Healthcare M&A: What Decision Makers Need to Know Before Partnering

The flurry of hospital and health system mergers, acquisitions, consolidations and other partnerships over the past few years is not expected to slow down anytime soon. In fact, those in the industry should anticipate quite the opposite.

According to KaufmanHall, 90 mergers and acquisitions (M&A) were announced in the healthcare space by the end of 2018. More than half of these transactions involved companies with revenues of more than $100 million, including several mega-mergers, with seven transactions involving companies with net revenues of more than $1 billion. These trends continued through 2019, with 71 transactions announced through the first three quarters of the year. The next 12 months should be nothing different.

These deals are driven in large part by provider responses to the challenges and opportunities created by national and state healthcare reform initiatives. Many hospitals seem to be searching to find the right structure that positions them to thrive under a reimbursement model that rewards quality, efficiency and integration.

To many hospital boards of directors, the decision to enter into the merger arena is not an easy one. Indeed, some hospitals may be forced to enter the game out of sheer necessity to survive in today’s competitive market. These issues are compounded by changes in reimbursement by the federal government and a shift from volume reimbursement to innovative, value-based payment methodologies. This change has forced hospital executives to evaluate and decide whether or not they have the appropriate infrastructure to even participate in these initiatives, let alone prosper in this environment. Suffice it to say, the industry is in some uncharted waters.

Because of this, it can be difficult for hospitals and healthcare organizations to know whether or not they should partner, when to partner and what type of organization to partner with. At Buchanan, we’ve led hundreds of mergers and partnerships in the healthcare industry. There are a few things every organization needs to think about before they get started:

Before considering a partnership, first step back and evaluate your organization’s needs, goals and long-term strategy.

Before making any preliminary plans to enter a transaction or partnership, healthcare organizations must begin by looking internally at their own needs. When it comes down to developing a long-term strategy, hospital boards should feel compelled as part of their fiduciary obligation to review the needs of the community, the condition of facilities and equipment, medical staff needs, IT capabilities, and the financial health of the institution, among others. Perhaps a regional hospital is looking to physically expand its presence with a new facility. Maybe a hospital is seeking to expand its medical staff or gain economies of scale. Or perhaps a hospital is looking to upgrade its IT infrastructure. Regardless of the underlying motivations for growth or evolution, healthcare organizations must start by looking internally. If they cannot fix these problems themselves, only then may it be time to seek a partnership.

Hospitals and health systems must also consider the amount of surplus capital the institution has on hand, or has access to, so it can meet its immediate operational needs and projected future long-term costs. While many hospitals may have sufficient cash on hand to meet current working capital needs, they may not have adequate retained capital (net assets) to replace current buildings and equipment. While each situation differs greatly, the demand on capital to strengthen, update or even replace physical facilities is a leading factor that drives many independent hospitals to consider merging.

This strategic review process must be continuous and ongoing. Identifying these needs and developing a strategic plan early on will help an organization stay nimble and ready to react.

After a thorough self-review, deciding what type of partnership to pursue should consider multiple factors.

Based on the findings of the strategic review, an alliance might be an option and boards of directors and executive teams must think about what type of arrangement they’re seeking. An outright merger isn’t the only type of partnership that can benefit healthcare organizations. Many hospitals are committed to maintaining their independence but need access to clinical and support services through strategic alliances with other healthcare providers. There are a number of recent examples of hospitals that have successfully forged strategic partnerships with other health systems rather than entering into a full-scale merger, which can provide significant benefits for providers and patients alike.

A service line partnership is one way for two organizations to come together and expand their offerings while remaining independent. Many hospitals seek a strategic partner in order to expand needed services not presently available to their patient community. In this regard, many independent facilities seek larger health systems as partners. These healthcare systems often offer strong and stable networks of hospitals, physicians and ancillary care services that offer a more integrated range of services over a broader geographic area than the independent hospital could provide on its own.

In other cases, a hospital may identify a certain clinical area that it wishes to improve or to develop but does not have the necessary resources to go it alone. A clinical co-management agreement or other type of arrangement creates a mechanism for hospitals to partner with physicians or other providers to jointly provide key hospital services and improve patient outcomes. These types of arrangements allow the parties to remain independent while working together to improve patient care in specific clinical areas.

However, an outright acquisition can still make the most sense for many organizations. While it typically takes the longest to execute and comes with the most risk and legal hurdles, an acquisition often opens up the most potential for cost savings and future growth.

Knowing when you’ve found the right match can be a complex process.

Depending on the type of arrangement an organization wishes to pursue, there are a number of legal and regulatory considerations to take into account when selecting a final match, particularly from an antitrust perspective.

For organizations pursuing a service line partnership, it typically makes sense to look for a partner that operates in a neighboring geographic area. Service line partnerships by nature provide community access to new services and modalities of treatment without having to lose the hospitals’ individual identities or relinquish governance of their organizations.

Outright mergers and acquisitions come with a larger legal and regulatory lift. Careful attention must be given to comply with federal and state antitrust laws. In some cases, regardless of the intent of the parties, planned mergers may fail because of antitrust concerns and other regulatory obstacles.

The regulatory approval process varies in intensity from state to state, and it is critical that organizations verse themselves in the legal nuances within their respective regions. The two organizations will go under enormous scrutiny, and it’s best to come prepared. In some cases, especially where the transaction involves a not-for-profit hospital being acquired by a for-profit buyer, the legal scrutiny will be more extensive and the review time lengthier.

Additionally, health systems must look at and preemptively address any potential workforce concerns. For example, if one organization has a workforce that is represented by a union, the negotiations may be further complicated by having to deal with a bargaining agreement that may be in place between the institution and the union. A bargaining agreement may even have specific provisions that need to be addressed in the event of a change in control.

Even if there is no union involved, a number of other employee complications must be addressed. For example, are there any golden parachutes that may discourage a would-be suitor from proffering a bona fide offer? Also, out of loyalty to the current workforce, is there a desire by the one party to retain their employees, while the other party may be seeking opportunities to eliminate any duplication of resources? These issues need to be resolved early in the process.

Understanding when to engage legal counsel is crucial.

Partnerships and other transactions are complex and should not be taken lightly. It’s important to engage legal counsel early in the process so that both parties can begin strategizing for the intense work that lies ahead. Ideally, organizations are consulting with lawyers before the selection process even begins in order to avoid legal headaches. Yet too often, counsel is brought into the process after a term sheet has been negotiated, leading to, at best, more work for both parties and, at worst, a failed transaction.

As healthcare players large and small continue to partner with one another, organizations thinking of a possible transaction or affiliation must consider the legal and antitrust implications. This essential first step is critical to getting new partnerships off on the right foot.