Deal structure is the foundation of a health care transaction. This post offers practical tips and hypothetical case studies for laying the groundwork for a successful health care transaction.
Establish Guardrails, Timeline, and Expectations
The fundamental question when beginning a transaction is to ask: what is the deal going to look like? Is it a merger, an asset or equity purchase or sale, a joint venture, or some other type of transaction? What is the form of consideration? Is it a purchase or sale of all of the assets or equity, or are the selling parties going to retain an interest in the business? Are there multiple seller or buyer parties, or multiple entities being transferred? A visual deal structure chart is a great tool to plan out what the deal will look like – step by step. We utilized a deal structure chart in the hypothetical case study detailed below.
- An existing operator of ambulatory clinics was selling a partial interest in more than 40 facilities to a hospital. The clinics were owned by over two dozen subsidiaries with multiple direct and indirect owners. It included asset and equity transfers, purchase and sale components, and working capital contributions. Early in their negotiations, the parties created structure slides to map out the different ownership and transfer elements. The slides started with the basic structure of where the parties wanted to end up, and evolved into detailed charts with explanations of each step that needed to occur, material tax, regulatory and licensure considerations, and agreements needed to get there.
- The structure slides served not only as a tool for the parties’ business and legal teams, but facilitated discussions and analysis from the accounting, tax, regulatory, and licensure experts. The structure charts also helped analysis from a payor contracting perspective where it became apparent that certain facilities would require changes to Taxpayer Identification Number that would require re-credentialing and implications for revenue streams following the closing. The slides were also used as a basis for supplemental organizational charts that went to the state’s Department of Health for its review and approval for Change of Ownership (CHOW) and Change of Information (CHOI) purposes.
- Both parties’ counsel contributed to and signed-off on the structure slides. This gave all parties an understanding of the timing and put everyone on equal footing with respect to expectations on what the agreements would look like, regulatory filings involved, and the steps that needed to occur to get to the closing.
Key Elements of the Deal
Even in deals that do not involve the scope of 40-plus facilities with multiple owners, there are several other key factors (some of which are described below) that drive deal structure in health care transactions, no matter the size. In different ways, all of these factors impact deal terms, drafting, and negotiations.
Governmental Approvals and Regulatory Requirements
In health care transactions, governmental approvals and regulatory requirement considerations often drive the deal and deal documents. The threshold question with respect to governmental approvals and regulatory requirements is whether approval is required prior to closing. If approval is required to close, the agreements need to be drafted for a signing with a delayed closing.
Deals with a Delay Between Signing and Closing
In the case of a transaction requiring a governmental approval or the satisfaction of a regulatory requirement prior to closing, there may be a delay between when you sign the deal documents and when you close the transaction. In deals with a delay between signing and closing, representation and warranty bring-downs and disclosure schedule updates, conduct of the business between signing and closing, and the parties’ obligations between signing and closing will be points of negotiation.
- Due Diligence & Disclosure Schedules: Buyers and sellers need to refresh and review due diligence and disclosure schedules for the period between signing and closing. This could be a straightforward redo of what the parties did prior to signing. However, what happens if a new issue is identified that impacts the purchase price agreed to in the purchase agreement? The purchase agreement likely has a material adverse effect “out”, but the threshold is very high and difficult to meet. Even with a material adverse effect “out”, the parties most likely want to do the deal. What other approaches can you take? If a significant issue comes to light between signing and closing, dig into the representations and warranties. It is very likely that an important issue would relate to a representation and warranty that could allow for a reopening and relook at the purchase price.
- Limiting Conduct: Buyers want to limit the actions that the seller can take between signing and closing without their approval by requiring that the seller conduct the business only in the ordinary course consistent with past practice. Buyers will want the right to approve anything out of the ordinary. Sellers want as much leeway as possible and want to limit the actions that they need to go back to buyer for to approve.
- Required Actions: Other key covenants will relate to actions that the parties are required to take between signing and closing, such as obtaining governmental and third party approvals.
- Who is responsible for completing and filing the license application?
- What are the parties’ obligations for cooperation and assistance with responding to questions and follow-up from agencies?
- What is the timeline from filing to approval?
- If there are extensive delays, do you want the ability to terminate and walk away from the deal?
A health care provider and group of physicians entered into a deal for the purchase and sale of the assets of three health care facilities owned by the physicians in a state that required the parties to sign the purchase agreement, submit a license application, and not close until the license was approved. The buyer was concerned that there could be material changes to EBITDA between signing and closing if the license application process dragged on. To address this, the parties included terms in the purchase agreement that set a threshold EBITDA at signing and agreed that a decline greater than a specified percentage would be considered materially adverse for purposes of the definition of material adverse effect. In other words, if there were a decline greater than the specified percentage, it would constitute a material adverse effect, resulting in failure to satisfy a buyer condition to closing and the ability for the buyer to walk away. Importantly, the EBITDA calculation was a schedule attached to the signed purchase agreement that included all of the components and adjustments, which was intended to avoid disagreements regarding the EBITDA calculation at closing.
Third parties can delay and even derail a deal. It is imperative to know who your third parties are, to understand which third parties have approval rights (e.g., parties to material contracts, landlords), and to engage with third parties as early as possible. However, understand that even when parties cover all of the foregoing, the best-laid plans may still go awry.
An operator of three health care facilities and a third party purchaser were involved in a three-facility purchase and sale where the landlords for each facility were engaged early in the deal. The landlord for one of the facility’s premises held the deal hostage with requests and demands related to the lease assignment causing delays that neither party could control. The delays were so disruptive to the overall transaction that the buyer and seller ended up reevaluating the deal structure to eliminate the facility. The seller closed the facility and consolidated it with one of the other facilities. A three-facility deal became a two-facility deal, we reworked all of the agreements, and the facility in question closed. At the end of the day, the deal was supposed to be a straightforward asset acquisition, based on a previously negotiated agreement, and due to a rogue third-party, the deal needed to be restructured to save it.
Conclusion: Practice Pointers
- Start discussing deal structure early on, even before the letter of intent and term sheet phase, and certainly before putting pen to paper to draft definitive agreements.
- Deal structure can evolve throughout the transaction, and parties need to be ready to pivot and adjust. Transaction counsel need to remain flexible and creative.
- Time dedicated to focusing on deal structure at the onset will be a time and money saver later.