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In June 2016, AmSurg Corp. and Envision Healthcare Holdings, Inc. (Envision) announced they have signed a definitive merger agreement pursuant to which the companies will combine in an all-stock transaction. Upon completion of the merger, which is expected to be tax-free to the shareholders of both organizations, the combined company will be named Envision Healthcare Corporation and co-headquartered in Nashville, Tennessee and Greenwood Village, Colorado. The company's common stock is expected to trade on the New York Stock Exchange under the ticker symbol: EVHC. Bass, Berry & Sims served as lead counsel on the transaction, led by Jim Jenkins. Read more.

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Surviving Diligence: Key Concepts for Specialty Pharmacy Transactions

Specialty Pharmacy Times


January 7, 2016

DILIGENCE—it's a core part of every transaction, however, the quality and intensity of diligence varies widely.

Often, buyers and sellers of specialty pharmacies (SPs) focus so heavily on the financial aspects of a transaction that they overlook regulatory and operational issues that are essential for proper valuation or that may expose potential risks and liabilities that can undermine the ability to operate the pharmacy successfully.

Providing a buyer clear and concise documentation evidencing the SP's operations and practices is often the key to a successful transaction. Even though a seller may have compliant practices, the lack of good documentation may kill a deal.

Good documentation can also be very helpful in the post-closing integration process. Furthermore, a strong deal team is a must-have for both buyers and sellers.

Good deal teams often consist of executive-level SP staff, financial and accounting support, operations and billing consultants, and legal counsel with industry depth and a finger on the pulse of the market. Diligence is an exhausting and sensitive process.

Buyers with a thoughtful game plan and a seasoned deal team will be much more likely to spot a bad deal early and walk away or properly value and close a good deal. For a seller, preparation and a strong deal team can be essential to making a buyer comfortable and ensuring the deal closes.

An Ounce of Prevention

Understanding potential buyers' interests, pain points, typical concerns, and market "hot points" can help sellers get their house in order before going to market, thus easing tough discussions during diligence.

These preparations often include conducting mock diligence interviews; gathering the documents typically requested during diligence; completing a review of the seller's business and practices to identify and resolve difficult issues; and conducting market intelligence to highlight current "hot-issues" affecting recent transactions.

Often, the very act of gathering the documents required to complete a typical diligence request list will help a pharmacy identify gaps in its operational and regulatory compliance efforts. This proactive approach also allows enough time for the pharmacy to take appropriate corrective action if needed.

Looking Under the Covers

During the diligence process, buyers vet SPs for financial strength, operational prowess and regulatory compliance. Buyers should strive to achieve a balance by focusing on important relevant information and digging in with strategic follow-up and corroborative requests.

Getting bogged down in minutiae can drive inefficiency, but allowing a seller to spoon-feed a buyer only selected information can lead to unwanted surprises later during integration. It is also important to be on the lookout for potential complications of "upsizing."

Operational practices that are somewhat common in smaller SPs because of the SPs' lack of regulatory and operational sophistication often have to change post-close. The buyer must consider the impact of these changes on valuation, especially if the practices are revenue drivers or if the cost of improving compliance is material.

Even when the buyer can overcome these compliance concerns, it may insist on earn-outs or significant indemnification and escrow obligations. Good diligence is pointed and deliberate.

A review of the following areas allows a seller to highlight its practices and a buyer to get a material understanding of the asset.

  • Quality of Earnings: perhaps the most significant aspect of diligence is the quality of earnings (Q of E) assessment. Generating a Q of E report may take time, and buyers should start the process as early in diligence as possible. Since unexpected Q of E results can derail a deal, it is better to have that information early in diligence before significant time and money are invested. Early alignment between legal diligence and the preparation of the Q of E can be a great way to lower overall costs while driving more impactful analysis of financial practices of the pharmacy.
  • Sales and Marketing Practices: a buyer should look at sales policies and practices to ensure compliance with Stark Law, the Anti-Kickback Statute, the Civil Monetary Penalties Law and applicable state laws. Interactions, gifts and entertainment provided to referral sources, including referral practice office and nursing staff, should be analyzed. Buyers tend to look for expense reports containing certain key information to confirm compliant practices. If expense reports do not provide sufficient documentation of sales staff activities, interviews with staff members may be required. Patient relationships, particularly in genetic diseases such as hemophilia, will be reviewed. Sales staff compensation structures will be reviewed. An SP considering going to market should consider periodic training of its sales staff, maintain close review of its practices and require sufficient documentation to prove its compliant practices.
  • Reimbursement Practices: reimbursement diligence is often deep and wide. Among the areas reviewed are billing and coding, co-pay collections, billing for non covered services and wastage, prior authorization practices, and determination of medical necessity. Buyers should carefully review patient financial assistance programs to determine compliance and proper documentation. Reimbursement consultants dig deep to uncover disparities in an SP's reported and actual practices. Noncompliant reimbursement practices can result in significant legal or recoupment liability. Sellers who cannot show solid billing practices may have to accept less-than-favorable indemnification obligations. SPs with lax co-pay collection practices or financial assistance policies that do not require documentation of a bona fide financial need, may have to take a higher percentage of the purchase price as earn-out to share the risk that patients may go elsewhere once the SP converts to the buyer's more rigorous policies post-close.
  • Operations: operations diligence can be the most sensitive area of analysis for both buyers and sellers. Unlike other areas where the analysis tends to be more objective, each SP has its unique value proposition that has been purposefully crafted through deliberate operational processes. A buyer's exacting analysis of the SP's operations can prompt emotional responses, which are often counterproductive. SPs benefit from strategically crafting a deal team that harnesses external industry experts and key internal players well versed in both the seller's offering and the buyer's expectations.
  • Contracts: buyers often target SPs based on strategic payer coverage or limited distribution drugs. If those contracts can be terminated by the payer/manufacturer upon a change of ownership, buyers may become gun-shy. However, contract diligence is more than checking stacks of paper for change of ownership provisions and making lists of payer coverage and limited distribution drugs. The regulatory landscape for SPs is ever evolving, even more so recently. A savvy buyer's counsel will dig in on key contractual relationships, particularly those in which manufacturers pay the SP for enhanced services, to ensure the target's current obligations are in line with the buyer's risk tolerance.
  • Licensure: adequate licensure may seem like a no-brainer for an SP going to market, but keeping up with the ever-changing state pharmacy law requirements can be burdensome for small to mid size SPs. A seller's failure to maintain adequate licensure may raise concerns for a buyer and add unwanted friction to the negotiation process. Sellers would benefit from having a dedicated employee chart to assist with ensuring compliance with state pharmacy obligations. In the last year, many states have added requirements for compounding pharmacies. For SPs that compound any product, a review of state licensure could be beneficial.
  • Compliance: compliance diligence often goes beyond a review of policies. Buyers will also want to understand how well the seller monitors and complies with its policies. SPs considering going to market would benefit from revisiting their training modules and conducting a Health Insurance Portability and Accountability Act risk assessment.
  • Non-Compete Agreements: buyers are often reassured when management level employees, particularly those integral to operations, and sales staff have executed non-compete agreements. SPs considering going to market may want to put non-competition agreements in place as a preparatory act. Once employees learn of possible transactions, obtaining a non-competition agreement may be a more difficult task.

Building Your Team

A good diligence team can help sellers survive diligence and keep buyers from getting less than they bargained for. The best diligence teams not only know the industry, the market and the SP's strategic plan, but also show efficiency and sensitivity in their roles.

It is rare that one or two SP employees will know enough about the SP to run diligence alone. However, an executive management team member with a deep understanding of the roles and responsibilities of the SP's management team and good working relationships with those team members can often run point effectively.

Consultants who have experience in the SP space can efficiently dig in on issues that otherwise would be difficult challenges in diligence. For example, accounts receivable reports usually do not clearly give a picture of an SP's collection of co-pays, but a consultant savvy in the issue can provide a good analysis.

Legal counsel that understands the industry and market can help spot risks and valuation concerns for both buyers and sellers. Team members who are cognizant of the pain points of the other side are better suited to frame diligence requests and responses.

While a diligence team must be detail-oriented, it is just as important that buyer and seller teams approach diligence with a certain level of sensitivity. Building trust and respect during diligence facilitates a smooth and profitable integration. That is a win for both sides.

Specialty Pharmacy Times previously published this article on December 10, 2015. The original publication may be accessed with a free login by visiting Specialty Pharmacy Times.

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