VarSeq 2.6.0: Advancing Pharmacogenomics and Genomic Analysis
Healthcare Transactions and Compliance
1. Presenting a live 90-minute webinar with interactive Q&A
Healthcare Transactions and Compliance
with State and Federal Laws and Regulations
Structuring Transactions, Overcoming Regulatory Challenges,
Determining FMV, and Performing Due Diligence
THURSDAY, DECEMBER 20, 2012
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
Today’s faculty features:
Theresa C. Carnegie, Member, Mintz Levin Cohn Ferris Glovsky & Popeo, Washington, D.C.
Curtis H. Bernstein, CPA/ABV, ASA, CVA, MBA, Managing Director, Altegra Health, Denver
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4. Healthcare Transactions and
Compliance with State and
Federal Laws and Regulations
Theresa C. Carnegie – Member, Mintz Levin
202.661.8710
TCCarnegie@mintz.com
Curtis Bernstein, CPA/ABV, ASA, CVA, Altegra Health
720.240.4440
curtis.bernstein@altegrahealth.com
5. Today's Discussion
1. Health Care Transactions Trends
2. Federal and State Regulatory Challenges
3. Effective Due Diligence
4. Valuation Considerations
5. Strategies to Minimize Regulatory Risks
6. Hypotheticals
5
7. Health Care Transactions – Trends
• Unprecedented levels of change in the health care industry.
– Patient Protection and Affordable Care Act (ACA)
– Care Delivery Reform
– Payment Reform
– Increased Enforcement
• These changes bring challenges and opportunities.
– Some providers struggle with the intensive human and capital
requirements and are motivated to sell or affiliate.
– Other providers are more advanced and better positioned to
compete and look to expand their footprint and improve scale.
7
8. Health Care Transactions – Trends
• Past few years have been very active for the health care
M&A market and strategic collaborations and affiliations.
– In 2011, 980 health care mergers and acquisitions worth $227.4
billion.
– In first 2 quarters of 2012, 500 health care deals recorded worth
$95.2 billion.
• Health Care Segment Trends
– Hospital/Health System Consolidation
– Physician Practice Acquisitions
– Expansion of Health Insurance Companies into Health Care Services
– Increase in ASC and Urgent Care Center Acquisition
8
10. Navigating the Regulatory Challenges of
Health Care Transactions
• Health Care is a Highly Regulated Industry
–Businesses in the health care industry are regulated by a
wide array of federal and state laws enforced by various
specialized regulatory agencies.
–Violations of these laws can subject parties to health care
transactions to onerous sanctions, including criminal
penalties.
10
11. Federal and State Health Care Laws
• Medicare/Medicaid Billing and • Stark Law and State Self-Referral
Reimbursement Requirements Prohibitions
• State Licensing and Certification • Federal and State False Claims
Requirements (Entities and Acts
Individuals)
• HIPAA and State Privacy Laws
• Industry Accreditation
• State Corporate Practice of
Requirements
Medicine Prohibitions
• Federal and State Anti-Kickback
• State Fee Splitting Laws
Laws
• Antitrust Laws
• Beneficiary Inducement
Prohibitions • FDA Requirements
11
12. Federal and State Fraud Abuse Laws
• Federal and State fraud and abuse laws are always a
main focus of any regulatory review in health care
transactions.
• Includes – Anti-Kickback Laws, Stark Laws, FCA.
• These laws can have a significant affect on deal
structure.
• Permissible Structures
• Valuation Parameters
• Payment Structure
12
13. Federal and State Fraud Abuse Laws
• The financial implications of non-compliance with fraud
and abuse laws can be significant.
• Under ACA the reach of both the federal anti-kickback
statute (AKS) and False Claims Act (FCA) has been
expanded.
– Lessened the government's burden on proving intent for
AKS violations.
– Linked AKS violations to violations of the FCA.
– Provided for enhanced civil and criminal penalties for
violations.
13
14. Federal and State Fraud and Abuse Laws
• This expansion is combined with an overall trend toward
increased government enforcement.
• Under the HEAT Task Force health care fraud enforcement
is a "cabinet-level" priority.
• OIG increasingly focused on pursuing responsible
individuals for exclusion and CMPs.
• Penalty of exclusion from participation in federal health
care programs can be a death sentence for a health care
company.
14
15. HIPAA – Privacy and Security Laws
• Under the HITECH Amendments to HIPAA, business
associates are directly subject to HIPAA privacy and
security requirements.
• Business associates are subject to statutory penalties for a
failure to comply with HIPAA’s Privacy, Security, or Breach
Notification Rules.
• Increased OCR Enforcement
– Massachusetts Provider Settles HIPAA Case for $1.5M (Sept. 2012)
– Alaska DHHS Settles HIPAA Security Case for $1.7M (June 2012)
– Phoenix Cardiac Surgery Settles Case of $100K for Lack of HIPAA
Safeguards (April 2012)
– BCBST Settles HIPAA Case for $1.5M (March 2012)
15
16. Corporate Practice of Medicine Restrictions
• Prohibition - Many states have strict “corporate practice of medicine”
prohibitions that limit the extent to which a lay entity can control
physicians and/or share medical practice revenues with physicians.
• Exceptions – Although restrictions and exceptions vary by state, many
states have exceptions for:
• Professional corporations
• Not-for-Profit Hospitals
• HMOs
• Teaching Hospitals
• Penalties – If a lay entity is found to be practicing medicine through a
corporate form, the corporation could be liable for the unlicensed
practice of medicine and subject to criminal and civil penalties.
16
17. Corporate Practice of Medicine Restrictions
• If the state has a corporate practice of medicine prohibition
alternative deal and operating structures must be
considered.
• Where alternative structures involve Management
Agreements, parties must consider state fee-splitting laws.
–Some states have strict fee-splitting laws that prohibit
physicians from sharing fees with non-professionals –
e.g., Illinois, New York.
–In such states, management fees may not be based on a
percentage of revenues.
17
19. What is Due Diligence?
• It is the process of obtaining and reviewing information
about a company and using that information in the context
of a specific transaction.
• Due to the multi-layered regulatory environment, targeted,
thorough, and thoughtful diligence is necessary in all health
care transactions.
19
20. Why is Due Diligence Conducted?
• Evaluate overall transaction, value, and purchase price
• Identify risk areas
• Identify issues that must be addressed in the Purchase
Agreement
• Ensure proper disclosures by Seller
• Understand Seller’s operations
• Evaluate financing and structure of transaction
• Plan for post-closing integration
20
21. Common Areas of Focus for Health Care
Regulatory Due Diligence
• Contractual Arrangements
• Corporate Books and Records
• Licenses/Permits
• Compliance Program
• Government Correspondence and Investigations
• Litigation (pending/threatened)
• HIPAA Compliance
• Billing and Coding
• Marketing Materials
21
22. When reviewing these common areas, consider…
• Contractual Arrangements
– Does the arrangement potentially implicate the AKS or Stark Law?
– Is it structured to comply with a safe harbor and/or exception?
– Are the services provided legitimate?
– FMV payments?
– Is the arrangement used to improperly move money from a regulated
entity to an unregulated entity?
– Are the management services and fees set up to comply with
corporate practice of medicine prohibitions?
– Does the compensation structure improperly incentivize increased
services or increased coding?
22
23. When reviewing these common areas, consider…
• Corporate Books and Records
–Does the structure comply with the corporate practice of
medicine?
–Is money transferred between affiliated entities in a proper
way?
• Licenses/Permits
–Does the seller have all of the required approvals?
–Do employees have all required licenses?
–What governmental filings are necessary as a result of the
transaction?
23
24. When reviewing these common areas, consider…
• Compliance Program
–Is the seller an entity that is required to have a Medicare
compliant compliance program?
–Does the program comply with CMS guidance and Federal
Sentencing Guidelines?
–Is it effective and updated regularly?
–Does the seller regularly screen employees and contractors
against the OIG exclusion list?
–Is there a compliance hotline? What issues have been
reported?
–Who receives annual training?
24
25. When reviewing these common areas, consider…
• Government Correspondence and Investigations
–How is the seller's relationship with the government?
–Are there any pending investigations or audit findings?
–Has the seller received any warning letters?
• Litigation
–Health care fraud and abuse related litigation?
–Any recent departures from the company?
–Does the company conduct exit-interviews?
25
26. When reviewing these common areas, consider…
• HIPAA Compliance
–Has the seller implemented proper safeguards and security
systems along with comprehensive HIPAA policies,
procedures, and training?
–Regulators will assume lack of documentation equates to a
lack of compliance.
–Are there existing breaches or complaints that will create post-
closing liability?
–Are IT security procedures adequate?
• Consider post-closing costs of implementing new or upgrading
existing systems.
26
27. When reviewing these common areas, consider…
• Billing and Coding
–May require outside consultant review.
–Are billing and coding procedures in compliance with
applicable law?
• Marketing Materials
–Are the Medicare Marketing Guidelines applicable to the
seller? If so, has the seller complied with them?
–Does the seller adequately train and supervise its sales force?
–Are the seller's materials truthful and accurate? State
consumer protection laws reach much further than the federal
AKS and state kickback laws – has the Seller complied with
them?
27
28. Outcome of Due Diligence Review
• Based on the due diligence review, be prepared to adjust
the transaction structure, documents, and price
–Representations and Warranties
–Indemnification/Holdback/Escrow
–Disclosure Schedules
–Conditions Precedent to Closing
–Adjustments to Purchase Price
–Legal Opinion
28
29. How do the due diligence findings affect the value
of the transaction/venture?
• Has the Seller conducted business in a manner that may create
risk under health laws (or other laws)?
• Will a self-disclosure need to be made? If so, how much money
may need to be re-paid?
• Are the Seller's financial projections based on its past faulty
billing procedures?
• Are the financial projections based on relationships and
arrangements that violate the AKS or Stark Law?
• Are the Seller's facilities about to have their licenses revoked?
• Will the Seller's payor contracts be terminated as a result of the
transaction?
29
31. Importance of Fair Market Value - Legal Perspective
• That a transaction is valued appropriately and consistent with fair
market value is important from both a financial and legal
perspective.
• In the health care industry, an arrangement (i.e., service
agreements, leases, acquisitions) that is not priced to be
consistent with fair market value can raise significant red flags
under fraud and abuse laws and is unable to fall within an AKS
safe harbor or a Stark Law exception.
• Fair Market Value is not just an issue of the price of the
transaction, it often impacts every arrangement for health related
services that is reviewed in due diligence.
31
32. Importance of Fair Market Value - Legal Perspective
• Although legal counsel is generally not in a position to
determine FMV, it should be on the look out for problematic
compensation structures or unsubstantiated valuations.
• In Advisory Opinion 10-16, the OIG questioned the
Requestor's method for establishing fair market value.
• The OIG noted that it is precluded from opining on fair
market value, but stated that it must "evaluate whether the
method used to determine that a fee represents fair market
value appears reliable."
32
33. Fair Market Value vs. Investment Value
• Cannot account for what a specific buyer brings to the
table, only what the most likely hypothetical buyers could
operationally adjust.
–Example #1: Hospital proposes to purchase a 51% interest in
a physician-owned ASC. Within the hospital, physicians
employed by the hospital perform 1,500 cases per year that
could be performed in an ASC setting.
–Example #2: Private equity group proposes to purchase 10
diagnostic imaging centers from radiology group. Private
equity group owns 25 other centers in the regional area and
has 15% higher managed care reimbursement than the
radiology group.
33
34. Billing and Coding Assessments
• As part of the valuation process, valuators should perform a
review of the sellers coding when applicable.
–Volumes are compared to Medicare or other benchmarks
• What is the distribution of patient visit codes?
• What is the use of ancillary services as a percent of total services?
–When reviewing MA or MA-PD Plans –
• Has the Plan been using appropriate documentation to support its
risk adjusted scores?
• What are the RADV audit results for the Plan?
• Will documentation practices need to change?
34
35. Adjusting Historical Financial Statements
• Removal of Non-Recurring Expenses
–Implementation of EMR
• Consideration of meaningful use payments
• Additional Expenses to Account for Growth
–Space and staff needed to support growth
35
36. Projections
• When performing an income approach, most valuation
practitioners will prepare a projection (generally 5 years).
–Example: Physician practice owns a sleep lab and proposes to
sell the lab to the local hospital. The sleep lab has two beds.
Practice currently performs 650 sleep studies of which 200
require CPAP.
Growth Rate 5.0% 5.0% 5.0% 5.0% 5.0%
CPT code Historical Year 1 Year 2 Year 3 Year 4 Year 5 Capacity
Total 650 683 717 753 791 831 730
95811 200 210 220 231 243 255
95805 450 473 497 522 548 576
36
37. Terminal Value
• At the end of the projection period, the valuator will develop
an amount projected into perpetuity (generally the point
where the company matures).
–Example #1: Hospital proposes to purchase 20 physician
cardiology group. Five of the physicians are 55 or older. As
part of the negotiations, physician propose to reduce
compensation by 15% to drive more value to the purchase
price.
–Example #2: Rehabilitation hospital opened in March 2012
with brand new equipment and furniture. As part of the
valuation, the valuator projects capital expenditure for the next
five years of $25,000 per year.
37
38. Assets Purchased and Liabilities Assumed
• The valuator MUST know the terms of the transaction and
tie back to the terms prior to the execution of the deal.
–Example #1: Hospital proposes to purchase a physician
practice. As part of the deal, the parties negotiate whether the
hospital will assume the practice's debt. The valuator
determines that assets purchased equate to $1 million. The
practice has $200,000 in debt, which the hospital assumes
upon execution of the transaction. Effectively, the hospital has
paid $1.2 million in consideration.
–Example #2: Hospital purchases fixed assets from practice.
Practice’s debt is subject to a lien on the fixed assets.
38
39. Assets Purchased and Liabilities Assumed
• Is value transferred to the buyer upon sale?
–Example #3: Hospital purchases physician practice. Hospital
proposes to purchase certain tangible and intangible assets.
In addition, physicians will earn higher compensation post
transaction than earned when they owned the practice.
39
40. Market Approach
• Understanding the comparable transactions is critical to the
application of the market approach.
–Personal service businesses should generally not be valued
based on a revenue multiple when the owners of the business
remain employees
–Application of an earnings before interest, taxes, depreciation,
and amortization (EBITDA) multiple or any other “market”
defined multiple is only meaningful if the factors considered by
the market are considered when applying the multiple.
• Example #1: Surgery Centers
• Example #2: Independent Physician Associations (IPAs)
42. Transaction Structure
• Asset versus Stock
– In an asset transaction, the Buyer can limit the assumed liabilities.
Although certain liabilities may follow the assets even if not expressly
assumed:
• Tort Liabilities
• Tax Liabilities
• Environmental Liabilities
– In stock transaction all liabilities are included (known and unknown,
contingent or otherwise).
• Accordingly, due diligence, representations and warranties, and
indemnification protections are critical.
42
43. Purchase Price Allocation
• Appropriate allocation of value to assets and liabilities is
critical
–If a purchaser buys intellectual property, non-competes, etc.
and does not record the value of those assets on its financial
statements, the purchaser will likely have a difficult time
defending against any breach for improper use of technology
or competition.
44. Representations and Warranties
• Address Regulatory Compliance in Reps & Warranties
– Non-compliance can impose significant successor liability and
potentially large penalty assessments for fraud and abuse violations.
– Typical Health Care Representations & Warranties
• Licenses and Permits
• Legal Proceedings
• Compliance with Laws
• Payment Programs
• HIPAA
– Other Considerations – Definitions, Material Contracts, Absence of
Certain Events, No Undisclosed Liabilities
44
45. Holdbacks, Escrows and Earn-Outs
• Buyers can use holdbacks, escrows and earn-outs (where
permitted) to address regulatory risks.
• Typically tied to performance, revenue, or compliance
benchmarks.
• Holdbacks and Escrows
–Portion of purchase price held back or placed in an escrow
account for a period of time to secure indemnification
obligations or to address regulatory non-compliance.
–Mitigates risk for Buyer.
–Recent surveys estimate that 10% is reasonable – but
depends on non-compliance the escrow/holdback is intended
to address.
45
46. Holdbacks, Escrows and Earn-Outs
• Earn-Out
–Portion of the purchase price is contingent on the future
financial performance of the target business.
–Payment is contingent on a future event, such as exceeding a
specified gross revenue, net income, or EBIDTA.
–Buyer pays the agreed earnout amount, if at all, in the years
subsequent to the sale upon satisfaction of the contingency.
–Must ensure that earn-out structure is permissible under
applicable fraud and abuse laws.
46
47. Survival and Indemnification
• Survival Periods for Reps and Warranties
–Create "classes" of reps and warranties.
–"Standard" versus "Fundamental"
• Health care representations and warranties as "Fundamental"
• Caps and Baskets
–Limit and apply to only certain reps and warranties.
–Exclude Fundamental reps and warranties.
• Sandbagging
–Protection against recovery due to constructive knowledge.
47
49. Billing Practices
• Hospital is looking to acquire a chain of urgent care clinics.
Hospital determines through due diligence that the Seller
has been incorrectly billing federal and private payors for a
specific service.
• Seller also discloses pre- and post-payment audit reviews
by CMS and private payors with respect to the billing
practices.
• What steps can the Hospital take to address these
regulatory risks?
49
50. Corporate Practice of Medicine/Fraud and Abuse
• Private equity group is interested in acquiring large
anesthesiology group in North Carolina. The
anesthesiology group provides anesthesia services on an
exclusive basis to several outpatient surgery/endoscopy
centers owned and operated by physician-owned entities.
• The anesthesiology group pays the centers a fee for
management services including pre-operative nursing
assessments, space for physicians/personnel, records, etc.
and assistance with transfers of billing documentation.
• What issues should the private equity group consider in
connection with the potential acquisition?
50
51. Fraud and Abuse
• Outstanding MA Plan is looking to buy Standard MA Plan.
During due diligence, Outstanding MA Plan learns that:
–Standard MA Plan has engaged Codes R Us to perform
coding reviews of beneficiaries medical records. Codes R Us
is paid $50 per chart reviewed and $25 for each additional
code found that will increase the Plan’s revenue.
–Standard MA Plan offers senior citizens in the area free
transportation , free classes, and gift cards.
–Standard MA Plan has arrangements with physicians that are
undocumented and/or provide for extremely high
compensation amounts.
• Issues? What should Outstanding MA Plan do?
51
53. Contact Information:
Theresa C. Carnegie
Direct Phone: 202-661-8710
Email: TCCarnegie@mintz.com
Curtis Bernstein
Direct Phone: 720-240-4440
Cell Phone: 561-901-5309
Email: Curtis.Bernstein@AltegraHealth.com
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Editor's Notes
Unprecedented Levels of Change PPACA – on-going publication of implementing regulations – ever evolving regulatory landscapeMajor Goal = promote and reward lower cost, higher quality care and greater accountability across providers for patient healthCare Delivery Reform - ACOsPayment Reform – FFS to bundled and global payments, comparative effectivenessIncreased Enforcement – HEAT Task ForceBottom Line = Providers must lower costs and increase valueSome providers struggle with the requirements necessary to effectively provide services and to participate in the next generation of health care delivery – e.g. the expense associated with EHR acquisition and implementation.This motivates them to sell to or affiliate with larger and stronger players in the market.Other providers are well positioned to effectively compete in the new landscape.As a result, they may seek out acquisitions, partnerships, or collaborations that will expand their footprint, establish them as an industry leader in a particular area or improve economies of scale.
Deal activity in 2011 was up 11% from the $205.6 billion worth of deals in 2010. Hospital and health system consolidation trend continues.Hospitals are facing payment challenges and spiraling health care costs – Consolidation allows them to increase market share and negotiate leverage with commercial payors.Ability to demonstrate lower costs while providing high quality care will be the key driver in governmental and commercial reimbursement going forward. Physician alignment is another strategy for hospitals to control costs, drive improved quality and offer continuity of care. At the same time physicians are preparing for a future where they will be required to provide care for more patients with less reimbursement and opt to give up their independence for the income stability afforded by hospital employment.Have seen the expansion of insurance companies into health care services. Since passage of ACA there have been several mergers, acquisitions and partnerships of insurers and provider systems with the goal of reducing health care costs and improving quality. E.g. proposed affiliation between Highmark and West Penn Allegheny Health System, Humana's acquisition of Concentra (which provides PT, urgent care and OT), and WellPoint's acquisition of CareMore Health Plan (an MA Plan and Clinic Network).Payor and provider affiliations will become more common as ACA is implemented and demand for lost-cost, high quality care escalates.Urgent care centers are gateway to the hospital (alternative to crowded ED) and competition from pharmacy clinics – CVS and Walgreens
This is just a sample of the general categories of laws. There may be additional laws or regulatory requirements to consider depending on the industry in which the target participates and the review will have to be targeted to the industries specific regulatory issues – e.g. health plans, pharmacies, pharma manufacturer, medical device manufacturer, physician, laboratory, hospital, nursing homes, home health.Maybe specific state or federal regulatory schemes applicable to the industry – e.g., state gift ban, sunshine laws, etc.I'm going to discuss in a little more depth some of these laws that have take on greater and greater importance in the deals I work on.
Federal and State fraud and abuse laws are always a main/significant focus of any regulatory review in health care transactions.These laws are not only important in the due diligence stage of a transaction but are an important consideration from the outset when the deal is being structured. Health care transactions must be carefully structured so as not to run afoul of federal and state fraud and abuse lawsFraud and abuse laws will often determine permissible deal structures – for example if a client comes to me and says we'd like to enter into a JV with a physician group to own and operate a lab. I have to tell them this is not permissible under the Stark Law if the physicians will refer patients to the lab.The AKS and Stark Law contain safe harbors and exceptions for permissible arrangements and transactions should be structured to comply with these whenever possible – e.g. JVs should comply with the small investment interest safe harbor to the AKS, if there are ancillary arrangements as part of the transaction such as consulting agreements, equipment leases or real estate arrangements – these should all be structured to comply with applicable safe harbors.FMV is a key component under the AKS and Stark Law. Buyers in the health care industry face enforcement risk if they overvalue a target, disguise payments. Parties need to be able to document FMV and how it was determined. Fraud and abuse laws may limit the payment structures available to the parties. We'll discuss earn-out later in the presentation, but these may not be an option where the seller will be a referral source post-closing. If want to do a management agreement, have to consider state fee-splitting laws.
In May 2009, the Department of Health and Human Services (HHS) and Department of Justice (DOJ) created the Health Care Fraud Prevention and Enforcement Action Team (HEAT). With its creation, the fight against Medicare fraud became a Cabinet-level priority. HEAT’s work is directed by HHS Secretary Kathleen Sebelius and Attorney General Eric Holder.OIG looking to alter the cost of doing business mindset of some corporate executives who run offending companies.Also want to alert physicians who receive kickbacks of their potential personal liability under exclusion and CMP authorities
Although providers have been operating under HIPAA for over a decade, the HITECH Amendments significantly increased HIPAA's reach and the potential liability for Business Associates.Before HITECH, business associates had only a contractual obligation to comply with the HIPAA Privacy and Security Rules, through a business associate agreement with a covered entity. Now, all business associates have a statutory obligation to comply with both HIPAA and HITECH. For the first time, business associates are subject to statutory penalties for a failure to comply with HIPAA’s Privacy, Security, or Breach Notification Rules.Massachusetts Provider Settles HIPAA Case for $1.5 Million – September 17, 2012Alaska DHSS Settles HIPAA Security Case for $1,700,000 – June 26, 2012HHS Settles Case with Phoenix Cardiac Surgery for Lack of HIPAA Safeguards --April 13, 2012HHS settles HIPAA case with BCBST for $1.5 million --March 13, 2012
In my practice I have seen an significant increase in CPOM issues. This is driven by the industry consolidation discussed earlier and PPACA driven changes in health care landscape.Physician practice acquisitions, urgent care clinics, Corporate entities need to carefully consider state CPOM restrictions before entering into transactions and if they proceed have to structure the deal to comply with CPOM.The corporate practice of medicine doctrine provides that lay corporations have no professional rights, privileges, or powers and therefore may not engage in the practice of medicine directly or indirectly by employing licensed professionals
Can consider friendly physician structure or other affiliates short of acquisition that can achieve business goals.Even arrangements that are not acquisitions can run afoul of state CPOM laws – e.g. management arrangements may run afoul of state CPOM laws if certain functions are delegated to the manager.Some states have strict fee-splitting laws that prohibit physicians from sharing fees with non-professionals – e.g., Illinois, New York, In such states, management fees may not be based on a percentage of revenuesNew York’s fee-splitting prohibition provides that a physician’s license may be revoked, suspended or annulled for professional misconduct if the physician requests, receives, participates in, or profits from “the division, transference, assignment, rebate, splitting or refunding of a fee” or “a commission, discount or gratuity” in connection with “providing professional care or services.” New York State Education Law § 6531
The seller indemnifies the buyer for losses caused by any breach of the representations, warranties or covenants. Seller may agree to place a portion of the purchase price in an escrow account for a period of time to secure payment on the indemnification. If there are no claims against the escrow the full amount is ultimately paid to the sellers; if claims are made, all or a portion of the escrow will be paid to the buyer and any balance paid to the seller.There is no consensus on what is “fair and reasonable” or “market” for escrows. How much should be placed in escrow? Depends on relative bargaining power. Seller may get higher total price by agreeing to indemnification holdback. Recent surveys estimate that 10% is reasonable.
What is an Earnout? - Typically, a portion of the purchase price is contingent on the future financial performance of the target business. Buyer pays the agreed earnout amount, if at all, in the years subsequent to the sale upon satisfaction of the Contingency. Payment is contingent on a future event, such as exceeding a specified gross revenue, net income, or EBIDTA.Contingent purchase price, or an “earnout” is an increasingly popular technique in private, middle market M&A transactions. An earnout is a valuable device for permitting a buyer and seller to reach agreement on a sale when the parties cannot agree on price.According to the Houlihan Lokey 2011 Purchase Agreement Study, summarizing 2002-2010 transactions in which Houlihan Lokey acted as investment banker:In 2002 - 2010 18% of transactions included an earnoutFrom 2009 – 2010 21% of transactions included an earnoutThe median earnout as a percentage of price was 9% in 2009 and 2010Earn out can help where Buyer wants the seller to stay active in and focused on the business after closing; Less risk for buyer; buyer can avoid overpaying for the target; Earnout as an incentive to retain and motivate key personnel of the target after closing.