows the buyer to recover back some of the purchase price if any of the representations is materially misleading, for example, the seller did not disclose certain liabilities. Representations are not a substitute for due diligence, but they do provide additional security to the buyer.
The last important piece is the non-competition agreement. In most cases, the buyer should receive a non-competition agreement from the seller. Otherwise the buyer is at risk that, after collecting the purchase price, the seller will set up a competing practice across the street. For more information on non-competition clauses, see May a physician compete against his or her former practice?
This whirlwind tour is over. Remember that buying or selling a medical practice is a complex process. Legal, tax, accounting, valuation and psychology issues are all involved. Before you do anything, get competent legal counsel to help you.
ABOUT THE AUTHOR: Matt Dickstein, Business Attorney
Matt Dickstein, Business Attorney, provides business legal services in the San Francisco Bay Area and the Silicon Valley, California, including San Jose, Palo Alto, San Francisco, Oakland, Hayward, Fremont, Walnut Creek, Pleasanton and Sacramento. Since 1994, I have been representing businesses of all types, big and small. I handle business transactions, corporations & LLCs, real estate ventures, professional practices, and franchises.
Copyright Matt Dickstein - Business Attorney
More information about Matt Dickstein - Business Attorney
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
Due Diligence
Both the buyer and the seller should go about the due diligence process in a business-like manner. Most buyers of a medical practice have experience in the profession and understand what to look for, so I won’t belabor the issue. At a minimum, (1) check the seller’s medical license for a history of complaints or litigation, (2) review the practice’s financial statements and tax returns for the past three years, (3) analyze whether the seller’s relationship with referral sources and patients can realistically be transferred to you (conversely, beware if the relationship is so intensely personal that it can’t be separated from the seller), (4) beware of prior employee / contractor misclassification in the practice, and (5) check for liens, unpaid back taxes (including sales taxes), unpaid workers compensation, unpaid trust fund taxes, unpaid vacation liability, unpaid bills, and current and potential lawsuits.
Deal Terms
The first deal document is a letter of intent, also called a term sheet. The parties use a letter of intent to confirm basic deal terms. The letter of intent should not be binding on the parties, except for such matters as due diligence procedures and perhaps a lock-up or exclusive period within which the seller may not field other offers.
Purchase price is the primary deal term. Be sure to take taxes into account, because it’s the after-tax price that counts. Payment terms are almost as important as the total purchase price. For medical practices, usually you use some combination of cash, promissory note, and earn-out (which is money that is paid over time based on the practice’s post-closing performance). Sellers love cash and buyers love earn-outs. Also consider who collects the accounts receivable that were booked before the closing date.
IMPORTANT: Make sure that you have an attorney analyze the payment terms for compliance with the CA and federal Stark and Kickback laws.
Another deal term is legal structure – will it be a stock or asset sale? As a rule of thumb, buyers want to buy assets and sellers want to sell stock.
◦ Stock Sales. Here the buyer takes the entire medical corporation, leaving all contracts, assets and liabilities in place for the buyer. The buyer gets a carry-over basis, while the seller pays taxes on the appreciation in their shares (with no double-tax). This is why sellers love stock sales.
◦ Asset Sales. Here the buyer takes the assets of the practice but not the liabilities (except those that the buyer agrees to assume); also the buyer gets a stepped-up basis in the assets. This is why buyers love asset sales. The seller keeps the un-assumed liabilities, and might incur the dreaded double tax (if the seller uses a C corporation), that is, the corporation pays taxes on the asset sale, then the shareholders pay taxes again when the corporation dividends the remaining purchase price to them.
Fixing Prior Defective WorkAll of us (even lawyers) make mistakes. When buying a medical practice, the deal terms should include the fix-up of the seller’s prior defective work (if this makes sense given the nature of the practice). For patients who stay on, usually the buyer will re-do, for free, defective work done by the seller. Hence the buyer and seller need to allocate the responsibility and costs for the re-do work + the time period for doing the work, for example, for the first year after closing, the buyer might do the fix-up work then charge the seller some agreed-to fee for the work.
Also address the purchase of tail insurance by the seller. For more information on malpractice tail policies, see Leaving a medical practice / closing a medical practice.
Deal Documents
Once the parties agree to the basic deal terms, they move on to the deal documents including the purchase agreement. In the purchase agreement, the seller makes representations about the practice. This allows the buyer to recover back some of the purchase price if any of the representations is materially misleading, for example, the seller did not disclose certain liabilities. Representations are not a substitute for due diligence, but they do provide additional security to the buyer.
The last important piece is the non-competition agreement. In most cases, the buyer should receive a non-competition agreement from the seller. Otherwise the buyer is at risk that, after collecting the purchase price, the seller will set up a competing practice across the street. For more information on non-competition clauses, see May a physician compete against his or her former practice?
This whirlwind tour is over. Remember that buying or selling a medical practice is a complex process. Legal, tax, accounting, valuation and psychology issues are all involved. Before you do anything, get competent legal counsel to help you.
ABOUT THE AUTHOR: Matt Dickstein, Business Attorney
Matt Dickstein, Business Attorney, provides business legal services in the San Francisco Bay Area and the Silicon Valley, California, including San Jose, Palo Alto, San Francisco, Oakland, Hayward, Fremont, Walnut Creek, Pleasanton and Sacramento. Since 1994, I have been representing businesses of all types, big and small. I handle business transactions, corporations & LLCs, real estate ventures, professional practices, and franchises.
Copyright Matt Dickstein - Business Attorney
More information about Matt Dickstein - Business Attorney
View all articles published by Matt Dickstein - Business Attorney
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
