Guide to closing a private equity transaction: Negotiating the letter of intent

Part II of the Series: Guide to closing a private equity transaction

As emphasized in the first installment of this series, preparedness is the cornerstone of successfully closing any corporate transaction. Advance planning on the front end often ties directly to getting deals done and also contributes greatly to the efficiency of each step along the way. Once preparation for a potential transaction is complete and an interested buyer or investor is identified, the parties proceed with negotiating a letter of intent (LOI).

With a few exceptions (which are acknowledged below), the LOI is a nonbinding document but should include those terms essential for both parties to close the transaction. This is the stage of the process when the parties are in the best position to ensure that their investment of time and money required for negotiating a definitive purchase agreement is justified. Naturally, aligning deal terms with business objectives is highly dependent upon the deal itself and the circumstances under which each party approaches it, but there are foundational terms for any transaction that require careful consideration.

The structure 

Chief among these is the structure of the transaction itself, especially in the context of medical practice acquisitions. Is the buyer seeking to arrange a purchase of the equity of a medical practice (which potentially would avoid recredentialing with payors and obtaining new Medicare and Medicaid provider numbers, thereby avoiding any interruption in cash flow) or looking merely to execute an asset purchase? Deal structure has far-reaching implications. For instance, a buyer could be exposed to certain legal liabilities in the context of an equity purchase that could be limited or avoided altogether in the context of an asset purchase. Avoiding potential liability is particularly desirable to buyers of medical practices, where licensing requirements and complex fraud and abuse can create significant potential financial exposure for past non-compliance. Understanding those liabilities — and other variables at play — are part of the preparation and influences the desired deal structure. 

The art of valuation

Valuation is often more art than science and can significantly vary depending upon the methodology used and the parties involved in the negotiation. For medical practice acquisitions, there are generally three accepted approaches: (a) income approach, (b) market approach and (c) asset approach. Understanding these methodologies and key variables help create realistic expectations and strategies for supporting the most favorable price. The LOI stage of the transaction is the appropriate time to hammer out how the purchase price is calculated and how it’s subject to adjustments at the time of closing.

Payment plan

Once the parties land on what is being bought and how much it might cost, an equally important deal term involves the form of consideration that will be paid, which may be cash, rollover equity, a combination of the two, and/or a promissory note (with principal terms of the note included, if possible). The degree to which the buyer expects the seller to be a part of the ongoing business or operation (which is often the case with medical practice acquisitions) plays a decisive role in how the buyer chooses to pay, as does the amount of working capital a buyer believes is necessary post-closing. In any event, it is wise to address the form of purchase consideration at the LOI stage.

LOI building blocks

Among other aspects to consider during the LOI stage, the following are especially important for medical group sellers to weigh:

• Required working capital at time of closing and how it will be calculated
• Any amount to be held in escrow and the terms governing the payout of such escrow
• Type of representations and warranties to be made, including the duration and any caps and baskets
• Material terms of any expected post-closing physician employment or consulting agreements for the sellers and/or key employees
• Duration and scope of any restrictive covenants
• Real estate to be included or specific assets to be excluded (such as accounts receivable)
• Time period for conducting due diligence and target date for closing
• Time period during which the seller refrains from negotiating a similar transaction with other parties
• Obligation to keep the terms of the LOI confidential
• Any termination and/or transaction fees that are required to be paid by the buyer or investor in the event the transaction does not close

Final steps

As noted, most of the above terms are nonbinding in the LOI context; however, there are some items that should be stipulated as binding. These include provisions ensuring that the negotiations are exclusive to the parties involved, that the LOI itself remains confidential, and that any required termination fee or transaction expenses are paid. Once the LOI is hammered out, the parties are ready to proceed to the due diligence phase of the transaction.

Other articles in the series:

Part 1 - Guide to closing a private equity transaction: Preparing for a transaction
Part 3 - Guide to closing a private equity transaction: Due diligence
Part 4 - Guide to closing a private equity transaction: Healthcare regulatory issues
Part 5 - Guide to closing a private equity transaction: Material terms to negotiate

Additional Resources

• "Mergers, acquisitions, and the dirty little secret of medical practice governance" (MGMA Podcast)
• "Four important factors to consider during mergers, acquisitions" (MGMA Stat)
• "Insights: Owning it! Strategic planning, navigating M&A and staying independent in healthcare today​" (MGMA Podcast)