By: Carmin Grandinetti and Daniel Fisher

There is a recent trend of physician practices partnering with private equity firms (PE Firms) as hospitals and other large health systems have curtailed their acquisition of physician practices.

Physician practices and PE Firms are looking to align themselves to create a larger, more robust platform for the delivery of primary care or specialty care, such as ophthalmology/optometry, dermatology, gastroenterology, pain management, urology, orthopedics and behavioral health.

These alignments provide physician practices the opportunity to gain efficiencies and access to capital to expand the range of services that the practice may offer its patients and give the practices the ability to leverage best practices across a regional or national network.

Four Sectors

The four sectors with significant activity with private equity are facility-based specialists (anesthesia, radiology, emergency department and hospitalists), retail medicine (dental, dermatology, ophthalmology and optometry), disease-state specialties (gastro, orthopedics and urology) and primary care. The principal drivers of this trend are as follows:

• The leveraging of IT, revenue cycle and other administrative support.
• Providing physicians with additional capital to develop ancillaries.
• Making better use of care managers and mid-levels.
• Providing physicians with the ability to engage in risk-bearing contracts with managed care plans.

There are regulatory considerations when PE Firms acquire physician practices, including the corporate practice of medicine, the Stark Law and anti-kickback laws. The corporate practice of medicine doctrine (CPM), a state law issue, generally prohibits a business organization from practicing medicine or employing a physician to provide professional medical services.

The Kentucky Board of Medical Licensure has issued several opinions that have eroded the prohibition against the CPM and has indicated that it will not enforce the prohibition on CPM if: (a) the physician remains in compliance with standards of practice and professional responsibility; and (b) the employer does not interfere with the exercise of the physician’s independent medical judgment or the patient physician relationship.

Most other states are more restrictive than Kentucky with respect to CPM. Consequently, the following is a typical private equity structure that avoids CPM:

• The PE Firm forms a management service organization (MSO) that acquires all the assets of the physician practice.
• The purchase price for the practice is based on a multiple (g. 10x) of a negotiated percentage of the practice’s cash flow (e.g. 30 percent) and is paid up front to the physicians in cash and equity in the MSO, with the equity portion being issued on a pre-tax basis.
• A new professional services entity owned by a friendly physician employs the physicians and is responsible for delivery of the professional medical services.
• The MSO enters into a management agreement with new professional services entity, in which the management fee equals the negotiated percentage (g. 30 percent) of cash flow that was used to calculate the initial purchase price.
• Under the management agreement the MSO employs all the support staff and mid-levels and is responsible for the ownership and development of all ancillary services, including any ambulatory surgical centers, imaging, laboratory, pharmacy, home health, and rehab therapy services.
• The physicians’ compensation for their professional services is based on the percentage of remaining percentage of cash flow after payment of the management fee.
• The physicians and the PE Firm would share in profits of the MSO in proportion to their respective ownership interests in the MSO.

The ownership structure of the MSO coupled with the physicians’ referrals to the ancillary services implicates several aspects of the Stark Law and the anti-kickback laws. We mention this here to provide a cautionary note only, as these laws are much too complex to include full discussion for this article. If properly structured, however, the physicians in the practice can refer their patient to the ancillary services maintained by the MSO.

There are several benefits to the physicians in these types of transactions:

1. The transaction gives physicians the ability to monetize of portion of the going concern value (or goodwill) of their practice today.
2. Physicians can focus on the practice of medicine and patient relationships as part of a much larger organization with more efficient “back office” functions and a focus on the development of proprietary practices and protocols for improved quality of services. These proprietary practices and protocols should result in more effective and efficient care, which is a growing component of physician compensation by third parties.
3. Physicians will have access to capital to develop a platform for the delivery of ancillary services.
4. With better control over the delivery of healthcare to their patients, the physicians and the MSO can negotiate new contracts involving risk shifting with managed care companies.

-Carmin Grandinetti and Daniel Fisher are partners with Bingham Greenebaum Doll in Louisville, Ky.