In this episode, Michael and Brad focus on the impact private equity had on one of our physician clients. As part of our theme this season, we zoom out and discuss the big picture impact private equity is having on the medical industry. In the second part of the episode we break down valuations and fair market value, and the pros and cons of structure of the purchase agreements.
Listen to the full episode using the player below, or by visiting one of the links below. Below is the episode’s transcript which has been edited for readability. If you have any questions or would like to learn more, email us at info@byrdadatto.com.
Transcript
Intro: [00:00:00] Welcome to Legal 123s with ByrdAdatto. Legal issues, simplified through real client stories and real world experiences. Creating simplicity in three, two, one.
Brad: Welcome back to another episode of Legal 123s with ByrdAdatto I’m your host Brad Adatto with my cohost Michael Byrd.
Michael: Thanks, Brad. As a business and health care law firm we’re often immersed in the heavy details of a particular issue or project. It’s beneficial, if not mandatory to every so often take a step back and evaluate the bigger picture. This season’s theme is zoom out. We have all been immersed in life of a global pandemic and we’re going to make sure with each story this season that we step back, look at how the issue we discuss will be impacted by and in our new normal.
Brad: Michael, I’m really excited about today’s episode because we get to have movie talk again.
Michael: You really [00:01:00] should have started your own podcast on movies, it would have to be a really niche movie podcast focused on eighties and before. Because that’s really what you’d like to talk about.
Brad: You know, that, that makes sense if it’s eighties and before I could actually call it Brad Busters movie review, and only the people from the eighties would even understand what the busters part was about. But I could conceptually see this being a billion dollar concept. Spotify probably would be signing me like Dax Shepard, or Alex Cooper, or Joe Rogan to exclusively be on their sites. But today in our movie talk, we get to discuss the impact of a famous line call or famous line, which they say greed is good.
Michael: Vintage 1980s, Brad, you did not disappoint. For those not tracking and as old as Brad and I, this is from the movie Wall Street where Michael Douglas played Gordon Gekko, [00:02:00] a super wealthy corporate raider who had many unscrupulous tendencies. And I do remember Brad, a light blue horseshoe loves Anacott Steel.
Brad: Well, hold on Michael. In my defense, they did do a follow-up to this movie in 2010 where Gordon Gekko, spoiler alert, got out of prison and was back to some of those old tricks again.
Michael: Yeah, that’s not compelling at all. Objection overruled. So where are you going with all this?
Brad: Well, Gordon Gekko owned and ran his own hedge fund in this movie. And he was buying companies, he was trying to buy low, sell high, or take the companies apart, piece by piece. Plus he may have done a little inside trading to get ahead of the game which I still think might be illegal or frowned upon, but of course this no way represents what the hedge funds or private equity are doing in today’s industry. So let’s fast [00:03:00] forward out of the movie world of the 1980s into the real world where private equity is actually constantly seeking different industries. But Michael, they’ve definitely been heavily involved in the medical industry.
Michael: True enough, Brad. I mean, they’ve been dominating in certain markets like pharmacy and skincare, labs, imaging, ambulatory surgery centers, and hospital systems. And I think where you and I even see it impacting our client base is over the last decade, moving into the services side, the practice of medicine side like dermatology or dental practices have a robust private equity presence. Optometry, pain clinics, medical spas, and really you and I have both noticed is partly the inspiration for bringing it up in a few different episodes now is during the pandemic, we’ve seen an increase in [00:04:00] calls from private equity, wanting to understand better the kind of surgical practice and just to name a few, we’ve seen it in retina, spine and plastic surgery practices.
Brad: Yes. Correct. So today’s story will focus on the impact private equity had on one of our clients. And we will learn, did our client actually partner up with Gordon Gekko? Or just another private fund looking to make an honest buck.
Michael: Well, Brad, so you ran point on this file so give us all some background before we kind of get into the deal points.
Brad: So our client was a well-respected surgeon. He was in the late sixties. He’s actually married to another physician and on top of this he actually had done very well financially, invested wisely and so he was pretty well off. He was just a sole provider. He had no plans of ever bringing on another physician, much less selling his practice. [00:05:00] His practice, his sub-specialty that he practiced under there’s only a few physicians in the country that actually provide these same surgeries. So today we’ll call our client, Dr. Bud Fox.
Michael: First and we’ll get to this more later, but it sounds like he had the classic, what we call, drop mic plan for retirement. Just close the door one day. He’d got it all built up. Well, we’ll talk more about that a little bit later I’m sure. But first why Bud Fox?
Brad: Fair enough question. That was the name of the character that Charlie Sheen in the movie Wall Street played, and that character, Gordon Gekko basically helped convince the Bud Fox to make some bad decisions. And so I just thought we could stick with our theme today by calling him Dr. Fox.
Michael: Okay, fair enough. Sticking with Wall Street. Let’s keep going.
Brad: All right. So Dr. Fox gets this unsolicited phone call from Mr. Gekko, who is [00:06:00] running a large health care fund on the east coast and they want to add Dr. Fox and his surgical practice to their platform. Mr. Gekko sells Dr. Fox and Howl B just a real simple deal. They’ve done hundreds of these deals and what it’s going to do is help Dr. Fox with his exit of the practice of medicine and Dr. Fox is like, okay, that sounds great. So he executes this letter of intent before speaking with any council because you know, he read it and it seems simple.
Michael: Okay. We need to have a button in here for the red flags when they start flying that I can just like give some sort of sound effect or something. Because I feel like you said it that just to trip me.
Brad: Oh, maybe.
Michael: Okay. Well, first of all, red flag number one was simple.
Brad: I did see that a few times.
Michael: Yes. Red flag number two was him just signing the letter of intent. I mean we’ve had a few episodes and I remember specifically having Ben [00:07:00] Hernandez on and he talked about the issues that go into a letter of intent and why that’s so important, but let’s just step back for a minute and visit about the letter of intent. What is the letter of intent? It is that initial document that you’re trying to get on the same page of the material terms. And you know, this could be one of your trigger words because we joke that you get triggered by non-invasive. Well, you could get triggered on these where you hear the word non-binding and of course they are non-binding but they are impactful. And so the trap that Dr. Fox fell into was thinking this is simple, as you said, and it’s non-binding and we’ll get to the documents later [00:08:00] so who needs to worry about any of this, I’ll just sign it and kick the can down the road as to anything important that needs to be done.
Brad: Unfortunately, Michael, in this particular case, you are correct across the board. That’s the only fortunate cause I wanted to be the correct person, but yes, everything you just said is absolutely correct. And everything you just explained is what Dr. Fox did not understand is that he locked himself up in certain deal points even though it wasn’t binding, it had handcuffed us down the road, as we talked about.
Michael: I have a quick question too. I know in a lot of M&A deals, they have some binding provisions in it. I don’t know if you recall, did they lock him up from shopping?
Brad: Yeah. So that was the big thing that he was not allowed to shop around once he executed. And so going back to he signed this LOI and he thought was pretty simple. They told him in a few weeks they’d have the final purchase agreement. So fast forward they did, they got him [00:09:00] these purchase agreements and then Dr. Fox, again very well educated individual, he started trying to look at the LOI and figure out what it said and then what the purchase agreement said. And the good news in this case is he did hit that little button and he stopped and asked for help. And that’s actually when we got brought in. On the initial call we spent a significant portion of it just trying to understand what did he think the deal was going to be? What was told to him and what was important?
Michael: Yeah, I’m curious, how did all that line up with the letter of intent?
Brad: Yeah, not one of the major deal points he wanted was in the purchase documents and certain aspects of the LOI didn’t even match the purchase document.
Michael: Hm. Okay. Tell me more.
Brad: All right. Perfect example of things that happened was the number of years that Dr. Fox was still gonna have to practice under this new group was higher in the purchase agreement than it was outlined in the letter of intent. They had a whole bunch of funds [00:10:00] being escrowed that were never noted in the letter of intent. Michael, do you want to note to the audience what escrow means?
Michael: Yeah. A lot of times when buyers are buying a practice in an acquisition like this they want to know that they’re getting, what they think they’re getting. And they protect against that risk by having a certain portion of the purchase price set aside in escrow and held in escrow for some period of time sometimes months and even a few years to where they can see what plays out. And if some of the contingencies happen they may be able to keep some of those funds or if they go the way they’re supposed to go, they get released to the seller.
Brad: Yeah. All good points. So they also never discussed the LOI. They had a non-compete in the purchase agreement, which is actually pretty standard. The LOI said it’s going to be a stock purchase agreement and they moved it to an asset purchase agreement, which we’ll talk about the difference in a little bit, but [00:11:00] worse if you can even imagine is that the asset purchase agreement had all this really heavy language on that reps and warrants that we only typically see in a stock purchase agreement, non asset purchase agreement. So we were representing Dr. Fox and we went in and started negotiating with Mr. Gekko’s in-house counsel and unfortunately, we were able to make some modifications, but basically we kept getting the same line over and over again, these are the same doctors, they’re the same documents all our doctors executed. We don’t make changes. This dragged on for months and we weren’t going very far with this thing and the demands that our client wanted. They wouldn’t agree to it. Basically after a while we just ran into a brick wall.
Michael: Straight out of the hospital negotiations playbook, this is the way we do it and you like it. Well, those are some pretty significant and material terms and I’d like us to dive deeper in some of them on the second half of this episode, including as you mentioned, the [00:12:00] stock purchase agreement versus asset purchase agreement. And of course, I’m curious and want to learn what happened with Dr. Fox and Gordon Gekko after this break.
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Brad: Welcome back to Legal 123s with ByrdAdatto. I’m your host, Brad Adatto here with my cohost Michael Byrd. Now this season’s theme is zoom out as part of our zoom out we talk about the bigger picture about what’s going on in this case with [00:13:00] private equity and the medical industry. So Michael, what are some of your thoughts as we zoom out on this particular issue with private equity?
Michael: We alluded to it a little bit noting an increase in phone calls that we were getting both from private equity companies themselves that are trying to explore investing in medical services and different specialties and from our practices who had received some sort of interest. And my thoughts are that I think that there’s a lot of money on the sidelines during the pandemic. Health care has been a kind of a frenzy for a decade plus and there’s been a lot of different areas that have attracted a lot of money. And so we’re now just seeing more and [00:14:00] more interest in the provider side of health care. And I think dentistry and dermatology and some other specialties kind of paved the way and a lot of the trepidation that private equity may have had based on hospitals attempt to do this back in the eighties, where they tried to acquire medical practices. That was a fail but it’s a different time and I think there’s some traction. I think physicians are more willing to be employees now than they were ever before and that’s such an important aspect for private equity because they need the doctors to be employees because they’re the ones that have to treat the patients.
Brad: Totally agree with that. So less just keeping with this zoom out moment. How do you think it’s impacting the market, Michael?
Michael: I think it was driving valuations up. We did an [00:15:00] episode in the past where we’ve alluded to how valuation works in medical practices and the main thing to understand is there’s locker room talk out there that medical practices aren’t worth anything. And we’ve had to contend with that current against that premise when we’ve had doctors trying to sell their practices for years, for our entire career. And what we’re seeing not only is confirmation that there can be significant value in medical practices, but we’re seeing deals that have unprecedented valuations compared to what we’ve seen in the past for traditional medical practice.
Brad: Totally agree with that statement.
Michael: So I have a follow-up question for you as it relates to this story. You discussed that [00:16:00] they switched this deal for Dr. Fox from a stock purchase agreement to an asset purchase agreement. I know we’ve talked about this in the past, the differences between a stock purchase agreement and an asset purchase agreement. Talk about this and the overall impact for Dr. Fox.
Brad: Yeah. And I’ll take a little bit bigger step back even and then get into how it impacted Dr. Fox. But as a reminder to our audience who hadn’t listened to the past episodes, the stock purchase agreement is an arrangement where you’re buying the actual stock of the entity. So typically you’re either buying it from the company itself or from the individual owners who own the stock. You’re actually not buying any of the assets the entity owns just the stock. And when you buy the stock, you buy everything it owns, including its debts and liabilities. While in an asset purchase agreement, you’re actually only choosing which assets owned by that company that you’re choosing to take. So I choose to buy this equipment or I choose to buy this accounts [00:17:00] receivables, or I choose to assign the lease to myself. You get to choose it’s a totally different concept. Conceptually being that when you go to a stock purchase agreement you assume all liabilities, unless you choose otherwise while an asset purchase agreement, you don’t assume any liabilities unless you choose otherwise. So let’s fast forward, back into our current situation where we have Dr. Fox. Dr. Fox originally was going to basically assume all his liabilities and that way, when he was going to retire, they had all those liabilities. And so to him, it made sense. It was great. When they switched it to an asset purchase agreement, and I know when you and I typically represent an individual who wants to purchase another individual when we can and we prefer asset purchase agreement. We will definitely get into that in a second, but let me stay on Dr. Fox’s story. That meant they were pulling and choosing which assets they wanted to take. So like his lease and some of his employees and stuff like [00:18:00] that. But that meant all the liabilities that were part of his practice prior to that purchase were all going to be still remaining for his liability. So his tax liabilities, his other employment liabilities, he still was liable for that. And he needed to make sure that he had money set aside to take care of any of those liabilities. The other piece though if I mentioned early on the reps and warrant, they’re asking him to represent and warrant a whole bunch of things, which are typically not part of the asset purchase agreement, which meant if he said, oh yes I had a great compliance plan in place and later on it turns out he didn’t have a great compliance plan in place they could hold that against them saying, hey, in your reps and warrants, this is not correct. Which makes no sense, typically in your asset purchase agreement, again, going back to our Gekko in-house counsel, who kept saying over and over again well, that’s how we always do deals. And so that was kind of that the part that we kind of bumped heads [00:19:00] on that asset purchase, stock purchase agreement. I don’t know if you have anything else to add that you thought of between the two.
Michael: My first observation is that sounds a lot different than what his expectations are. There’s a significant impact to Dr. Fox as it relates to him having the deal carved up differently than what he was expecting. And I’m curious what happened? Did he end up just signing the standard asset purchase agreement that Gordon Gekko required of all of his doctors?
Brad: Yeah, actually, no. After months of back and forth with Gordon Gekko’s group, we actually narrowed the asset purchase down to just a few key terms and conditions that Dr. Fox had to have, or he wouldn’t execute this deal. Gekkos group refused the terms so we ended up having a long call with [00:20:00] Dr. Fox walking through his remaining options from everywhere from executing the agreement that was staring in his face to just basically terminating the transaction. And those were his options.
Michael: So what did he decide?
Brad: I call Gekko’s council and told them that we were sending an official notice of termination of the agreement, which was consistent with the letter of intent. And as a courtesy, I wanted to give him the heads up before he received it via US mail and email. And there was this really awkward long pause from the attorney. He said basically, is he really walking away from this deal? He’s getting paid $2 million at closing. How can he be walking away? My response was pretty simple. If you remember, Dr. Fox did not need this money. He was well off [00:21:00] and he would be happy to join their organization. But if these certain terms were not there, there was no reason for him to do it. So he decided to walk away.
Michael: Power move the tables get turned on Gordon Gekko. So did the deal die?
Brad: Yeah, not exactly. About two weeks later to the day of the call, we actually inked the deal with the key terms that were important to Dr. Fox, which they never, Michael, never added to their agreements. My client got $2 million at closing for his solo practice but Dr. Fox’s ability to walk away from the deal was a significant advantage. Most physicians who Gordon Gekko’s groups, they’re not willing to walk away from that kind of money and the private equity. They pretty much know this. They were actually counting the fact that greed is good. Our doctor was not tempted nor willing to sign anything they put in front of him this time because if you remember we had him sign an LOI early on. Michael, [00:22:00] as we get done with this incredible story of walking away from $2 million, but still getting the $2 million, what are some of your final thoughts?
Michael: I alluded to this at the beginning when I talked about the drop mic plan, we actually added this to our speeches because we have doctors who are like I’m good, I just want to wind my practice up. I don’t need to sell it, i’ve gotten what I want out of it. And I really just want the freedom to control when I walk away. We just added in our speeches and said that’s the drop mic plan. It’s like, I’m gonna do my thing until I’m done and then drop the mic and walk off into the sunset. Now there’s stuff that goes into that. Like making sure you don’t have any liabilities and all that sort of thing, but what’s fascinating here is he had that drop mic strategy and had all the [00:23:00] financial resources built around that to when there was this unexpected opportunity that arose with private equity he could just sit in that and use that as negotiating leverage that if it doesn’t work for me, I’ll just go back to my plan A from the beginning and once again is a really powerful tool to take down the big great Gordon Gekko.
Brad: Yeah. And that’s a great point, Michael, a lot of physicians don’t have that exit strategy in place. And so when something, an opportunity like this just shows up, they feel like they must take it. Going back to referencing Ben Hernandez, that unsolicited offer that we talked so much about to a lot of these individuals, all of a sudden $2 million and all I got to do is A, B and C. That sounds so great. They don’t realize what that A, B and C is actually, you know, A through quadruple Z. [00:24:00] They don’t realize that what they’re getting themselves into, but he had a plan. He knew that he was going to work through a certain number of years, right. He knew that he had put away the money that he needed to live a very comfortable lifestyle. And this was just a little bit of something extra that he could put into his savings if he needed it. But he didn’t. And I agree with you, the mic is a very powerful ability that you can just walk away and you don’t have to sell your practice. You don’t have to find that next physician because you position yourself and your exit strategy to be your own boss. Even to the day you decide to retire. That doesn’t mean that there isn’t value there because he was able to get $2 million. And that doesn’t mean that for our clients that still want to bring on young physicians to buy them out that that’s not a great plan too, these are the ways in which for him it made sense to him. And just to kind of fast forward to the end of this story, he became a sensei like a lot of ours because the group knew that he was going to be with them for about three [00:25:00] years, Gekko. And so they brought in a young physician early on to train underneath him to learn this very, very specialty subspecialty of surgery. And so it was a win for the Gekko group and ended up being a win for our doctor.
Michael: All great points, Brad. Earlier I mentioned talking about what a medical practice has value in kind of the current we’ve had to swim against that private equity is helped solve, and I’m excited for our next episode because we’re actually gonna have someone on, a special guest who values medical practices and who does these deals and we’re going to learn a little bit more about medical practice value.
Brad: Yes, we are Michael. So join us next Wednesday when it’s Fake or Real: A Medical Practice Has No Value With Anna Brewer.
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