Mar 22 2021

M&A for Small Hospitals: Trends, Considerations and Challenges to Overcome

What should small hospitals consider if they see a merger and acquisition in their future? An expert shares four tips.

The healthcare sector has undergone tremendous change over the past several years, putting significant strain on the bottom line of many small hospitals. A seemingly perfect storm of evolving patient expectations, tightening budgets, shifting reimbursement models and regulatory reform at state and national levels is driving trustees and other decision-makers to find new ways to maintain financial viability in an increasingly competitive market.

The COVID-19 pandemic has exacerbated many financial struggles. Surges in coronavirus cases over the past year have forced hospitals to delay elective and nonemergency surgeries and medical procedures to free up capacity to treat those diagnosed with the coronavirus.

As more individuals stayed home under lockdown orders, inpatient volumes plummeted, and profitable outpatient locations were forced to temporarily close their doors. This has led to steep drops in revenue for hospitals across the U.S.

Small hospitals are feeling increased pressure to partner with larger organizations that may be better equipped to handle the increased operational, technological and administrative burdens imposed by this evolving healthcare environment. This trend is already playing out: 22 transactions involving hospitals took place during the fourth quarter of 2020 alone.

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To many hospitals, the decision to enter into a merger is not an easy one. It can be difficult for hospitals and healthcare organizations to know whether or not they should partner with another organization, when to partner and what type of organization to partner with. Here are a few things every organization needs to think about before they get started, such as knowing when to involve legal counsel and making sure they know what their own organization needs.

1. Evaluate Your Organization’s Needs, Goals and Long-Term Strategy

Before making any preliminary plans to enter into a transaction or partnership, small hospitals must begin by looking internally at their own needs.

When it comes to developing a long-term strategy, hospital boards should feel compelled as part of their fiduciary obligation to review the needs of the community, the condition of facilities and equipment, medical staff needs, IT capabilities and the financial health of the institution, among other factors.

Perhaps a hospital is looking to physically expand its presence with a new facility. Maybe a hospital is seeking to expand its medical staff or gain economies of scale. Or perhaps a hospital is looking to upgrade its IT infrastructure. Regardless of the underlying motivations for growth or evolution, hospitals must start by looking internally. If they cannot fix these problems themselves, only then may it be time to seek a partnership, whether by merger or strategic alliance.

Hospitals and health systems must also consider the amount of surplus capital the institution has on hand (or has access to) so it can meet its immediate operational needs and projected long-term costs. While many hospitals may have sufficient cash on hand to meet current working capital needs, they may not be able to replace current buildings and equipment or invest in technology infrastructure to keep pace with the changing trends in reimbursement. For example, these trends may require more sophisticated information systems to benchmark and track quality outcomes and patient participation over a broad patient population throughout a patient’s entire episode of care.

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Though each situation differs greatly, the demand on capital to strengthen, update or even replace physical facilities and the need to build or rebuild IT capabilities are leading factors that drive many independent hospitals to consider merging.

This strategic review process must be continuous and ongoing. Identifying these needs and developing a strategic plan early on will help an organization stay nimble and be ready to react.

Indeed, to ignore this review is paramount to a board violating its duty of care to the hospital and, if a tax-exempt hospital, to its charitable mission to serve the healthcare needs of its community by assuring that those needs do not go unattended.

2. Review the Partnerships Available Outside of an M&A Transaction

An outright merger isn’t the only type of partnership that can benefit a small hospital. Many hospitals are committed to maintaining their independence but need access to clinical and support services through strategic alliances with other healthcare providers. There are a number of recent examples of hospitals that have successfully forged strategic partnerships with other health systems rather than entering into a full-scale merger. These partnerships can provide significant benefits for providers and patients alike.

A service-line partnership is one way for two organizations to come together and expand their offerings while remaining independent. Many hospitals seek a strategic partner to expand needed services that may be unavailable to their community.

In this regard, many independent facilities seek larger health systems as partners. Larger systems often offer strong and stable networks of hospitals, physicians and ancillary care that can provide a more integrated range of services over a broader geographic area than an independent hospital could provide on its own.

In other cases, a hospital may identify a certain clinical area that it wishes to improve or develop but doesn’t have the necessary resources to go it alone. A clinical co-management agreement or other type of arrangement creates a mechanism for hospitals to partner with physicians or other providers to jointly offer key hospital services and improve patient outcomes. These arrangements allow the parties to remain independent while working together to improve patient care in specific clinical areas.

However, an outright acquisition or merger can still make the most sense for many organizations. Though it typically takes the longest to execute and comes with the most risk and legal hurdles, an acquisition often opens up the most potential for cost savings and future growth.

3. Consider the Regulatory Review and Approval Process in Your Area

When it comes to outright mergers and acquisitions, careful attention must be given to compliance with federal and state antitrust laws. In some cases, regardless of the intent of the parties, planned mergers may fail because of antitrust concerns and other regulatory obstacles.

The regulatory approval process varies from state to state, and it is critical that organizations understand the legal nuances of their regions. The two organizations will undergo enormous scrutiny, and it’s best to come prepared.

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In some cases, especially where the transaction involves a not-for-profit hospital being acquired by a for-profit buyer, the legal scrutiny will be more extensive and the review time lengthier. In addition, in many cases, the state’s attorney general may have to approve the transaction before the parties can complete the acquisition and will often hold public hearings to assure that the proposed merger is in the best interest of the affected communities.

Additionally, hospitals must pre-emptively address any potential workforce concerns. For example, if one organization has a workforce that is represented by a union, the negotiations may be further complicated by having to deal with a collective bargaining agreement between the institution and the union.

4. Knowing When to Engage Legal Counsel and Other Experts Is Crucial

Acquisitions and other partnerships are complex and should not be taken lightly. It’s important to engage legal counsel and other experts early in the process so that both parties can begin strategizing for the intense work that lies ahead.

Ideally, organizations are consulting with lawyers and experts before the selection process even begins in order to avoid headaches. Yet too often, counsel is brought into the process after a term sheet has been negotiated, leading to, at best, more work for both parties and, at worst, a failed transaction.

As hospitals continue to partner with one another, organizations thinking of a possible transaction or affiliation must consider the legal and antitrust implications. This essential first step is critical to getting new partnerships off on the right foot.

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