There are opportunities and strategies for mitigating risk when investing in companies operating under or negotiating CIAs, according to experts who spoke on a panel at the Annual Healthcare and Life Sciences Private Equity & Finance Conference in Chicago on February 21 and 22.
Experts included Scott Brown, Vice President at The Edgewater Funds, David Campbell, Managing Director at Getzler Henrich, & Associates, LLC, Eric D. Coburn, Managing Director at Health Care Investment Banking, Duff and Phelps, Catherine Hess, Senior Counsel at McGuireWoods LLP, and Helen Suh, Senior Counsel at McGuireWoods LLP (moderator).
Here are 6 key points from the panel discussion:
1. There are multiple reasons to invest in companies currently operating under a CIA. Such companies, which may experience minimal growth during the term of the CIA due to the administrative burdens related to compliance, may be poised for significant growth once the CIA term expires. It is often difficult for such companies to balance sales growth and maintain the compliance obligations associated with a strict monitor. Changes in investment or ownership structures in companies with expiring CIAs may yield a revitalized focus on growth or provide novel opportunities for partnership. Sellers that are or have been subject to CIAs also demonstrate a particular resilience going through the process and coming out the other side. Such sellers have also made significant investments in compliance infrastructure, which may increase the comfort level of an investor partner, particularly an investor partner with a lower risk tolerance.
2. Continued enforcement efforts by the Office of Inspector General (OIG) have been focused on a number of high-risk markets. Some of the market areas where enforcement efforts have been focused in recent years have included compounding pharmacies, home health, hospice, nursing homes, and behavioral health (with a heavy focus on detox programs). The OIG’s investigation efforts infrequently result in CIA settlements, however, the cost imposed on companies that settle and agree to a CIA has also increased, as five (5) years is now the standard length of a CIA (previously, 3 years was common) and independent review organizations are required for many CIA parties. The OIG publishes an annual “Work Plan”, which identifies government enforcement priorities over the upcoming calendar year, and which provides invaluable insight into particular market focal points.
3. There are a number of different considerations for buyers and investors when engaging with target companies with existing CIAs or that are in the course of negotiations with the government regarding a CIA. It is imperative to ensure that a buyer/investor conducts comprehensive and thorough diligence on the target company prior to investment, including an in-depth inquiry into the circumstances giving rise to the CIA. As part of that process a buyer/investor should confirm that the target company is willing to address the issues that gave rise to the investigation or CIA. The target company should also be capable of incurring the ongoing cost of the monitor and other compliance obligations and have freely disclosed risks and documentation relating to the CIA during the diligence process.
4. There are also several circumstances in which the buyer/investor should reconsider the investment. For example, if the fraud alleged by the government goes to the core of the target’s business model, the business may no longer be viable after the implementation of a CIA. The investment risk would also shift substantially if the target insists on engaging in litigation rather than entering into a CIA, which may not be conducive to a culture of change and may lead to exclusion from federal government programs (and potential abandonment by commercial payors as a result). In addition, understanding the scope of the CIA is imperative, as prospective buyers/investors may inadvertently take on the risk that the CIA opens the buyer’s entire business to scrutiny as well.
5. There are several structural tactics to consider during deal negotiations with a company under a CIA which an investing party may utilize to lessen the impact the CIA may have on investor returns. Some tactics include longer and larger escrows, representation and warranty insurance (which could be very expensive for certain high-risk markets identified above and typically exclude known liabilities), escrow release dates tied to chart audits, or certain other special indemnities.
6. Seller should also consider how best to minimize the impact of the CIA on the value of the business moving forward. There are a number of operational tactics that might be employed. One such way to demonstrate the value of the business is to ensure that certain quantitative metrics are set up to track information to present to prospective investors. In addition, consistent management oversight, accountability, and involvement demonstrates commitment to the future of the business and may be viewed positively by prospective investment partners.