What You Should Know About Merging Your Practice

By Steven Peltz, CHBC

   Two podiatrists meet for dinner and one raises the possibility of merging their practices. “Why do we have two offices, two billing systems and two complete staffs?,” one may ask. “We each need another provider but not full time, and we each pay a different accountant to do the same thing. Is there something here that would make more sense?”     “Mergers and acquisitions.” That was the hot phrase we read about in the ‘80s and ‘90s. People often equated this phrase with larger market share, fewer expenses and more profit. Sometimes it was an accurate description.    Until the mid-‘80s, it was not necessary for medical practitioners to seriously consider merging their practices to capture a larger patient base. Until then, practitioners could bill and expect to receive 80 percent of charges based on UCR (usual, customary and reasonable) from the insurance company and 20 percent of the charge from the patient. Imagine getting paid what you charged.    Today practitioners can still charge what they want, but if they are “par” (participate) with the payers, they receive a reimbursement based on the payers’ fee schedule and the remaining amount is adjusted or written off. As a result, practitioners are looking for ways to maintain their income in the face of decreasing reimbursements and increasing expenses. One approach to maintaining income and creating security is merging with other practitioners.

Separating The Assumptions From The Realities

   Unfortunately, practitioners often have unrealistic expectations or fantasies of what results they will see after merging their practices. Here are some incorrect assumptions of what a merger will accomplish:    • more profit;    • more time off;    • a better negotiating stance with payers (depending on the practice’s size);    • fewer expenses;    • less time spent on administration (a merged practice may be able to hire professional management); and    • the notion that bigger is better. Here are some correct assumptions of what a merger will accomplish:    • more, less or the same number of offices;    • more owners or partners;    • more security for the partners;    • a better chance for increasing your quality of life;    • one tax identification number to use for billing;    • usually one practice management system;    • one retirement plan;    • one fee schedule;    • one set of governance documents; and    • a new accountant and attorney (usually) for the practice.    Merging does not necessarily mean you have to change the way you practice, your office, your office and hospital schedules, vacations, holiday call schedule, clinical protocols, relationships with referring sources or office staff. A merger also does not necessitate a change in vacation or compensation and bonus formulas.

The Ins And Outs Of Operational Mergers

   In an operational merger, two or more offices are consolidated into one or fewer offices. The new office can be one of the existing offices or, as is usually the case, a new, larger office is acquired.    For the purposes of this article, Dr. Able’s practice is a solo practice whereas Dr. Smith and Dr. Jones team up in another practice. Both practices are in the same town about two miles apart. The doctors are all in their 40s. They each earn different amounts ($160,000, $190,000 and $245,000). They have different practice management systems (PMS), different schedules and only one operates at the hospital. They have known each other for 10 years, trust each other and each is comfortable with the other’s level of clinical competency. These evaluations are the first and most important steps in the due diligence process.    Ideally, a committee made up of one doctor and one staff member from each office will work from the doctors’ wish list and try to get a feel for what an ideal office would look like. Then they determine how many square feet they need for this office. They contact a realtor to find the space in a location within a reasonable radius from each of the previous offices. Loyal patients will travel to see you, but not too far.    After finding the appropriate space and location, the same committee determines the configuration based on their ideal office and incorporates the changes based on the amount the doctors want to spend. The new office should have at least one more exam room than they planned. In addition, it should have enough chairs for the patients of four doctors. (Yes, there are only three docs for now but plan ahead.) There should also be a larger business area, a separate area for billing and collecting and a staff break area. Also be sure to pick a location that has enough room for parking and is close to transportation.    In an operational merger, each staff will lobby the doctor to keep its PMS, super bill, schedule and other components that the staff feels are “better” than what the other practice has. While that reaction is expected, it may not be best for the new entity. The cost to expand Dr. Able’s PMS is $17,000. Expanding the system of Drs. Smith and Jones would cost less than $6,000. While both systems are different, both are capable of performing all the tasks necessary to run a practice. Regardless of the cost differential, Dr. Able’s staff lobbied for the new entity to use their system.    However, because all three doctors will equally share the start-up costs, it is in Dr. Able’s best interest to agree to expand Drs. Smith and Jones’ PMS. Recognizing his staff’s anxiety about learning a new system, Dr. Able takes one of his staff members to the other practice to spend a day using its system. The staff of Drs. Smith and Jones’ office is aware of the feelings of Dr. Able’s staff about a new system. They have accordingly prepared themselves to demonstrate that their system will work fine without saying that it is a better system than the one Dr. Able’s staff had been using.

Overcoming Fears And Fostering Staff Cooperation

   Sometimes the fear of change clouds minds from seeing the objective. Your support staff may let it be known that they don’t think a merger is a good idea but what they may mean to say is they are uncomfortable with the perceived changes. Your employees may be very good and loyal but be aware to differentiate between concern that is change-related and genuine concern that the switch may not be best for the new practice. Work with your staff to show they felt the same way before their previous PMS was replaced by the current system. Point out previous anxieties over an office move or apprehension over a new office manager, and how these worries eventually faded away. Working with your staff to alleviate their concerns will make them strong advocates of what you want to accomplish.    At the beginning of this process, be aware that your staff may feel some of them may be fired as a result of the consolidation. Our recommendation has always been to let the staff know early on that no one will be let go as a result of the merger. Yes, you may have more staff at the beginning of the merger, but you will have the opportunity to reduce staff by attrition as opposed to firing.    The staffs of both practices then prepare a list of their vendors and what supplies they purchase from each. Each creates a binder with all the forms and assorted paper used in the office. This includes the patient information sheet, fax cover sheet, referral forms, hand outs, super bill, receipts and forms that are in the chart. A sample chart with the labels used on the outside (purge year, last letters from the patient’s name, labels to indicate special conditions, billing arrangements, etc.) is also placed in the binder.    The staffs then compare the binders and examine which form and format they all feel would work best in the new office or they could use this time to design an improved form. When the move into the new office takes place, the charts from each practice are moved into the chart area of the new office, but kept separate. As the patients come into the new office for their appointments, the chart is then filed in the new merged chart area with any new changes placed in and on the chart. This saves an enormous amount of time trying to combine the charts before seeing the patients. This also helps purge the charts of patients who have left the practice. Keep a list of all patients from each practice.    Members of both staffs meet and present to each other their doctor’s office hours and hospital OR time. The staff presents their recommendations to the doctors on what a new combined schedule for all three doctors might look like.    The staff next should list all the participating payers for each practice. Find out (when possible) how long it will take to get a new provider number and address approved by the payers with a new tax identification number.    The doctors should view the staffs’ recommendations seriously but should allow themselves the final decision, which may differ from their staff’s recommendations.

What Financing Options Should You Consider?

   There are two ways to finance the new practice during the start-up period and first few months.    Line of credit. Shop around for a line of credit from a bank. The banks are in a competitive situation and have to bid for your business by submitting a term sheet. Each doctor signs for an equal share of a line of credit from the bank. The new practice will bill for services performed after the merger date and those funds go into the new practice’s bank account. The line of credit will pay for staff salaries and the operational costs until cash flow meets expenses. The staff will also continue to work the accounts receivable (A/R) from the previous practices. As those funds come in (A/R), they are deposited into the previous practice’s bank account. The doctors will draw from those funds for their salaries. After a few months, there will be enough funds coming in for services after the merge date to pay for all expenses and begin to pay back the line of credit.    Accounts receivable (A/R). The second option is to use collections from pre-merger services to pay for start-up and operational needs. The merged practice would still need a line of credit, but it can be smaller. As all three doctors will be equal partners, they should each contribute the same amount to the new entity. The group’s new accountant would explain how this works. Track the collections from each doctor for pre-merger services that are put into the new practice’s bank account. If they are not equal after an appropriate time, discuss the available options for equalizing the initial start-up contribution (capitalization) with your consultant, accountant or attorney.

Addressing The Compensation Issue

   The easiest way to determine compensation is to have each partner receive the same compensation. Of course, that naive assumption will immediately end any discussion of a merger among these three doctors. In our example, there were three different compensations ($160,000, $190,000 and $245,000 respectively). Here are two examples of how the group’s new compensation formula may look.    Example 1: Add the three salaries together to arrive at a total of $595,000. Determine the percentage of each salary to the total:    160/595 = 26.9 percent    190/595 = 31.9 percent    245/595 = 41.2 percent    Total= 100 percent    As long as all three partners’ schedules are the same after the merger as they were before the merger, the profits (salaries) are divided as above.    If the profits are greater than $595,000 at the end of the year, those profits are split equally. If the profits are less than $595,000, the salaries are reduced based on the percentages above.    Example 2: Take 75 percent of the lowest paid partner’s W-2 from the previous year and use that as the base salary for each partner. After the monthly expenses have been paid, distribute the remaining profits based on productivity. When using a formula similar to example 2, it is important that each partner keeps his or her own patients that follow him or her to the new practice. New patients are then divided equally between the partners.

How Do Strategic Mergers Work?

   Due to the growth of suburbs and the ability of the population to travel, strategic mergers are more common now than in the past. In this type of merger, two or more offices might be anywhere from one to 30 or more miles apart. Since the practices may be in different towns or due to a lack of space or other factors, each office will stay in its present location.    In this form of merger, the partners will manage their practices, which are now referred to as profit centers. They will make all the decisions regarding hiring, firing, salaries, hours of operation and bonuses for staff as they did before. All their expenses will be paid out of their profit center’s collections. Other than a new PMS, a central billing office, changes in forms and the process for payables, there really are not many changes to your practice in a strategic merger.    All profit centers will have to convert to one PMS and one tax ID number similar to an operational merger. There is usually one central business area that pays all bills, calls in payroll and does the billing and collections.    When we merge practices, we request the partners attend a meeting at least every other week during the first year. Each month, the partners receive a detailed financial report on their profit center’s collections, expenses and profits, and a report for the entire practice.

How Governance Documents Can Safeguard The New Practice

   There are three basic documents required if you form a corporation and two if you form an LLC. When forming a corporation, a shareholders agreement, employment agreement and a deferred compensation agreement are essential. These agreements are worked out before the effective date of the merger. Working through the issues these agreements identify will help you decide if you can get along with your partners.    The shareholders agreement explains how you acquire shares, how you lose shares and what type of vote is needed for specific situations.    The employment contract explains how you get paid, your benefits, vacations, holidays and how you can be terminated, among other details.    The deferred compensation agreement explains what you or your estate receives if you die, become disabled or retire. To ensure the viability of the practice, there is usually a time limit required to work for the new practice in order to receive 100 percent of your retirement benefit. To eliminate any financial strain on the practice, there is also a cap put on the amount that can be paid out in any one year for any reason. If the amount to be paid out exceeds the cap, the cap stays and the time period of the payout increases.

Understanding The Different Phases Of A Practice Merger

   A practice merger occurs in three phases and anyone can drop out at anytime. An important component of the documents and one that allows participants to feel more comfortable is a “bailout” provision. It allows any partner, within 12 months of merging, to leave the new entity and revert to his or her previous practice. However, they must pay for whatever costs they incur.    Phase 1. Write up governance documents and concurrently begin the operational assessment and determine costs. These costs entail PMS, moving and construction if you are pursuing an operational merger but only PMS costs if you opt for a strategic merger.    Phase 2. Once you have identified the costs, present the model of the practice to the partners.    Phase 3. Monitor and adjust during the next 24 months.    Merging requires a great deal of communication and time for meetings. Do not try to merge without taking it very seriously and without planning ahead.

Realizing The Potential Merger Benefits

   In either type of merger, there are now partners who will cover for you when you go on vacation or are sick.    There is a formula or predetermined amount you or your estate will receive in case of death, disability or retirement. This eliminates the nightmare of trying to agree on an amount when something happens.    In a strategic merger, if your profit center can use another physician but does not need one full time, you can split the cost with your partners and use the new physician at other profit centers in addition to yours.    If there is an underserved area, you and your partners can share the costs associated with opening a new office as opposed to footing the bill yourself. Likewise, if there is a new piece of emerging technology that can enhance patient treatment, the group practice can purchase it and spread out the cost across a larger patient base.    If you merge and control a very significant amount of the services in your area, it may allow you to discuss your concerns with payers on a more level field.    In any merger, there are economies of scale one will be able to recognize as a result of being able to purchase in larger amounts. Mr. Peltz is the president of Peltz Practice Management and Consulting Services. He can be reached via phone at (845) 279-0226, via fax at (845) 279-4706 or via e-mail at speltz1@aol.com.

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