Thinking of Selling Your Medical Practice to a Private Equity Buyer?

During the past decade, private equity (PE) firms have been rapidly acquiring medical practices, driven by the potential for high returns. In fact, during this time, PE investments in healthcare have exceeded $1 trillion. While PE firms initially targeted dermatology, gastroenterology, and ophthalmology practices due to their higher profit margins, consolidation potential, and operational efficiencies, PE firms are now increasingly targeting medical aesthetics, pain management, and fertility with a focus on scalable, high-margin specialties.

Physicians often want to practice medicine, not run the business of a medical practice. Employee issues, billing issues, federal and state regulatory compliance issues, and more are all an unwanted headache. Physicians want to be in the exam, procedure, and operating room, not in the business office of the practice. So, a PE firm can easily entice physicians with a promise of ownership in a larger entity with no management obligations. But, do physicians truly understand PE equity purchases of their medical practices?

Here are the basics:

A PE firm forms a management services organization (MSO). The physicians or professional service entity, whichever is the owner of the practice, transfers the non-clinical assets to the MSO. The MSO pays the owner(s) for these assets, typically 60% in cash and 40% in rollover equity, based on its valuation of the practice, which may be more beneficial to the PE firm than to the owner(s). However, such equity has economic rights only or, in other words, no voting rights. In addition, the MSO will have the right to dilute, repurchase, and/or drag along such equity, but the physicians may or may not have anti-dilution, put, or tag along rights. In fact, the physicians may be subject to a directed equity transfer agreement which can be triggered by the MSO with or without cause. Further, the physicians will be bound by a restrictive covenant, the term of which may be as long as five years and the radius of which may be as large as 25 miles.

The clinical assets and liabilities remain with the owner(s) of the practice. The owner(s) indemnify the MSO for all liabilities. Yet, the owner(s) have no control over the management of the practice (including the hiring of physicians or any other increase in the expenses of the practice). The MSO manages the practice, providing such items as space, equipment, supplies, billing services, administrative and management service for non-clinical operations, and/or leased employees. In return, the owner(s) compensate the MSO through, for example, a flat fee or a fee based on expenses plus a mark-up. To ensure such payment, the owner(s) agree to a lockbox for the receipt of claims reimbursements, sign a power of attorney in favor of the MSO, and grant a security interest to the MSO in the practice revenue.

So, is PE the way to go?

The life cycle of a PE investment is three to seven years with a recent study showing that 51.6% exit within three years. Further, 97.8% exit through secondary buy-outs. In sum, PE firms are engaged in multiple arbitrage and add-on consolidation. It’s capitalism on steroids. For physicians nearing retirement (with a lifetime of savings in the bank, desire for a reduction of administrative burdens, and little concern over a restrictive covenant), a PE buy-out may be an attractive option, but for physicians in their prime, a PE buy-out may not be. Further, for the healthcare of a nation, the PE abbreviated timeline and exit incentives may deter long-term investment in care delivery and the workforce needed for high quality care.

This has caught the attention of regulators in New York.