Selling your practice: The due diligence, legal documentation and final negotiation phases 

October 19, 2020
Todd Petersen

Todd Petersen, CEO of VitalSkin Dermatology, covers the ins and outs of the due diligence, legal documentation and final negotiation stages of selling a practice. 

In the previous Selling Your Practice articles, we discussed why so many physicians are selling their practices. Once you have made the decision to sell your practice, we counseled you to continue growing your practice, prepare early and assemble a team of experts. It’s also important to:  

  • Know the difference between the two most common types of transactions – a capital sale and an asset sale. 
  • Complete an objective analysis of your practice and develop a financial pro forma. 
  • Prepare for negotiation by understanding the value of your practice. 

 Next, we turned our focus to identifying and reviewing potential buyers before putting your practice up for sale. That was followed by developing a confidential information memorandum (CIM), approaching potential acquirers, signing non-disclosure agreements, creating and soliciting a letter of intent and negotiating the material terms of a sale of your practice.  

Now that you have your signed the letter of intent, it’s time to discuss the due diligence, legal documentation and final negotiations phases. 

The Due Diligence Process  

Due diligence is the investigative process a buyer takes before entering into a purchase agreement with a seller. The purpose is to confirm the facts provided in the confidential memorandum, and thoroughly assess the selling practice’s business, assets, capabilities and financial performance, to help the buyer make an informed final decision. The scope of the process depends on the complexity of the letter of intent and the size of the transaction. The more complex and expensive the transaction, the more due diligence will be done. Warning – this can be a lengthy and time-consuming process. 

There are multiple areas that buyers will want to investigate, including the following: 

  • Organizational: Articles of incorporation, by-laws, minutes of the board of directors, the stock book and ledger, names under which the practice does business, shareholder agreements, etc. 
  • Practice operations: The organizational chart, a claims audit on billing practices, payor contracts, internal performance data for all operating functions, third-party accreditation files, copies of DEA numbers, APP contracts, collaborative support agreements, etc. 
  • Debt: All loan and mortgage agreements and liens. In today’s environment, this includes all Paycheck Protection Program loans that haven’t been forgiven already. 
  • Financial statements: Three to five years of prior audited or compiled financial statements, any prior management letters from independent auditors, current year financial statements and a list of deferred costs, prepaid expenses or unrecorded liabilities. If the financial transaction carries enough risk and/or is material enough, the buyer may have a third-party audit firm complete a quality-of-earnings report. 
  • Receivables: An accounts receivable aging report, a breakout of revenues and accounts receivable by payor, a list of all accounts receivable that are in dispute and past accounts receivable performance metrics. 
  • Inventory: An inventory and major supplier listing, contracts and terms.
  • Fixed assets: A list of property owned by the practice which is included or excluded on the financial statements, including real estate, furniture, fixtures and equipment. This also includes copies of property titles, depreciation schedules, methods of depreciation, an estimate of the remaining useful life, any recent appraisals, etc. Additionally, the buyer will want to visibly inspect all material assets. 
  • Leases: Copies of any capital or operating leases, including a schedule of any future lease payments. This may include rental agreements for the practice location(s). 
  • Tax matters: Copies of current and past income tax returns, payroll tax returns, property tax, sales tax returns and personal property tax returns. This should include copies of any correspondence with the IRS or state taxing authorities, any audit results and ongoing disputes and a list of any prior agreements or elections made with the IRS. 
  • Information technology: Documentation of the major applications used to operate the practice, the hardware and network configuration, third-party support agreements, the data security environment and any third-party cyber security audits and details related to any suspected or confirmed data breaches. 
  • Human resources: Employment contracts for the practice physicians, advance practice providers or other key employees, as well as copies of the employee benefit plans, employee handbook(s), and a list of all practice employees along with key information such as compensation, bonus, hours worked, title, job description, etc. 
  • Intellectual property: All trademark registrations and a list of all website domains owned by the practice. 
  • Contracts: Current government contracts and other contracts relating to commercial drug reimbursement rates, EHR, equipment/supplies, maintenance, IT/telecom, etc. This also includes lists of all oral contracts and copies of confidentiality, noncompetition and similar agreements. 
  • Litigation: List of claims, lawsuits or investigations against or brought on by seller. Also, all judgements, orders and decrees that the seller is subject to. 
  • Environmental: Internal reports for current and former property owned by seller, including emission statements/reports, notices or suits served to seller by federal or state regulatory agencies and waste disposal reports. 
  • Licenses: All federal and state permits, licenses and accreditations held by seller, and all reports and notices relating to laws and regulations from federal or state agencies. 
  • Compliance: Copies of compliance programs (monitoring, investigation and action policy protocols) and reports/meeting minutes relating to compliance programs, as well as compliance audits for coding, billing and clinical appropriateness. This can also include government audit contractor requests, and any citations for violating federal or state inspections. 
  • Insurance: Insurance policies and names of all agents, brokers and companies. All policies for property, liability, workers compensation, disability, automobile, etc., should be included. Also disclosed should be current pending claims, claims of more than $50,000 over the last five years, loss experience in that time and historical workers compensation expense. 
  • Government and third-party payor: Numbers for Medicare and Medicaid, and documentation for liabilities like retroactive adjustments, settlements, overpayments, compliance issues, etc. 

Material findings during the due diligence process that weren’t previously disclosed will often impact the final negotiations and adjustments to previously negotiated terms, and these will also be needed. These findings may even cause the buyer to walk away from the proposed sale. So, as we’ve mentioned in previous articles, sellers should be up front and disclose any material issues early in the process. 

Legal Documentation and Final Negotiations 

Legal documentation can be prepared after the due diligence process is completed, or during the due diligence process. There are often several documents that govern the sale of the practice and are dependent upon the structure of the sale. Regardless, practice sales will include a purchase agreement. 

The purchase agreement is the master document that governs the overall sale of the practice. It often includes the following sections: 

  • List of assets acquired: Identifies the assets being acquired, including inventory, accounts receivable, fixed assets, real property, intangible assets, etc. 
  • List of excluded assets: Includes a list of excluded assets that are not part of the practice purchase, such as cash, personal artwork, real property, etc. 
  • Purchase price: The final purchase price will be outlined in the purchase asset agreement. 
  • Tax issues: The purchase price will be allocated to each of the purchased assets (usually done with the help of a third-party appraiser) and the remainder of the purchase price will be allocated to goodwill. 
  • Malpractice insurance: It’s typical for the provider to purchase tail insurance to cover any potential malpractice claims resulting from services provided prior to the sale date. 
  • Representations and warranties: The seller will make certain representations and warranties of fact that encourage the buyer to purchase the practice. If these representations and warranties prove to be untrue, the buyer will have legal recourse up to and including backing out of the sale. 
  • Indemnification: In the event the buyer breaches the representations and warranties, the seller will provide an indemnification to reimburse the buyer for costs and expenses incurred by the buyer. Likewise, the seller may ask for an indemnification in the event the buyer breaches their responsibilities. 
  • Restrictive covenants: Most practice purchases will come with a set of restrictive covenants, including a non-compete provision, and a non-solicitation of employees and patients provision.  
  • Employment agreement: If there will be an ongoing employment arrangement, a formal employment agreement will often be part of the overall purchase agreement. 

As you can see, the due diligence, legal documentation and final negotiation phases of selling a practice can be lengthy, complex and tedious. But they’re all critical parts of the process. Without a thorough completion of these steps problems may result on either side, causing a longer delay of the sale, or in certain situations a complete termination of the deal. 

Again, being clear, up front and working together with the buyer will help ensure a smoother process for both. We’ll continue our series next month and discuss the final closing process in more depth.

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