Smaller Companies Aiming High in HCB Transactions
In many healthcare business transactions, larger companies sweep in on smaller entities in order to grow their footprint in a geographic location. However, there are times when a smaller company can make larger strides and pick up the larger competition. The Ambulatory M&A Advisor finds out the details of these types of transactions and what is to be expected when these moves are made.
Michael Blau, Partner with Foley and Lardner LLP says that a transaction where a smaller company acquires a larger company is not very common but it does occur and is usually one of three things, or a combination of them.
“One is if the smaller company just happens to be strategically better positioned than the larger company. Maybe the smaller company is one in a hotter space with more up-to-date technology and just happens to be a smaller company at this point. Strategically, I think a smaller company that is better positioned as a potential acquirer is possible, otherwise it would need to be a well resourced smaller company, one that has significant access to capital, both equity capital and debt financing, or has otherwise large strategic reserves. I think it also has to have strong or even stronger management; those are the profile elements that one would see in the situation where a smaller company is acquiring a larger company,” Blau says.
William Horton, Partner with Jones Walker agrees that these types of transactions are uncommon in the healthcare industry.
However, Horton says that one area where it may arise, though, is the situation where a private equity fund or other investment group has acquired a relatively small company that it intends to use as a platform for “roll-up”-type transactions – i.e., where the small company provides a foothold in an industry sector that the investment group intends to use to acquire other companies and combine them.
Another situation that could arise is where you have a management team from a company that has been sold that is looking to get back into business.
“In that scenario, you may have a team that has successfully built up a business and sold it, and then has formed a new start-up to try to replicate that process. In either case, the key is that the small company has to have access to capital and, typically, some management depth in the relevant sector,” Horton says.
Ann Bittinger, Healthcare Transaction Lawyer, Owner of The Bittinger Law Firm disagrees with the thought that these are uncommon transactions, and says that in her experience, she thinks they are fairly common in recent healthcare.
“I think it is all about funding, risk, and service line optimization. By service line optimization I am talking about expansion in either different ways to funnel patients through the center, and also different ways to reach different sectors of the healthcare market. We are seeing some situations where healthcare providers are reaching out and buying smaller companies that do payor work. We also see a lot of movement in the payor and provider merger market, which is very interesting,” Bittinger says.
As far as how to complete such a transaction as a smaller company, Bittinger says that funding is the bottom line, not the sheer size of a business. It is about the underlying entrepreneurial degree of the smaller company buying the larger company.
“I think that with the influx of more and more private and venture capital into the healthcare market, we are going to see more smaller companies that are savvy enough, get backing through private equity markets and become able to make moves in ways that the industry has not seen in the past,” she says.
Legal Issues and Transaction Structure
Brian Berlandi, Co-founder and Partner of the firm Berlandi, Nussbaum & Reitzas explains that the structure of this type of a deal is critical. Berlandi says the buyer needs to consider whether it wants to do an asset purchase, or a stock purchase (in which case it would buy the assets and the liabilities).
“In the latter instance, the buyer needs to be VERY careful to understand what the liabilities may be, as the buyer does not want to inherit a liability that could put them out of business. The implications could be disastrous. The usual myriad of representation and warranties from the seller will also be critical in order to minimize buyer risk,” Berlandi says.
In terms of transactional legal considerations, Blau says this goes back to diligence.
“You may or may not as a smaller company have the resources to adequately diligence a much larger company. If you don’t then there may be skeletons in the closet that you just had not identified that may come back to bite. From a legal perspective, if I am a smaller company, I am going to really want to make sure that I have really good indemnity provisions, representatives and warranty insurance, escrow involved,” he says.
In terms of the transaction structure, Blau doesn’t think there is anything unique about the transaction structure based on the size of the company. In the healthcare space, it is generally preferred to do asset transactions in order to avoid assuming either malpractice liabilities or fraud and abuse liabilities that one would rather avoid than not assume.
Although the transaction structure isn’t something that is going to change much Horton says the details are really going to depend a lot on the particular facts, including change-in-control triggers, potential licensure or certificate-of-need issues, the tax position of the companies (and the sellers of the target company, if the deal is to be a stock purchase or merger).
“It may be possible to do a relatively straightforward stock or asset purchase, or it may be necessary to design a more complex recapitalization transaction or other tax-driven structure to meet the needs of the parties. The only thing you can say for sure is that there is no one-size-fits-all answer,” Horton says.
Benefits and Risks
“I think the main benefit is service line optimization. If you are getting into a service line or a market that you were not in before that can compliment your current business, that is really the sole benefit of this type of transaction.
If the bigger company is smarter about doing thing in the healthcare reform environment that we are in, that might be another benefit. For example, payment reform and MACRA issues; if the bigger company is already prepared for MACRA reporting, that might be a good benefit for the smaller company to be able to get on board instead of having to create something themselves,” Bittinger says.
“In terms of the risk, if the funding is not an issue, it is the question of whether this investment is something that the company can manage going forward. A way to effect that risk is thorough due diligence. This is not only to see the legal risk that a smaller company might not have seen in the past, but thorough due diligence will help them from a management standpoint in understanding everything they are getting into in buying a company that is bigger than theirs.”
Blau says that in any given circumstance the benefits of such a transaction are going to vary, but in general for a smaller company, it is probably looking to get to scale faster than would otherwise be the case.
This is especially evident if the company being acquired is in the same space or in a complimentary space. It really does affect their scale and their market power of influence. This type of transaction can also help scale to efficiency.
“You can drive down unit costs, you can drive down your staffing cost on a relative basis. This is to accelerate the sale for market power, but is also to accelerate the scale for unit cost and cost efficiency purposes,” Blau says.
In terms of the risks, a smaller company may not have the management bandwidth to really transact a deal with a larger company and to be able to adequately diligence it and be able to figure out how to adequately operationally integrate it.
“A lot of companies that do M&A where they have challenges all of the time is when they haven’t really done all of the groundwork that is necessary to figure out how to integrate the companies on a going forth basis. If you are a smaller company, you may or may not have all of the resources to throw at it to adequately diligence it to follow through all of the work streams that are necessary to figure out how to do all of the administrative integration, technology integration etc.”
Horton takes the topic back to structure and says that the benefits and risks depends a lot on that matter and the plan for how it will be financed.
“For example, if the smaller acquirer plans to finance the transaction by fairly quickly selling off duplicative or non-strategic assets or business lines of the target company, the acquirer will want to investigate how easy or complex it will be to do that. If the target company operates through distinct line-of-business divisions or subsidiaries, it may be fairly easy, as a legal matter, to break pieces off to sell. If the target company operates in a more centralized, unified fashion, it may take more time and effort to reorganize it into “sellable” pieces. In addition, the acquirer will want to carefully look at things like change-in-control agreements, potential litigation or regulatory exposure, and similar factors that may result in significant post-closing costs and/or obstacles to the ongoing growth of the business,” Horton says.