CEO SUMMARY: Physician practice management (PPM) companies represent a powerful new economic trend. Greater numbers of pathologists will soon confront a career-changing decision: should we sell our pathology practice to a PPM? Regardless of how pathologists answer that question, their business will not stay the same. This second installment of our special series addresses the “do’s and don’ts” of selling a pathology practice. Here is practical wisdom and insight into the sales process. It is a messy process, because it involves money, emotions, and radical disruption to the status quo.
ECONOMIC FORCES ARE TRANSFORMING the profession of pathology. During 1998 and 1999, the most obvious catalyst for change will be pathology-based physician practice management (PPM) companies.
These pathology PPMs must buy pathology practices to create the revenue base necessary to support their business plan. It is known that at least seven or eight pathology PPMs are organizing to compete against AmeriPath, Inc., the first publicly traded pathology PPM.
There may be as many as nine or ten pathology PPMs in the market by year’s end. Each PPM will canvas the country and attempt to convince pathologists that they should sell their practice. This unrestrained acquisition activity will blow through the pathology profession like a free-wheeling hurricane.
Unfortunately, many pathologists are unprepared for the acquisition hurricane soon to hit their community. The purpose of this article is to alert and equip pathologists for the coming storm. Armed with better knowledge about the sales process, pathologists can negotiate more effectively with financially sophisticated buyers.
“The hurricane is a good metaphor,” stated Christopher Jahnle, Managing Director of Haverford Healthcare Advisors, a financial services firm based in Paoli, Pennsylvania. “The odds of riding out a hurricane with minor damage are excellent when someone has advance warning and time to get ready. But when they don’t prepare for the hurricane, the worst can happen and often does.
“That is why pathologists are well-advised to gain basic knowledge about the sales and acquisition process before they enter into negotiations to sell their practice,” recommended Jahnle. “Most pathologists probably remember a few years back when physician colleagues rushed to sell their practices to hospitals. Once the consequences of having a hospital administrator run his practice became obvious, many a physician came to regret the speedy decision to sell his practice to the hospital.
“This same dynamic is one that pathologists would do well to avoid,” Jahnle noted. “Since it is difficult to unwind these deals once they are consummated, it is better for pathologists to do their homework in advance of launching negotiations to sell their practice.”
Jahnle is intimately familiar with such situations. Haverford Healthcare Advisors has probably valued and packaged more pathology practices for potential PPM sales than any single entity. As an advisor to these pathology practices, Jahnle had a birds-eye view of the internal wrangling which accompanied the prospect of selling the pathology practice.
“My list of essential do’s and don’ts when selling a pathology practice come directly from watching pathologist partners wrestle with the financial and emotional issues triggered by sale negotiations,” observed Jahnle. “No one should discount the emotional intensity of the partners when changes to income, control and lifestyle must be discussed.”
“My number one thing to do is to have common alignment of motivations and objectives among the practice partners,” he said. “Why do you want to sell? What kind of price is agreeable to the partners? How will the practice operate after the sale?
“Answers to these questions are not simple,” he added. “Each pathologist in a practice is affected differently by a sale. Expect to find intense emotions attached to specific issues. That is why it is essential that the partners establish a common framework for why they would consider a sale and what they want the sale to accomplish.
“My second essential thing to do relates to making decisions,” said Jahnle. “Before commencing negotiations, develop a mechanism for your group to expeditiously evaluate complex issues and make decisions. You want your group to speak with a unified voice, representing the variety of interests which exist within any pathology practice around the country.”
Jahnle had an interesting example of how the absence of a pre-agreed process for making decisions can cripple discussions within the pathology practice. “In one instance, we represented a practice of 18 pathologists. Their partnership agreement required a unanimous vote to sell the practice or affiliate with a PPM. The original goal of the partnership agreement was to provide the partners with an equal voice.
Jahnle’s 5 “Do’s”
1. Do align motives and objectives of all pathologist partners before commencing sales negotiations.
2. Do develop a mechanism for evaluating complex issues & making expeditious decisions.
3. Do have realistic expectations about the purchase prices before launching sales negotiations.
4. Do retain outside expertise in valuation, legal, and management to guide the sales transaction.
5. Do be persistent and patient. It generally takes six to eight months to consummate a sales transaction.
“In negotiations with a potential buyer, the offer involved a huge amount of money,” he explained. “As it turned out, 17 pathologists voted to sell. One younger pathologist couldn’t make up his mind. He voted against it.”
“You can imagine the tension within the practice triggered by that one negative vote. Today they are still independent. But that process of having 18 partners meet twice a week for four to six weeks to evaluate the sales offer caused them to revamp their governance process.
“They modified their partnership agreement, which in itself was a painful process,” said Jahnle. “Now there is a governance structure which is built around a management committee of the business manager and three pathologist partners. Today that pathology practice has the organizational structure to expedite making decisions while including input from the pathologist partners.”
The third item on Jahnle’s list of things to do involves purchase price expectations. “It is crucial that the partners have realistic expectations about the market value of their pathology practice,” he explained. “It is similar to when a seller lists his residence for sale. If the owner lists the price too high and brings the house to market, the most interested buyers will tour the house and refuse to make an offer because of the unreasonably high price.
“To avoid losing your most qualified buyers, it is essential to understand how the marketplace values your pathology practice,” he continued. “Having the practice appraised and valued before putting it up for sale is frequently done. Not only do the partners learn the value range for their practice, but they can identify management projects which would legitimately increase the price prospective buyers would be willing to pay. The valuation has an added benefit. It often helps the partners develop a consensus before the sales process begins.”
Number four on Jahnle’s “to do” list involves outside expertise. “Most pathologists will sell a practice once in their lifetime,” he pointed out. “Legal, valuation, tax, and operational considerations make the sales process complicated and fraught with potential expo- sure in subsequent years.
“For that reason, it is recommended that they engage specialists with extensive experience,” advised Jahnle. “Pathologists have one opportunity to do it right. Outside expertise can maximize success.”
Complex Legal Issues
“For example, legal issues are extraordinarily complex. State prohibitions against the corporate practice of medicine and regulations affecting fee-splitting require sophisticated legal expertise to keep the pathologists compliant and on the right side of the law.
“Add to that the complications of the purchase agreement, the management service agreement, non-compete covenants and similar issues,” said Jahnle. “It is easy to see why the lawyer who prepared your will or gives you tax advice is quickly outgunned on these matters. It reinforces the importance of having top-flight legal counsel represent your interests during the sales transaction.”
Last of the “to do” items for Jahnle is persistence and patience. “Pathologists must keep in mind that it takes from six to eight months to negotiate and resolve all the issues involved in the sales transaction. Because of the multitude of details, it can be wearing to continually negotiate without a definite closing date.”
“That is why it is essential for pathologists to remain patient and persistent. Their goal of a consummated sale is attainable. Patience is particularly important, because pathologists tend to be very analytical. They can study a deal to death without making a decision. That is another reason why patience, combined with good outside expertise, is the combination which makes for a win-win sales transaction between buyer and seller.”
Jahnle also has a list of five essential “don’ts.” “Number one on this list is don’t limit negotiations to just one prospective buyer or PPM. That should be a prime directive.
“I have seen occasions where a pathologist falls in love with the first buyer that comes a-courting,” recalled Jahnle, “Worse yet, if it’s a bad deal, things can drag out for months, causing the pathologist to miss the market window of opportunity.
“Another important dynamic works in the pathologists’ favor when negotiating with multiple buyers,” added Jahnle. “Discussions move faster. There’s competitive pressure on the buyers to offer reasonable terms and conclude the sale. With just one buyer, the deal can string out.
“There is another positive benefit to meeting with several pathology PPMs,” he said. “After hearing the presentations and meeting with the executives from these companies, pathologists who might be skeptical of PPMs and cynical about their perceived ‘get rich quick’ schemes gain a better understanding of how these companies actually work. It also permits the selling pathologists to evaluate and compare both the business plans and the management teams of each PPM.”
The second “don’t” on Jahnle’s list relates to due diligence. “Don’t sell your practice without doing two things beforehand. First, meet all the key executives and managers at the PPM who will be working with your particular practice. Evaluate their competence and develop personal chemistry. After all, these are the people who are going to be working to make your pathology practice successful.”
Jahnle’s 5 “Don’ts”
1. Don’t fall in love with the first buyer. Play the field to get the best offer.
2. Don’t sell your practice without meeting all the management team and visiting pathology practices already in the PPM.
3. Don’t sell on price alone. Sell on the best combination of price and terms.
4. Don’t be embarrassed about receiving a large amount of money from the sale. The market sets value for the practice.
5. Don’t wait for the window of opportunity to close. Move deliberately when the seller’s market is most favorable.
Visit Pathology Practices
“Second, take the time to visit pathology practices which are already part of the PPM,” he continued. “The best way to learn if the PPM can deliver what it promises is to spend a day or two at one of its pathology practices. By investing time getting to know your future PPM partner, you will better understand the advantages and disadvantages of your future relationship.”
Jahnle’s third “don’t” on the list involves purchase price. “Don’t concentrate on the offer with the highest purchase price. More often than not, the offer with the highest purchase price is not the one selected by the sellers. There are dozens of transaction parameters which much be negotiated.
“These transaction parameters have great influence on working conditions, future profit distributions and opportunities to expand the practice’s revenue base,” stated Jahnle. “I can identify maybe 50 deal parameters that could be compelling enough to make someone choose to accept a lower purchase price.
“Number four on my list is interesting,” he continued. “Don’t be embarrassed by the fact that selling the practice may cause a pathologist to realize substantial wealth. In some cases, there is guilt that they might receive a large sum of money for their practice. There could be feelings that patient care will suffer, or their sale makes it more difficult for younger pathologists to succeed.
“It is important for pathologists to realize that these acquisitions are driven by established market pricing mechanisms,” noted Jahnle. “Payment multiples of five to seven times earnings are supported by the financial markets.
“Further, the marketplace is transforming healthcare and pathology,” he explained. “Acquisition of pathology practices by PPMs will occur. During the next five years, both young pathologists and older pathologists who chose to continue practicing medicine will be required to adapt to these new business models. That is why pathologists should not feel guilty about selling their practice for a large sum of money.”
Jahnle Describes One Big Pitfall To Avoid
“Confidentiality is important to the process,” noted Jahnle. “Before starting discussions, get a signed confidentiality agreement from each prospective PPM partner.
“It is also important to keep the entire matter confidential from employees and non-essential people until the day of the closing,” he added. “That is the proper time to make an announcement, and communicate effectively with clients and employees alike.”
Who generally spills the secret? “It is not the PPM,” notes Jahnle. “Almost invariably it is a pathologist who tells someone at golf or lunch. There is a high probability of a good deal going sour when word gets out. That is why it is best to maintain absolute confidentiality until the day the deal closes.”
Timing Affects Sales Price
“Number five on this list involves timing,” said Jahnle. “Don’t wait too long to investigate an affiliation with a PPM. Timing has a great deal to do with prices. Let me explain.
“Remember that, as recently as 1994, a clinical laboratory could be sold for 1.0 to 1.25 times annual net revenue. Today, most clinical laboratories would be offered a purchase price closer to 0.5 to 0.7 times annual net revenue. That is a significant reduction in price in a four-year period.
“I expect to see a similar change in pricing for pathology practices,” noted Jahnle. “During 1998 and 1999, the newly-emerging pathology PPMs will need to acquire pathology practices to build their revenue base. They will bid against each other to acquire the best pathology practices.
“But at some period, the marketplace will change. Acquisitions are expensive. Pathology PPMs will begin to emphasize management and marketing as the preferred methods for improving earnings. At that point, multiples paid for pathology practices will inevitably decline.
“That is why I believe we have an 18 to 24-month window where pathologists have the best opportunity to sell their practice for the highest price and best terms,” predicted Jahnle. “At some future point, market forces will naturally shrink the prices paid for pathology practices.”
When pathologists consider whether or not to sell their pathology practices, Christopher Jahnle’s list of do’s, don’ts and pitfalls to avoid becomes a valuable road map. It can guide pathologists away from the potholes and toward a successful sales transaction.
Pathology’s Generation Gap Affects Decision To Sell
What impact does the sale of a pathology practice have upon younger pathologists? This is an unsettling issue when the senior generation has the opportunity to “cashin” on a lifetime of work.
“A substantial number of older pathologists feel like their retirement needs are satisfied,” stated Christopher Jahnle, Managing Director of Haverford Healthcare Advisors. “They are interested in providing their younger colleagues with an independent place to work. During PPM negotiations, these pathologists consider the career interests of their younger partners as terms are negotiated.”
For younger pathologists, the healthcare world looks very different than it did when the senior generation graduated from medical school. With managed care reshaping and integrating healthcare, the future will contain fewer independent private practice opportunities. Instead, because of the growth of specialty AP firms and PPMs , there will be a greater number of salaried positions.
This trend can be seen at companies which provide national pathology services. DIANON Systems, Inc. and UroCor, Inc. offer salaried positions. As their anatomic pathology specimen volumes grow, both companies are adding.