In this episode, hosts Brad and Michael share the story of a doctor who received an unsolicited offer from a private equity group to buy her practice. This offer seemed like the perfect solution to the operational challenges she was facing. However, the promising opportunity quickly revealed risks threatening her practice’s stability. Discover the hidden pitfalls of unsolicited offers and the importance of thoroughly vetting potential buyers to avoid liabilities. Tune in for insights on protecting your practice before making your next move.
Listen to the full episode using the player below, or by visiting one of the links below. Contact ByrdAdatto if you have any questions or would like to learn more.
Transcript
*The below transcript has been edited for readability.
Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues simplified through real client stories and real world experiences, creating simplicity in 3, 2, 1. Welcome
Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host, Brad Adatto, my co-host, Michael Byrd.
Michael: Thanks, Brad. As a business and health care law firm, we meet a lot of interesting people and learn their amazing stories. This season we’re entering the most sophisticated season of a business. Brad, sophisticated means it’s fancy. We’ve talked about it, our theme this season is Buying and Selling a Business.
Brad: Well, Michael, as many people who have been listening know, that’s just one of the four Seasons. What are all the seasons?
Michael: Yes, Brad. We started with the building season, starting a business, and then we went into the operating season, running a business. We have the scaling season, when you’re growing a business, and now we’re in the buying and selling season.
Brad: Awesome. Well, thank you Michael for that refresher. [00:01:00] Now, Michael, do you and your family, do you ever shop at Target or Neiman Marcus?
Michael: Yes. neither are frequent places that we go, but we did just go to Target recently and of course, man, when my kids were younger, I felt like we supported the Target store nearest us – we kept them in business.
Brad: Very fair. Are you familiar with their core audiences?
Michael: Kind of. I mean, I have an impression of it. So shoppers going to Target, it is kind of an affordable brand, and Neiman Marcus is more of a luxury brand and have some edgier clothing lines along the way. But definitely you would think of it as more higher end. Why are you asking me about these companies?
Brad: Would it seem weird if these two companies ever branded products together?
Michael: [00:02:00]Well, it’s definitely hard to picture why.
Brad: Well, believe it or not, back in 2013, they collaborated on a clothing line.
Michael: Okay. I’m curious. I’m trying to picture Neiman Marcus and Target or Home Goods, but maybe that’s not what it was. How did it go?
Brad: Not well. The partnership marketing campaign didn’t make as many sales as expected because the two brands are, as you kind of described, polar opposite. This meant that both of these brands isolated their core audience. Target customers couldn’t pay for the expensive brand that offered edgy clothes, and Neiman Marcus customers were disconnected from Target’s affordable brand as such it was a huge co-branding failure.
Michael: So rather than bringing them all together, they just confused them? I guess looking backwards, it does seem like a terrible idea. I do wonder what their strategy was in the first place. Like, what were they thinking? What happened?
Brad: Yeah. Who knows? That’s a great [00:03:00] question. I’m sure they hopefully learned a valuable lesson here. Next, I know you’ve heard of it, Kraft and Starbucks.
Michael: Well, yes. Both have been staples in my life at different times. Kraft Mac and Cheese was almost a daily meal when I was back in college. At times we also, our family, has kept the local Starbucks in business with our visits. Why are you asking?
Brad: Did you know that they too co-branded a product together?
Michael: Co-branded Mac and Cheese? Coffee and Mac and Cheese?
Brad: Yeah, coffee mac and cheese. Well, if they’re listening, I hope you get some of the royalties for that idea, but no, that was not it. Kraft and Starbucks collaborated on what was supposed to be a mutual beneficial deal. They agreed that Kraft would sell packaged Starbucks coffee to grocery stores across America.
Michael: Well, I definitely remember back when I saw Starbucks coffee grounds or beans in the grocery store [00:04:00] for the first time. Seems like a good plan.
Brad: It was until Starbucks accused Kraft of not meeting the certain conditions of their partnership agreement, which included Kraft not looping Starbucks in on their marketing initiatives. These failures were said to be eroding Starbucks’ “brand equity”.
Michael: Fancy.
Brad: As such, in 2010, they actually terminated this 12-year strategic alliance with Kraft.
Michael: Well, it had to have had some level of success if it lasted for 12 years.
Brad: Yeah, I know. I guess it was only mostly successful, and Kraft was not happy with the ending of this partnership and accused Starbucks of trying to end the partnership without fulfilling their conditions after Kraft had helped Starbucks grow their packaged coffee business from 50 million to 500 million.
Michael: That’s a lot of coffee. So where are you going with this?
Brad: All right, stick with me. Well, we all know brands that have done amazing when they’re the perfect fit. Think about Nike. Nike and Apple, or Doritos and Taco Bell. These brands came together to create [00:05:00] a solution that meets the needs of their target groups. However, not all brand partnerships work out for the benefit of both parties involved. In fact, some of them end up having a negative effect resulting in loss of time, resources, and revenue.
Michael: Well, I usually have… I do speak Brad, but you can be hard to figure out, but I definitely see where you’re going with the story today because I know what we’re going to be talking about. I know that the same thing can be true when you’re buying and selling a business. And if they don’t have the right chemistry or understand their target audience, things can go bad.
Brad: Awesome. Well we have two people off camera right now, Cheyenne and Cynthia, so put a gold star next to Michael’s name. He’s starting off great today. He’s starting off strong, Michael, I’m proud of you. So let’s get to today’s story. Today we start with Dr. Emily Kraft, a highly respected pain management specialist, has dedicated her career to providing compassionate and expert care to her patients. She’s built a successful practice over the past 15 years, [00:06:00] known for its patient-centered approach and individualized treatment plans. However, as the practice grew, Dr. Kraft faced increased challenges in managing her business and just mostly with the operational side.
Michael: Dr. Emily Kraft, I see that you are going the easy route today, Brad, with your names. Just plucking them straight out of your opening story. Got it. Okay. Well, I like it. We can roll with it. The age old problem with this kind of setup you gave on Dr. Emily Kraft with a physician of medical practice is time. There’s not enough of it. And so, there is a constant friction between physicians doing what they’ve been trained to do, treat patients, which by the way is also how they make money, and the other side of it actually running the business that they own.
Brad: That’s right. And so the administrating burden was impacting her ability to really [00:07:00] focus on the patient care, leading up to concerns of long-term stability of her practice. Recognizing these limits in her managing that the business aspect. Dr. Kraft sought external help. She explored various options, including higher additional administrative staff, investing in advanced practice management software, consulting with health care management experts. However, these solutions that she considered didn’t really fully address the needs or really alleviate the pressure that she was having of running this growing business.
Michael: So in addition to the problem of time, which I just talked about, finding the right people to serve in the right role is hard. And we’ve talked about multiple times of the challenges of hiring and retaining top talent. I know last season in the scaling season, we camped out an entire episode when we had guest, Mary Beth Hagan on to kind of tackle this topic.
Brad: Yeah, absolutely. Well, as Dr. Kraft was struggling and weighing all her options, she received an offer from a private equity group called Target Capital [00:08:00] Partners, interesting in acquiring her practice. This promise of a large payout and professional management support seemed like a viable solution to these challenges that she seemed to not be able to help with her growing practice. The private equity firm presented an attractive proposal, offering to take over the business management via management service organization model, and allowing Dr. Kraft to focus on patient care.
Michael: Well, at least you are staying on brand with your lazy naming of the parties today, with Target Capital Partners. but when you were talking, you referenced the MSO model, and it makes me think that Dr. Kraft is in a CPOM state. For a quick reference, I know we’ve talked about this on many episodes. CPOM is the corporate practice of medicine. In many states in the United States, there are laws that say essentially that if your business is practicing medicine, only doctors can own that business. There’s many variables or exceptions that can apply on a [00:09:00] state by state basis. But when you have the CPOM issue and you have private equity, almost always, you’re going to have the MSO model that you just mentioned as the solution, a management services or organization to manage the physician owned practice.
Brad: Oh my gosh. All right. Cheyenne, Cynthia, second gold star for Michael. Put it on this chart. He’s doing great. You’re doing a good job, Michael.
Michael: Right. Do I get a trophy too?
Brad: No, just gold stars.
Michael: How many gold stars equals a trophy?
Brad: It’s a lot. I mean, it’s almost a whole wall now. You’re doing wonderful. Yes, you’re correct again, Michael. CPOM State. Target Capital Partners was interested in inquiring Dr. Kraft’s practice and really it is the ability to really promote this investment known for investing various sectors, including, they have invested already in pharmacies and diagnosis labs. The firm’s primary owner James Marcus and Rebecca Bell came from non-medical backgrounds with expertise in finance and business management.
Michael: So you said they [00:10:00] owned pharmacies and diagnostic labs. Did they also kind of have experience on kind of the services side with a medical practice?
Brad: Nope. Neither Marcus nor Bell had any background in health care or medical practice management. Their understanding of the medical field has really limited the finance aspects of these investments. They viewed medical practices through the lens of business efficiencies and profitability, emphasizing cost controls, revenue, maximizations, and obviously streamlining operations.
Michael: So I’m seeing some red flags starting to pop up. This lens that you speak of a pure business can be combustible without understanding kind of the needs of a medical practice, of safe and kind of patient-focused care, so it raises a question. Who was running the MSO to assist Dr. Kraft?
Brad: Oh, the MSO was solely owned by Target Capital Partners and as such, Marcus and Bell appointed themselves as the managers of the [00:11:00] MSO.
Michael: The same two people with limited knowledge of medical practice operations?
Brad: The same. Their primary focus was on implementing a system that aligned with the private equity group’s business strategy.
Michael: Okay. So this is actually a red flag. This lack of experience does not seem to solve the problem that Dr. Kraft was trying to solve. She was looking for help with managing her practice and potentially recruiting and the retaining of her team, and that doesn’t seem to be the focal point of what they’re bringing to the table.
Brad: Yes. So, hop in the DeLorean with me. Fast forward six months later, when we first were brought into this conversation. Dr. Kraft had retained litigation counsel and wanted to terminate the deal for breach of contract by Target and other unprofessional actions by the MSO.
Michael: Unprofessional action sounds so daunting, that really escalated fast in six months. Tell me what happened.
Brad: [00:12:00] First, the MSO was supposed to handle all the day-to-day operations. They assured Dr. Kraft, that they had a great track record on this process. Instead, it became very obvious, very quickly to Dr. Kraft that Marcus and Bell had no idea how to manage a medical practice or medical personnel at that.
Michael: Okay. Well, give us some examples.
Brad: For starters, the managers of the MSO wanted to align, this is their words, the practice with their business strategy, meaning the MSOs business strategy or their PE in this case. The MSO started sending emails and texts to Dr. Kraft’s former staff, which now actually were employed by the MSO after the closing. The staff needed to increase the referrals to Target Capital Partners’ ancillary facilities, remember, they had the pharmacies and labs. This created a lot of pressure to meet the Targets’ referrals on the staff that many of the staff, were really uncomfortable with being pushed to refer to these labs and pharmacies.
Michael: Target Capital Partners may have a target on their back quite soon if they are focusing on this referral pattern. I’m [00:13:00] sure that it raised Stark Law and anti-kickback laws and other ethical issues. I try to stay away from that as you kind of do our heavily regulatory work, of course, with Jay, but even I know that there are significant restrictions on referrals and physicians can’t be financially incentivized to refer patients to affiliated services unless they meet kind of the specific regulatory requirements to do so.
Brad: Ladies, get out another gold star. Michael, you’re crushing it today.
Michael: That has to equal a trophy now.
Brad: It must be, I mean, three stars and one is a trophy. I’ll get you that participation – that typing participation award kind of thing.
Michael: No, I want the real deal.
Brad: Okay. Marcus responded that he was aware of all these regulations that you just so brilliantly explained to everyone, but the MSO had assured Dr. Kraft everything was compliant. Well, [00:14:00] Dr. Kraft kept explaining to the MSO team that with she and her staff, there was a standard of care that they had to follow, and the physicians should only make these referrals based solely on medical necessity and not on financial incentives. If the staff is being pressured to use these facilities regardless of the patient’s needs, that’s an issue. Further, it obviously could harm the patient’s trust that these providers keep ordering these excessive labs and pharmacy scripts. Finally, Dr. Kraft had concerns with the risks of legal issues, including with her commercial payers who are being charged for most of these tests.
Michael: Sorry, I blacked out after you said I was brilliant. How did the MSO team respond to this?
Brad: Well, the MSO owner actually didn’t do a good job responding to them. They actually said they were frustrated with the lack of referrals that they wanted to see better results. The MSOs started pushing harder because they believed it was essential to their business model. Further, many of Dr. Kraft’s key employees started to leave [00:15:00] as they could not stand the management style of this MSO team. And further, it even started becoming very obvious to Dr. Kraft that they were not helping her with the day-to-day management. And they were actually making things worse since her team was leaving her practice.
Michael: When you say essential for the business model, I think they must have had a business plan that was counting on these referrals to their ancillary places. No wonder there was so much pressure. And it sounded like they were kind of at an impasse or things were not good. Well, especially when you told me that it had escalated so quickly. Well, let’s go into commercial and discuss the legal impact and what happened with Dr. Kraft and what options that she had.
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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host Brad Adatto, with my co-host, Michael Byrd. Now Michael, this season, our theme is Buying and Selling a Business, and we’re talking about real stories that happen to our clients as they’re going into this season. Today’s story has a lot of elements to it, and we kind of have to break it down to a couple major issues here. We have first, the unsolicited offer. Second, the lack of due diligence performed by the seller, and the separation of understanding between businesses and medical decision making, so that’s kind of like the way where the story is going. But Michael, let’s address [00:17:00] first this unsolicited offer that they got from this private equity group and maybe some of the pros of why someone would even consider it.
Michael: Yeah. And obviously things we know didn’t turn well, so this is more theoretical. What are the advantages to doing this in the first place? Well, obviously there’s a financial infusion, right? And you can’t ignore that you have this infusion of cash that can (a) help take some money off the table for the doctor, but also help kind of create this bigger checkbook to invest in new technologies, invest in staffing. That was a problem. Invest not just in having more staff and having the time to do it. And so then you kind of move on, okay, what are some other things? Well, this is a biggie for Dr. Kraft. That’s professional management – having that [00:18:00] expertise to relieve the burden so that she could focus on patient care. And so, I suspect I wasn’t involved with this deal, that that would’ve been a huge motivator to have that expertise, the wisdom that goes there, and the administrative relief of having someone else deal with the day-to-day stuff. Yeah.
Brad: And I want to just jump in real quick on the financial piece. I mean, not only is she getting an infusion, but if done correctly, she may have one of her biggest paydays ever. So this huge liquidity event occurs where she’s having cash that she never dreamed about having.
Michael: Yeah and if these go well without getting too much in the weeds, there’s a future chance for an even, we call it the second bite at the apple, a future event to have another exit. And so, it can be extremely attractive and advantageous to – that would definitely be one of the [00:19:00] pros. And again, what are the growth opportunities that go with this? So you have this capital that we’ve spoken of, we have this expertise that we’ve spoken of, and where can they take the business if you have kind of those resources? And so I can see why that would be a major attractive element to doing this, to having this offer come through.
Brad: Yeah. I think the other piece when you have an unsolicited offer is that it’s right there in front of you. You don’t have to go through any other organization to take you to market. I mean, they’re coming to you and you don’t have to go through the entire routine of taking it. So from that, all of a sudden you have an offer, it sounds great to you, you take it and you don’t have to do anything else. It’s immediate response and immediate ability to tackle that.
Michael: There’s an emotional pro to it, I guess. It can be a downside too, but it feels [00:20:00] really good to be wanted in the business scenario too. And so, someone tells you that they like what you’ve built, they love you and they want to invest, and so that in of itself can be an intoxicating feeling and be something that attracts you to doing this.
Brad: Michael, I like what you built. You’re doing a good job, buddy.
Michael: Yeah. Thank you. Talk about the negatives.
Brad: All right. So some of these cons I was thinking about, some of it has to do with the unsolicited offer and some of it just in general, just understanding when you are having the ability to sell into private equity or anyone else, is some different things to think about. So I kind of broke it down to two major kind of areas. One is just understanding it from a management style. Like, what’s being brought to you from management style? You may have a different style than they do, so start slowing down, spending [00:21:00] some time with them to understand how they plan to come in and manage you because in this case, that’s one of the important elements to her. And so, based on what we learned is she really didn’t understand how little they understood about management styles. And then find out really to your point, you said this earlier, is, is what are they trying to get out of this purchase? Well, in this particular case, they were trying to find someone to come in and help their ancillaries. Here’s somebody who needs it because of the pain management. They had pharmacy needs, they had lab needs, so this is a great way for us to capture these referral source. And the con is the conflict of interest issue here. Like, that should have been up front and center that they understood that they were going to push her to shift from patient care to financial goals that emphasized the ancillaries versus hers.
Michael: And I want to jump in too on the prior point of the kind of this alignment of [00:22:00] management styles is, even if it was perfect, like everything that she hoped for, you have to acknowledge that a downside to getting this unsolicited offer is that you’re losing control of your business in some way.
Brad: Agree. So not only the management style, but going back to this conflict of interest raises the perfect area that we were known for, the compliance risk, right? The compliance risk all of a sudden has someone really, truly slowed down and figured out the risks associated with what they’re asking that happen after the fact. So you brought up, which is still shocking Stark Law and anti-kickback statutes, obviously. For those who’ve listened to us before, we talk about even if this was a cash-based business, you have unprofessional, unethical issues that you run into with medical board and nursing boards. So again, that’s the understanding truly where they’re going with their end goals. What does that look like? And so financial targets are important, Michael, so I’m not [00:23:00] discounting that. But we have to understand, are those financials beneficial based on in this case, her practice or their ancillaries? Which by the way, I should have said this earlier, she had no ownership in any of that. She was not benefiting from that at all. It was purely the target piece that was benefiting. So for her, she should have understood that if what she was not interested in, but she was interested in being patient-focused and having help. And in this particular case, that was not the case. So I think that kind of leads us to the biggest con after that, which is she had lack of knowledge of what other potential buyers could bring to the table. So she had emotional situation where she tried other things that didn’t work. Someone says, “Hey, you look really cute, why don’t you go on a date with me?” And the next thing you know, they’re married. And she never had a chance to date anyone else in this very fast moving industry. And so, the lack of ability to go to market and see what other people would be interested in, what type of management skills they have, and comparisons was [00:24:00] an issue for her.
Michael: Play the field.
Brad: Play the field. There you go. So Michael, on that, talk about, we use this fancy word called due diligence and why it’s so important when you’re selecting these potential partners.
Michael: So let’s define it first. It’s a pretty intense process. So, it’s the part where the parties are investigating and evaluating kind of the other side, the partner, the people, and the investment before finalizing a transaction. So this happens after a letter of intent, and you can be assured that when you have private equity, that they are digging deep and looking at you and the business to make sure what they think they have is what they have, and so the process is pretty systemized. I mean, especially on the buyer side, and it should be on the seller side, but where you’re reviewing the potential partners [00:25:00] operations, their financial status, their kind of legal standing and other compliance factors and other critical factors. The goal is to evaluate risk and the benefits associated with joining forces in a partnership. And so, you want to make sure you have all the information before you make that commitment. But Brad, why don’t you talk about kind of the importance in these types of deals of the due diligence.
Brad: Yeah. And you kind of were alluding to this. The number one reason why buyers and sellers should utilize this due diligence on each other is risk mitigation. I mean, that’s what you’re trying to do. During this phase, you’re trying to identify what are the potential risks and liabilities associated with if we come together. Again, financial, legal, operational side. By uncovering these issues before you go further down the aisle, again, about going to our dating mode, organizations can kind of make a more informed decision and avoid these costly surprises if this deal is going to be good for just one party, but not mutual, right? So that’s [00:26:00] why you want to – if they’re going to spend time learning about you, you should be learning about them. And this allows both parties to have an informed decision if they should go forward with this “partnership”.
Michael: Importantly, this could have helped Dr. Kraft with this group because she quickly learned that they had never managed a medical practice before. And with a little due diligence on her side into them and their background, she would’ve figured it out. But Brad, quickly kind of outline why is it essential to separate the business and the medical decision-making.
Brad: Yeah. And we talked about in this in a couple of MSO podcasts before about separation of church and state, and the number one reason, obviously is providing patient care treatment must be consistent with the standard of care, which the physician and all the providers with that physician must follow. This centers around the focus on patient needs rather than financial considerations. Again, I’m [00:27:00] not saying anything wrong with that, but for them, in a number of States, and then these federal rules we were talking about, you really want to avoid situations where you get in situations where the financial and ethical conflict of interests start appearing. if the business decisions such as referring or for more referrals or more treatment protocols are influencing by financial rather than prioritizing the patient wellbeing, that starts becoming an issue – so the whole patient over profit kind of concept. Ultimately, even in a MSO model, providing medical autonomy is essential for compliance between the business side and the medical side.
Michael: Yes, business and medical decisions often require different types of analysis and expertise, so you separate them and that ensures that each area kind of receives the appropriate focus and the right people involved so [00:28:00] it leads to better decision making. It also minimizes the pressure on health care providers to compromise clinical standards for business reasons, which she certainly was facing here. You are focused on patient care and really focused on kind of that effective care and delivery. As we’ve talked about before this clear separation ensures that business practices are aligned with long-term goals of the practice, again, without compromising the quality of patient care. So, I’m curious, Brad, what happened with Dr. Kraft and Target Capital Partners?
Brad: Unfortunately, they were in litigation for the next six months, as Dr. Kraft just wanted out and was trying to salvage what was left of her practice. As I said, we were brought in to assist Dr. Kraft’s attorney on guiding them through these issues. As we mentioned, this helped [00:29:00] obviously in a mediation of things we were discussing already. They were eventually able to settle and Dr. Kraft was able to get her practice back, but she had to return most of her purchase price. They did let her out of the non-compete, but she got her practice back. She told us that if she had dug a little bit deeper, she would never had done this deal with this group.
Michael: Due diligence.
Brad: If she ever tried to go this route again, she would spend a lot more time finding out if the buyer truly understood her business and how to manage a medical practice.
Michael: Sounds like she may have needed some of her own pain management services. What are your final thoughts, Brad?
Brad: Yeah, I mean, we’ve said it when profit meets practice, there’s a balance to it, right? Successful integration requires understanding respect for the medical ethics and a commitment to patient centered care. I guess to summarize it, while this unsolicited offer from a private equity group can offer much [00:30:00] needed financial benefits and growth opportunities that you were talking about earlier, but also presents risks related to the control, patient care, operational alignment, and each party must weigh these factors carefully to determine if this potential advantage outweigh the actual potential drawbacks. Michael, what are your final thoughts?
Michael: Restating a lot of what we talked about. Sellers commonly do not do due diligence on buyers of the business. That obviously was a big part of today’s story. The other side of it is that private equity will leave no stone unturned in evaluating a practice. And it’s appropriate, it’s important to make sure that the seller does the same thing. They investigate the buyer and make sure that they can do the things that they’re promising to do.
Brad: Absolutely. Well, Michael, next Wednesday, you and I’ll be back and we’ll actually discuss in more detail a Wall Street deal that you and I recently worked on. Thanks again for joining us today. And remember, if you like this episode, please subscribe, make sure to give us a five star rating and share with your friends.
Michael: You can also sign up for the ByrdAdatto newsletter by going to our website at byrdadatto.com.
Outro: ByrdAdatto is providing this podcast as a public service. This podcast is for educational purposes only. This podcast does not constitute legal advice, nor does it establish an attorney-client relationship. Reference to any specific product or entity does not constitute an endorsement or recommendation by ByrdAdatto. The views expressed by guests are their own, and their appearance on the program does [00:31:00] not imply an endorsement of them or any entity they represent. Please consult with an attorney on your legal issues.
