Private equity funds and strategic investors have recently shown strong interest in acquisitions of healthcare services companies such as surgical centers, hospitals, dialysis facilities, home health agencies and urgent-care centers. According to PitchBook Data Inc., since the beginning of 2009, 138 private equity investors have invested in 205 companies in the healthcare services industry. Investors are buoyed by long-term demographic trends and the expansion of coverage brought about by healthcare reform. This has led many sellers to examine whether the current market is ripe for recapitalization or exit transactions. However, in advance of taking a healthcare company to market, consideration should be given to the regulatory climate in which these companies do business.

Healthcare services companies are doing business in a particularly fluid regulatory environment. Although healthcare reform has been law for over a year, there remains uncertainty about a possible repeal of the new law coupled with the large number of new regulations required under the law. Amid this uncertainty, greater availability of enforcement funds and expanded applications of the False Claims Act and other healthcare regulatory schemes have bolstered increased scrutiny from a broad array of federal and state regulators.

Advance preparation can ensure two things in a transaction. First, preparation can mitigate the risk that a transaction's closing will be delayed or sidetracked by the discovery of a regulatory issue during due diligence. Second, if issues are presented early in transactions and solutions for these issues are readily available, then the bidder's price for the company will have incorporated the risk of these issues. This avoids a later repricing of a transaction based on the discovery of an issue late in the due diligence process. Preparation can lead to swift closure of healthcare transactions at attractive valuations.

In preparing any healthcare services company for market, sellers should consider the following key issues:

Relationships with referral sources. Buyers are focused on referrals source relationships because they are highly regulated and the financial impact of noncompliance can be substantial. Federal enforcement agencies have closely watched compliance with the Anti-Kickback Statute and Stark Law in recent years. This has been demonstrated in a number of recently announced settlements including a $20 million settlement by Detroit Medical Center before it was acquired by Blackstone Group LP-owned Vanguard Health Systems Inc. In preparation for any transaction, a seller should identify physician and institutional referral sources and consider whether a financial relationship exists and whether such a relationship is compliant with the Anti-Kickback Statute and Stark Law as well as other applicable state laws. Relationships that should be examined include physician employment agreements, leases, medical director agreements and supply agreements with physicians. Noncompliant relationships should be identified and corrected if possible.

Licenses, permits, accreditations and provider numbers. Two key issues should be examined in advance of a transaction with respect to licenses, permits, accreditations and provider numbers. First, all of these governmental permits should be up to date and unrestricted. Any recent suspensions or investigations by regulators should be closed out, and the seller should have evidence available to the buyer that no restrictions are in place. Second, sellers should be aware in advance of whether a change of ownership transaction will impact any healthcare licenses or permits. If possible, a holding company structure should be implemented to avoid direct changes of ownership. In many states, a change of ownership can trigger a state survey or other review of a company's compliance. As such, the seller should be aware of whether this might be triggered and work to structure the transaction accordingly.

Commercial insurance relationships. Although many providers focus on Medicare and Medicaid, commercial insurers (for example, Blue Cross and Blue Shield Association, United HealthCare Services Inc.) still pay for the majority of healthcare services provided in the U.S. Therefore, sellers should ensure that relationships with these insurers are in order. One key issue that has faced healthcare services companies is the waiver and discounting of patient co-payments and deductibles. Commercial insurers establish out-of-network policies that apply to patients that visit out-of-network providers. In the case of noncompliance with an insurer's policy, a seller should consider a pre-emptive change as buyers will price compliance into a deal. In the case of a compliant policy, a seller should ensure that the policy is documented so that buyers' counsel and advisers are comfortable.

Culture of compliance. In this highly regulated industry, buyers will be interested in evaluating a target's healthcare compliance plans, programs and practices to ensure a "culture of compliance" exists. A seller should expect and be prepared to respond to certain inquiries including: (1) Does the compliance plan address all of the seller's risk areas?; (2) when was the last compliance plan update?; (3) does the seller have an active compliance officer and privacy officer?; (4) is healthcare compliance training completed regularly?; (5) do board minutes reflect senior management's attention to healthcare compliance issues?; (6) has the seller made a systematic attempt to solicit compliance issues from employees and partners through compliance hotlines and other approaches?

Contracts. Contracts are often a source of significant value for any seller. Depending on the subindustry, core contracts may be with vendors, suppliers, customers, payors or lessors. Consequently, a seller must identify and review those contracts that will be the focus of the proposed transaction. Contract provisions that can cause issues include those pertaining to assignment, change of control, liability, restrictive covenants (such as noncompete or nonsolicit) and termination. The loss or suspension of payment under key contracts can translate to cash flow issues for the buyer.

Billing and coding. Billing and coding is an obvious area of interest, but one that could develop into a sticky issue among the parties. The importance of cleaning up old audits, both internal and external, cannot be overemphasized. A seller must be able to demonstrate that issues identified in old billing and coding audits (whether internal or conducted by Medicare or Medicaid) have been addressed and remediated. To this end, a seller may want to consider conducting a re-audit to demonstrate compliance. Even if exposure seems minor, buyers will view any governmental billing and coding issues as significant.

Patient privacy issues. For most, if not all, healthcare industry participants, patient privacy has become a concern and is in large part governed by the Health Insurance Portability and Accountability Act, as supplemented by the Health Information Technology for Economic and Clinical Health Act. The Department of Justice has requested more than $24 million for privacy and security enforcement in fiscal year 2010. The failure to comply with patient privacy laws can not only result in significant civil monetary penalties, but also reputational harm. Accordingly, a seller should have updated HIPAA and Hitech Act compliance plans, notices of privacy practices and breach protocols, and just as importantly, be able to demonstrate effective implementation of such plans, practices and protocols.

Tax preparation. Unlike the other items on this list, advance tax preparation can be largely a seller-side concern since a seller will naturally want to avoid having sale proceeds taxed as ordinary income (which is taxed at a higher rate than capital gains) or incurring other negative tax consequences. The structure of a transaction can impact tax treatment, so this issue should be addressed as early as the letter-of-intent stage. Certain common structures in healthcare (such as physician practice management structures) may have higher exposure to potential ordinary income tax treatment and require particular advance planning.

To position a healthcare services business to capitalize on increased buyer activity, sellers considering recapitalization or exit transactions are urged to review these issues in advance of any transaction. This preparation and implementation of corrective actions will translate to fewer repricing events and obstacles to a timely closing.

Kristian A. Werling exclusively represents healthcare clients and regularly represents private equity funds in acquisitions and divestitures of healthcare and life sciences companies. Amber McGraw Walsh focuses on corporate healthcare transactional work and regulatory matters for various healthcare providers. Geoffrey C. Cockrell has extensive mergers and acquisition experience representing private equity and strategic purchasers across diverse industries. All are partners from the Chicago office of McGuireWoods LLP.