Anatomy Of The Asset Purchase Agreement Part 2: Accounts Receivable
In our previous post in this series, we looked at the allocation of the purchase price between equipment, goodwill and non-competes. In this post, we examine the treatment of accounts receivable in the sale of a practice.
The importance of accounts receivable to an asset purchase agreement often depends on the type of practice you have. If you have a fee-for-service practice where your patients pay upfront for all of the work you will do, accounts receivable may not be a significant part of the transaction. However, if you accept payment over time, or some or all of your practice is insurance-based, then you will often carry significant receivable balances that must be accounted for in the asset purchase agreement. Although there can be variations, there are two ways general ways in which receivables are treated in asset purchase agreements:
The Buyer Assumes The Receivables As Part Of The Purchase Price
One option you can choose is to simply include the accounts receivable as part of the purchase price. If you are selling your practice, this is often the favored option because you will not have to worry about collecting from patients or insurance companies. However, one drawback is that the buyer will often discount the amount of the receivables, since he will have to wait for the payment, and may not be able to collect all of the outstanding balance.
If you are buying a practice, there are some benefits as well. You can immediately improve the cash flow of the practice by purchasing the receivables in the asset purchase agreement, since you will not have to wait until the post-closing services are performed, billed and paid to start receiving payment. Depending on the amount of a discount you are able to negotiate with the seller, you can also potentially make a quick profit, if the receivables pay more than the discounted purchase price.
However, trying to collect on someone else’s receivables can be cumbersome. In order for you to collect, the seller will have to execute an assignment agreement and you will have to contact all of the parties who owe the seller money to inform them of the assignment. Health insurers may also have company-specific forms they will require in order to process the assignment, and it can be a bureaucratic nightmare to ensure that the correct form is submitted to the correct insurer so that you can receive payment.
Also, including accounts receivable as part of the asset purchase agreement can lead to unwanted tension, and possibly litigation, between the buyer and the seller. There is the risk that some of the payors will continue to pay the seller, instead of the buyer, leading to disputes over the after-closing payments. Additionally, if the buyer is not as successful in collecting the receivables as anticipated, there can be claims of fraud or misrepresentation made against the seller. There is also the possibility that patients may dispute charges because of the work performed by the seller, a topic which will be addressed in more detail in a future blog post on Work in Progress.
The Seller Retains The Receivables After Closing
If you are buying a practice and do not want to go through the logistical hurdles of trying to track down the seller’s receivables, you can simply exclude receivables entirely from the asset purchase agreement and adjust the purchase price accordingly. This will leave the seller responsible for collecting the outstanding payments for all services performed prior to the closing date, and allow you to focus on building the practice, rather than chasing old debts.
If you are selling your practice, and especially if you are selling because of retirement or disability, collecting receivables after the closing date may be an inconvenience you do not want to deal with. However, there are some benefits to this approach. One benefit is that it will provide post-closing income, likely for a higher amount than if receivables are included in the asset purchase agreement. Another is that you will avoid potential disagreements or litigation with the buyer over the receivables.
Finally, there may be tax benefits in excluding the receivables from the sale, especially if the closing for the asset purchase agreement is at or near the end of your tax year. Receivables are generally taxed as ordinary income, but you can decrease your effective tax rate on the receivables if they fall in a different tax year than when the practice is actually sold. Therefore, if you sell your practice for a net gain of $600,000, including receivables, in 2014, your effective tax rate may be higher than if you sell the practice for a net gain of $500,000, excluding receivables, in 2014 and collect $120,000 in receivables in 2015.[1]
Some Factors To Consider
There are pros and cons to both approaches, for both sides of the transaction. In determining whether to include receivables and how to structure them in the asset purchase agreement, you should address the following questions:
- Payment history. What has been the seller’s track record in collecting the receivables, and how long has it taken him, on average, to collect? If it takes a long time for the seller to collect, or if he writes off a lot of collections, the buyer will be less inclined to include receivables and will demand a greater discount.
- Collection percentage. How much should the discount be for the outstanding receivables? Most asset purchase agreements will allocate different percentages for receivables based on age. For example, receivables less than 30 days old may be paid at 90%, 30-60 days old might pay 75%, and so on.
- Tax implications. Is there a potential tax savings if the receivables are excluded from the asset purchase agreement? If so, there may be an incentive for the seller to exclude them from the practice.
- Trust between the parties. Is there open and honest communication between the buyer and seller, with full disclosure in the negotiation process? If so, then there is a lower, but still present, risk of future litigation down the road.
Of course, this is just a broad overview of some of the issues that can arise with accounts receivable, and every transaction is unique. Whether you are buying or selling a practice, you should consult with an experienced advisor to guide you through how best to structure the transaction.
[1] Assuming that you do not have any other taxable income in 2015.