The Health Care Investor : Healthcare Lawyers & Attorneys for Life Science Companies & Investors

It is a rare healthcare company that has no regulatory risk exposure in at least a few material areas.  As sellers of healthcare companies prepare them for sale, they will need to navigate first the letter of intent (LOI) stage with potential buyers and ultimately the more detailed definitive agreements.

The key differences between negotiating deal points at the LOI stage versus the same negotiation at the definitive agreement stage are leverage and information.   At the LOI stage, the buyer is often still trying to get the deal (especially in an auction environment) and is operating with limited visibility into the potential magnitude of issues.  The seller often knows more about potential issues but believes the realistic exposure (vs. worst-case scenario exposure) is relatively small.  Once the LOI is signed, the leverage in the hands of the buyer often increases as the closing of the transaction becomes more certain  usually a key desire of the seller  and arguments that the buyer should absorb more risk usually devolve into re-pricing negotiations which the seller wants to avoid.

What should a seller do or not do at the LOI stage?

1.   Do not try to minimize sell-side due diligence.  While commissioning some level of sell-side legal due diligence will increase the initial expense of a transaction, it can avoid costlier pitfalls later in terms of late pricing renegotiations, risk to ultimate closing and delay.  It is difficult for the seller’s legal team to shield or shade these issues in the dark.  David Stienes, a Principal at LLR Partners, noted that “Dealing with prospective sellers who have performed preliminary work around the key regulatory issues and are willing to have open discussions in advance of an LOI is very comforting to us as buyers and allows greater certainty around our offers.   From the sellers’ perspective, it can also be a valuable tool in assessing the knowledge and ultimate viability of us as prospective buyers.   If interested parties are unwilling and/or unable to discuss these issues upfront, it could be a sign that they do not have a full grasp of the matters and will be educating themselves throughout the process.   This will greatly impact both certainty and speed to close.”

2.  Do not hide the ball.  While slowly parsing information at the early stage is the best pathway to getting an LOI signed, it is the worst way to limit the cost of such issues in terms of pricing, escrows and indemnity exposure.  

3.  Negotiate indemnity cap/survival terms for known issues.  This is often difficult prior to substantial due diligence; however, sellers can often pressure buyers to accept narrower limits at the LOI stage than later in the transaction process.

4.  Force heavier pre-LOI diligence on known issues.  It is unlikely that a buyer will do full legal diligence on issues at the LOI stage, but a request that buyers more fully review known issues can lead to more advantageous LOI treatment or at least swing some of the post-LOI leverage to the seller.

None of these strategies can fully insulate a seller from the impact of known regulatory issues on the sale process; but they can minimize the pain, expense and delay that these issues often cause.

 

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The U.S. dialysis industry includes more than 4,000 outpatient dialysis facilities (in addition to a large number of home dialysis programs) that service more than 350,000 patients suffering from end stage renal disease (ESRD). The industry self-classifies dialysis companies as either large dialysis organizations (LDOs) or small dialysis organizations (SDOs). The LDOs are few in number and include DaVita and Fresenius Medical Care, both publicly traded companies, as well as DSI Renal and Renal Advantage, both of which are backed by private equity funding.  In mid-2008, Congress passed the first major Medicare payment overhaul for dialysis providers in 25 years. Two years later, in anticipation of the January 1, 2011 implementation date, LDOs and SDOs alike are taking a close look at the potential impact on their businesses.   

As part of a more comprehensive ESRD program reform bill, the payment formula for dialysis treatments was reconfigured into a bundled payment for all dialysis services (including pharmaceuticals such as the common anemia management erythropoietin-based drugs). Pricing for those services will be influenced by a market update mechanism starting in 2012. Providers can elect to fully participate in the bundles approach in 2011 or may instead elect to have the approach phased in over four years beginning in 2011. Physicians will also get a 2% increase in the Medicare payment if they submit prescriptions electronically. Those who don’t use the so-called e-prescriptions by 2011 would have their fees cut by 1% the following year, rising to 2% in 2014. 

It is likely that the new bundling system will impact SDOs and LDOs differentially for a variety of reasons. For instance, LDOs enjoy impressive purchasing and contracting power and other economies. Further, some LDOs are vertically integrated such that their key equipment and fungible products suppliers are affiliates, which can result in a significant cost savings to the LDO.  

On the other hand, some industry analysts believe the impact of bundling will be felt differently by providers not necessarily along SDO versus LDO lines but rather based on other factors, such as a provider’s historical drug dosage orders or based on geographic factors. For example, Shari Levanthal of the American Society of Nephrology published an interesting article last year describing the findings of Columbia University/Harlem Hospital researchers who believe that dialysis providers in the east and southeast are particularly likely to feel an adverse financial impact due to historical variances in Medicare reimbursement.

In any event, the January 1^st implementation date for the new methodology is quickly approaching and dialysis providers of all size, modality focus and patient population would be wise to assess now the potential impact on their businesses and strategies for keeping costs low and quality high. 

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