Executive Update

August 2005    

Acquiring Practices:  Buying Strangers, Friends and Enemies
Part One – Purchasing a Competitor
Sandra E. D. McGraw, Michael Parshall and Mark Kelly

(This is Part One of a two-part series. Part One addresses the general business considerations in purchasing an area practice. This topic will be continued in the September Executive Update, addressing the transaction details from how to get started to how to proceed.)

For many ophthalmology practices, increased competition has led to shrinking patient bases and narrowing profit margins. For the smaller practice, where the senior physicians have already made their retirement income and continue to work to support themselves and care for their patients, this is one issue. However, for many other ophthalmologists, with years to go until retirement, the prospect of reduced reimbursement from Medicare and other third parties presents an unpredictable financial outlook. 

In the current environment, increased patient volume coupled with internal practice efficiencies, new therapies and continued geographic penetration can be the best sources of economic protection. But don’t forget to look before you leap. It is all too common for changes to be made before careful evaluation of the environment, understanding of the problems to be solved and creation of a well-devised plan of action. On the other hand, practices that subscribe to the “if it ain’t broke why fix it” philosophy also run the risk of being too slow to act and, as a result, getting left in the dust when change is mandated.

So, let’s look at methods to increase practice revenue. Internal practice efficiencies will facilitate an increased patient volume to a certain degree. There are limits given the office space, doctor’s capacity and patient base.  New therapies that have shown great promise should be considered, but the same space and capacity issues could apply. In addition, new therapies might not be a wise choice given the demographics of the community, population and/or patient base (such as refractive services in a senior-dominated community).

When the practice is operating at full capacity, an easy solution is to add another doctor to the current office, space permitting. If space doesn’t permit, relocating the practice to a bigger space within the same community is another solution. Both options make two assumptions. The first one is that the physician owner is willing to share office space and understands the resulting financial implications of a new associate or co-owner. The second assumption is that volume is the problem to be solved. When both conditions are true, moderate success can result when this strategy is carefully planned and executed.

Now, let’s assume this office is not operating at full capacity. One might assume that should be the end of the discussion. Let’s ramp up external marketing and start making phone calls to referring physicians. Sounds like a reasonable solution.But, stop to consider whether there is a nearby underserved community or another nearby practice that competes with your own. Specifically, consider purchasing an existing small practice — particularly that of a competitor or optometric practice in the community. We define a small practice as a practice that has a smaller number of providers than yours, so that it can be easily assimilated into yours. It might comprise ophthalmologists or optometrists, but the point is that it offers something that you do not now have — in this case, geography.

Why Purchase Another Practice?
At least 25 percent of the nation’s physicians are 55 years of age or older and ready to phase down and retire, or at least starting to think about it. Many solo doctors choose to sell their practices. This gives the established practices a significant opportunity to augment their already existing patient base. Such a purchase would allow an ongoing practice to afford to bring on a new doctor, expand to a new geographic area or simply bring current associates up to full volume. Each of these options, however, assumes you know what your target would look like. 
 
Research Practices in Your Community
If you are thinking of purchasing, do not just look for gray hair. Look for those ophthalmologists or optometrists who may have moved to the area a few years ago but who just cannot manage on their own. You will recognize these practices immediately. Look through the last 10 or 20 resumes your office received in response to job openings (any job opening.) Oftentimes they will have the same practice name on them. That is a pretty good indication that the practice owner probably cannot manage the practice (or does not want to) and cannot seem to find someone to do it for him. This is where you step in.

Don’t be limited by those practices you know. Have an open mind. Strangers are only that way because you have not met them yet. So how do you evaluate an attractive practice? Look at practices with a solid foundation. While it may not meet your practice standards, that practice is still up and running with patients and shows great potential.  
 
Research Practices Outside of Your Community
 If you really want to augment your patient base, you might consider purchasing a competitor or a practice not located in your immediate geographic area. That practice has patients (and, likely, referral sources, which must be considered) that you do not have access to at this time. Purchasing a practice could also intercept the practice’s sale to an ambitious young doctor who could become more serious competition than the retiring doctor ever was. At the same time, it may also present redundancies such as an additional office in the same area. 

Start by researching the community’s demographics and population. Is a new retirement center being built? If the area is growing (or has potential to grow) or is underserved, this is a pretty straightforward “make versus buy” decision. Know, however, that when you make (your own) you compete, and when you buy, (ideally) you co-opt and augment. A practice management consultant can help you scout desirable locations as opposed to those on the decline or oversaturated ones. Even if the location is too far for you to travel to on a regular basis, a new associate could be hired to manage this location.
 
Making the Economics Work 
The economics of the typical practice purchase, if properly structured, can be quite desirable. Consider, for example, a small solo practice grossing $500,000 per year. Assuming a purchase price for that practice is one year’s net income, or $200,000. Assume you can structure the sale to make most of it tax deductible or tax advantaged and spread the payments out over three to four years. The cost of the purchase, even including a moderate rate of interest, might be $4,000 to $5,000 monthly. On that basis, a purchasing group or doctor need retain only 20 percent to 25 percent of the purchased practice’s patient volume to break even on the purchase price — although usually more than 75 percent of the practice’s patients stay with the purchaser, or at least give the purchaser a try. Thus, the purchasing doctor should realize an additional cash flow of at least 75 percent of the previous practice income and probably additional net income (after overhead and taxes) each year if any efficiencies from the purchase can be realized (better use of staff technology, optical sales, procedure increase, etc.). This can be quite a dramatic return on investment if it is properly structured. 

Let’s assume you decide to enter a new geographic area. If you start your own practice and compete with the existing practices already there, how long can you afford to “get it up to speed?” What is your strategic advantage? If you instead purchased a practice and could at least find a way to break even on that purchase, recognizing you had to purchase equipment, lease space, market and invest in non-income-generating physician time building that practice, doesn’t a purchase sound like a way to jump-start that process? 

Unfortunately, many practices look at an area and see a particular “competitor” but ignore such valuable opportunities. They assume that if they simply wait patiently the ophthalmologist or optometrist will inevitably retire or slow down considerably. Once this happens, patients will have no choice but to go elsewhere, and the practice will acquire those displaced patients. In some cases, if that is what actually happens, this can be a good strategy. Simply circle the wagons, put that money into advertising and wait it out. 

Usually however, this strategy completely backfires. When a retiring physician slows down, surgery is generally referred to a competitor’s practice (not necessarily yours). So, the patients who stay with the doctor become very comfortable with the co-management relationship. As a result, the referring medical-only ophthalmologist gradually phases down, diminishing the value of the practice. You should have considered purchasing the practice when it was worth something.
 
Consider Who Has the Advantage
Most purchasers of ophthalmology or optometry practices are those doctors just entering private practice from residency (or fellowship). These physicians are recruited with the express purpose of buying out the senior doctor. Yet, existing practices have a distinct advantage in the bidding for a retiring doctor’s practice. An established practice can far more easily afford the purchase price; thus the selling doctor has greater assurance of payment. Since credit worthiness is a common concern in most practice sales, an already-established practice is often preferable to a young doctor. This is particularly true when the selling physician wants to stay on in any capacity. The Medicare Fraud and Abuse Safe Harbor allows for the purchase/sale of a practice by physicians in a position to refer to each other if the transaction (including all payments) is completed within one year (more about this regulation in next month’s article).

Despite the financial emphasis, the bottom line is patients. Most ophthalmologists and optometrists care deeply about their patients and the quality of care delivered. Many sellers wish to transfer their practice only to a successor who can provide high-quality medical care; again, an established practitioner or group will often be preferred because their approach to patient care has been established, even if it is a different community, whereas a recent graduate from residency hasn’t gained that trust yet.

There is also the intangible attribute of staying power. What seller does not want to know that he built something of value? A new physician purchaser already established in the community has the added advantage given the proven community commitment. 

Finally, there are the issues of risk. While restrictive covenants can be difficult to enforce in the employment setting, they are usually more enforceable in the practice sales setting. While this may initially appear to be a disadvantage, a seller must weigh the risk of bringing someone new into the practice, and then if it does not work out, trying to enforce the restrictive covenant to keep the doctor from practicing in the area, versus selling for the right price, with the understanding a similar restriction could be enforceable. Often, timing is the question: how long the seller plans to stay and whether or not the seller is willing to take the risk of a mistaken hire. 

In this article, we looked at some of the advantages of expanding your practice. In next month’s article, we’ll look at how to structure the purchase.

About the authors: 
Sandra McGraw is a both a consultant and a lawyer, with more 20 years experience advising physicians in their business and legal matters for The Health Care Group. Michael Parshall is vice president of The Health Care Group. He is an authority on practice valuation, mergers and acquisitions, practice and ancillary services development, operations and strategic planning. Mark Kelly, the chief executive officer of Eye Care Specialists, has more than 23 years of experience and has negotiated more than 15 practice acquisitions. As a result of the described strategies, practice revenues and locations have quadrupled over the last six years. Currently the practice employs 12 ophthalmologists, 10 optometrists and more than 200 employees.

All three authors will share their insight during the AAOE Program of the 2005 Annual Meeting in their Instruction Course “Marketing By Practice Acquisition” (course #475). Register and purchase course tickets now for best selection.  

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Introducing the 2006 Ophthalmic Coding Coach CD-ROM!
The 2006 edition of AAOE’s best-selling Ophthalmic Coding Coach will debut on CD-ROM this year. The CD-ROM will contain all of the detailed content and coding tips that make the Ophthalmic Coding Coach the most comprehensive ophthalmology coding reference available — plus the electronic format will allow you to search by code and by keyword. You can also print out pages for documentation. The member price for 2006 Ophthalmic Coding Coach CD-ROM (#012301) is $195. Buy the book and CD-ROM together (#012303) and save 30 percent! Now taking advance orders at www.aao.org/store.

You’ll save 10 percent when you order four or more coding products, so be sure to explore AAOE’s entire coding line. Visit www.aao.org/store and choose "AAOE: Coding and Reimbursement" in the Select a Subject drop-down menu to see a complete list.
 
AAOE in Chicago
The AAOE program of the 2005 Annual Meeting features 62 instruction courses, 39 new courses and 10 hours of pre-selected free programming. New this year: JCAHPO and American Board of Opticianry CE credits are available for select courses. View a complete schedule at www.aao.org/aaoe for more information. As always, CME credits are available for all courses.

Visit the Coding Questions booth in the Academy Resource Center to get answers to your most difficult questions. And don’t forget to stop by the Practice Management booth to preview new products and to schedule a free consultation with a practice management consultant. A schedule of consultants and area(s) of specialty will be posted to our Web site in early September. Sorry, no advanced appointments are accepted. If you haven’t already done so, register for the Annual Meeting now at www.aao.org/annual_meeting. All registration materials will be mailed when you register by Aug. 24.

Remind Your Doctors About DVD Customization at the Annual Meeting
Incorporating Academy patient education DVDs into your practice’s patient education plan can help to optimize patient flow and improve patient compliance. At this year’s Annual Meeting, doctors are invited to add their own on-camera introductions to the following Academy patient education DVDs: Understanding Diabetic Retinopathy (new in 2005), Understanding AMD (revised in 2005), Understanding Cataract Surgery, Understanding Glaucoma, Understanding LASIK and Wavefront, and Understanding Refractive Surgery. Because this service is offered only once a year, space is very limited. Schedule your doctor's appointment today. For scheduling instructions, pricing and descriptions of customizable DVDs, visit www.aao.org/patient_ed/custom_dvd.cfm

Registration Now Open for the Professional Choices Job Fair
If your practice is in need of an ophthalmologist, register today as a Hiring Practice at the Professional Choices Job Fair. The Job Fair will take place at the Annual Meeting on Sunday, Oct. 16, from 2:15 p.m. to 5:00 p.m. Job seekers’ employment preferences and synopses of hiring practices will be distributed prior to the Job Fair, and then the hiring practices and job seekers can meet in person onsite. The Hiring Practice fee ($360) includes admittance to the Professional Choices Job Fair Opening Session: Hiring an Ophthalmologist for Your Practice — What Do You Need to Know? The Job Fair is free for job seekers. Learn more at www.aao.org/jobfair.

Ethics Resources for Your Office
Now you can purchase the courses of the Academy’s Ethical Ophthalmologist Series on audio CDs that you can keep on-hand in your office for staff training. Each course carries with it 1 CME credit in ethics. The series includes three courses:

• Commercial Relationships, Compensation and Advertising (#015011)
• Informed Consent, Doctor-Patient Relationship and Delegated Services (#015013)
• Research, New Technology and Collegiality (#015015)

The courses are also available as online courses. Visit www.aao.org/store to learn more.

The July/August issue of EyeNet Magazine is online
Visit www.eyenetmagazine.org to read this month's issue. The issue's Savvy Coder features an ASC challenge with nine questions to test your billing knowledge. Practice Perfect provides you with information on how to navigate the payment appeals process.