Lindabury, McCormick, Estabrook & Cooper, P.C. Firm News & Events
For healthcare business owners considering a sale, the letter of intent is often the first significant step toward a transaction. It is also one of the most consequential.
A prospective buyer may present an attractive valuation, a proposed purchase price and a timetable for completing the acquisition. The owner may view the letter of intent (LOI) as a preliminary expression of interest, with the important negotiations to follow.
Although most LOI provisions are nonbinding, the document establishes the framework for the transaction. Terms negotiated at this stage frequently shape the definitive purchase agreement and influence the seller’s negotiating leverage.
For owners of physician practices, home care companies, med spas, management services organizations (MSOs) and other healthcare businesses, understanding the legal, financial and regulatory implications of an LOI is essential before signing.
Purchase Price
An attractive valuation does not necessarily translate into the amount a seller will receive at closing. Healthcare acquisitions are frequently valued using a multiple of adjusted EBITDA—earnings before interest, taxes, depreciation and amortization. The buyer’s adjustments for owner compensation, nonrecurring expenses and other operating costs can materially affect the proposed valuation. The LOI should identify the EBITDA figure and principal adjustments supporting the offer.
Equally important is whether the proposed price represents enterprise value or equity value. Debt, transaction expenses, working capital adjustments and other obligations may reduce the proceeds ultimately available to the seller. These issues should not be deferred entirely to the definitive agreement.
Working Capital and Purchase Price Adjustments
Working capital provisions can significantly affect the economics of a healthcare business sale. Buyers commonly expect the business to be delivered with sufficient working capital to support normal operations. The purchase agreement may establish a working capital target, with corresponding purchase price adjustments. The calculation can become contentious. Accounts receivable, accrued expenses, payroll liabilities and other current assets and obligations may be treated differently depending on the business and transaction structure.
Healthcare receivables present additional complexity because of collection patterns, contractual adjustments and potential reimbursement disputes. The LOI should establish the intended working capital methodology and identify significant exclusions or assumptions. A seller should understand how these provisions may affect closing proceeds.
Rollover Equity
Private equity transactions frequently require sellers to reinvest a portion of their proceeds in the acquiring organization. Rollover equity offers an opportunity to participate in the future growth and eventual sale of a larger healthcare platform. It also exposes the seller to continued investment risk.
The seller should understand the entity issuing the equity, its valuation, ownership rights, distribution priorities, potential dilution and restrictions on transfer. The economic terms may differ substantially from those applicable to the private equity sponsor. A transaction involving $7 million in cash and $3 million in rollover equity is not equivalent to receiving $10 million in cash at closing. The principal rollover terms should be established before the LOI is signed. Read More: “How to Prepare Your Healthcare Company for a Private Equity Transaction”
Earnouts and Contingent Purchase Price
An earnout provides additional consideration if the business achieves specified financial or operational results after closing. While earnouts can bridge valuation differences, they introduce uncertainty. The seller may no longer control decisions affecting performance. Changes in staffing, expenses or management policies can influence whether earnout targets are achieved.
The LOI should identify the performance measures, measurement period, calculation methodology and principal protections against actions that could undermine the earnout.
Healthcare earnouts also require regulatory scrutiny. Arrangements tied to referrals or professional services may raise fraud-and-abuse or professional practice concerns.
Post-Closing Employment and Management Arrangements
Healthcare acquisitions present regulatory considerations that distinguish them from many other business transactions. Corporate practice of medicine restrictions, professional ownership requirements, MSO arrangements, licensing, payer contracts and federal and state fraud-and-abuse laws may determine how a transaction can be structured. A proposed acquisition may require regulatory approvals, modifications to existing contractual relationships or a different ownership and management structure. These issues can affect purchase price, closing schedules, post-closing operations and the allocation of risk. Identifying regulatory obstacles during LOI negotiations can prevent costly restructuring or unexpected concessions later.
Exclusivity Can Affect Negotiation Leverage
One of the most consequential LOI provisions is exclusivity. Buyers frequently require sellers to refrain from soliciting or negotiating competing proposals while due diligence and definitive agreements are completed. Unlike many other LOI provisions, exclusivity is generally intended to be legally binding. Once exclusivity begins, the seller may lose the ability to pursue alternative buyers even if the proposed transaction becomes less attractive. The exclusivity period should be reasonable, clearly defined and tied to meaningful progress toward closing. Extensions should require the seller’s agreement. Confidentiality, expense reimbursement and other binding provisions also warrant careful review.
Negotiate the Transaction Before Committing to the Process
A letter of intent is more than a preliminary step toward selling a healthcare business. It provides an opportunity to establish the fundamental economic and legal terms while the seller retains meaningful negotiating leverage.
Not every issue can be resolved before due diligence. Nevertheless, the principal elements of purchase price, transaction structure, contingent consideration, post-closing obligations and exclusivity should be sufficiently defined to avoid material misunderstandings.
The objective is not simply to secure an attractive valuation.
It is to negotiate a transaction that delivers the anticipated economic value, allocates risk appropriately and advances the seller’s financial, business and professional objectives.
For healthcare business owners, experienced legal and financial advice before signing the LOI can be among the most valuable investments made during the sale process.