Trends in buying and selling medical practices

Trends in buying and selling medical practices: ©holwichaikawee - stock.adobe.com

Across the country, independent physician practices continue to sell to hospitals, private equity investors, insurance companies and other private professional buyers. According to the American Medical Association, the share of physicians working in private practices, or those wholly-owned by physicians, fell by 13% between 2012 and 2022 — from 60.1% to 46.7%. The percentage of physicians working in practices at least partially owned by a hospital or health system increased by almost 8% during that time period, while the share of physicians working in hospitals increased by 4%. It is unclear whether this trend will continue or reverse itself, but it is clear that physicians are driving health care developments.

Although the economy has recently impacted the ability of many buyers to acquire funds to complete as many acquisitions as in the past, activity related to the sale of independent practices remains strong. This is particularly true in certain geographical regions and within certain specialties. While buyers are still interested in acquiring health care businesses, there is a trend among certain buyers toward lower multiples when calculating business value, reduced cash paid at closing, and other creative financial structuring. For example, some investment banking/private equity buyers are now requiring physician practice sellers to take a larger percentage of the purchase price through “rollover” units in the buyer’s business or an affiliate.Other PE buyers are capping potential earnouts that physicians can achieve or are paying part of the purchase price through apromissory note that offers minimal interest, but also extends payments over a significant amount of time. There are many other innovative financing approaches being used as well to address the challenges due to a shortage of cash and higher interest rates, but certainly the deals are becoming less lucrative.

To address the changing landscape of health care transactions, practices must consider many factors, including these common challenges:

Choosing the right buyer

For physicians desiring to sell a practice in the near future, advance preparation is highly recommended. Every practice should engage in a review of its financial, legal, and operational systems to best position itself financially and to address any legal, billing, compliance, human resource, or other issues that may exist. It is always ideal to evaluate the practice carefully before undergoing due diligence with a potential buyer. Unexpected discoveries can cause a reduction in purchase price, delay closing, or derail the entire transaction.

There are different ways in which physicians can locate interested buyers, especially if they have a preference for a certain type of buyer (e.g., physician/practice, hospital or private equity). While local physician practices and hospital buyers may be easier to locate simply through connections or word of mouth, many physician practices do elect to use practice brokers when looking for a private equity buyer. In selecting the right kind of buyer, physicians must always first consider why they are selling. For a practitioner looking to retire quickly, they will not find private equity a good fit since the deals typically require a physician to commit to remaining employed for 3-5 years following closing. In such cases, selling to a local physician or hospital is a much better option, though even these buyers generally are looking for some time commitment to transition the practice after closing.

Physicians who are willing to commit to work for private equity often view the sale as a retirement approach. The significant cash payment at closing and potential rollover investment in the buyer or its affiliate, can serve as a valuable exit strategy. However, there can be a significant difference in working for private equity versus a hospital or private practice. Although many private equity buyers have taken steps to replicate the independent practice experience for practices they acquire, because of the need to generate profit there always will be a struggle among the goals of patient care, physician independence, and financial success.

Although every transaction is different, many physicians are looking for a buyer who offers more than a retirement strategy. This may include a promise to take over administrative burdens, obtain better payor contracts, provide infrastructure and operational support and other challenges that physicians are tired of handling. Taking on the burden of staffing, human resource issues, benefit costs, and similar issues also are big selling points. Of course, physicians need to make sure that even with all these benefits being offered, they still are finding the right partner who will not interfere with physician independence and decision making.

State reporting requirements

A new challenge for practice buyers is the increase in state scrutiny of health care transactions.A number of states have passed new laws that require some level of approval related to health care transactions. Typically, these laws are trying to capture transactions that are not large enough to trigger federal antitrust filings under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, which mandates pre-transaction reporting of significant transactions to the Federal Trade Commission and the U.S. Department of Justice Antitrust Division. The goal of these new laws is to give states the ability to evaluate the potential impact of healthcare transactions within their borders. A good example of this legislation is a recently enacted California law addressing health care transaction oversight. This law requires “health care entities” to notify a state agency of “material change transactions” 90 days prior to closing and applies to deals anticipated to close April 1, 2024 or later. As of Jan. 1, 2024, the following states also have reporting requirements for health care transactions: Connecticut, Colorado, Hawaii, Illinois, Massachusetts, Minnesota, Nevada, New York, Oregon, Rhode Island, Vermont and Washington, with similar laws pending in other states. Each state law is different and must be reviewed for applicability to a transaction.

Legal reporting requirements under these new laws can cause delays or even prevent a transaction from occurring if it cannot be completed in a timely manner or if a party to the transaction is unable or unwilling to comply with a state’s requirements. In most cases, the reporting will result in confidential information being shared and competitors possibly becoming aware of a potential transaction. It is important to note that the application of these reporting laws usually is based on the size of the transaction, so smaller transactions may not be impacted.It is difficult to know yet how these regulations, and any new ones that are passed in the coming years, willimpact health care transactions. However, it is essential for physician practices, their potential buyers and counsel to be aware of the requirements of the state(s) in which they are looking to complete a transaction. In some larger transactions, more than one state’s law could be applicable as well.

Corporate practice of medicine

When it comes to hospital or physician buyers, there often is synergy in allocating responsibilities and assuring decisions are properly made by clinical personnel. The issue becomes more complicated with private equity buyers who acquire a practice using a structure that allows them to somewhat control the professional practice. This structure is needed since many state laws prohibit what is commonly known as the corporate practice of medicine (CPOM). CPOM is a doctrine in which unlicensed individuals cannot engage or interfere in the practice of medicine or own a medical practice. In many states, there are formal laws or advisory opinions related to CPOM. To address CPOM limitations, private equity buyers and others seeking to manage professional practices will form a management service organization (MSO), which is a business entity that can be owned by unlicensed investors. The MSO enters into a management agreement with the professional entity (owned by a “friendly physician”) to manage the practice and provide services that are not otherwise prohibited by a state’s CPOM laws.

A common complaint from physicians who have sold to private equity is that private equity owners violate CPOM and interfere with physician decisions. A good example of this complaint is made in a California lawsuit against Envision Healthcare, which is facing a challenge from the American Academy of Emergency Medicine. The case accuses Envision of violating CPOM by exercising too much control over the physicians working under their model in violation of the CPOM prohibition in California. However, proceedings have been on pause since May 2023, when the defendant filed for bankruptcy. Although it is unclear if and when the case will resume, it is possible for other similar claims to be brough in California or other states with similar CPOM laws. Arguments about private equity overstepping CPOM laws include complaints about private equity establishing medical protocols, setting staffing levels, establishing patient encounter quotas, and determining physician best practices and quality metrics. Additionally, most private equity controls all medical billing, hiring and terminations of clinical staff, the setting of compensation for clinical providers and establishing terms of employment. It is uncertain exactly what types of services a particular court would find to be an actual CPOM violation; however, private equity buyers are watching the case carefully and adjusting their own transaction approach.

Physicians also need to take steps to make sure that they argue for a partnership with private equity that will not violate the CPOM. Putting all financial and operational issues into the hands of the MSO will arguably leave the professional entity with little to no control over its day-to-day operations and administration. It is critical that practice counsel take time to carefully negotiate the management agreement to limit MSO control where possible and ensure that all professional decisions are the sole purview of the practice and its providers. One approach growing in popularity in private equity transactions is the establishment of a physician governance board, which is assigned certain responsibilities in an effort to assure physician control over key decision-making that could impact the practice of medicine. This might include decisions like staffing levels, hiring and firing physicians, services and treatments offered, and clinical policies related to health care practice. The introduction of a physician governance board is a very important development for those physicians who want to sell to private equity, but still maintain clinical independence. It is also reassuring for patients who are concerned about whether their care is actually controlled by a physician once a practice is acquired.

Although transactions involving physician practices remains fairly strong across the country, it is significant that physicians continue to start new practices and grow existing independent practices every day. Many physicians feel very strongly about the right to maintain their independence and other physicians, who previously sold practices to hospitals or private equity, have been known to return to independent practice or start their own physician-led ventures. With increased regulatory oversight and growing concerns about CPOM, we can expect there to be an impact on physicians and the decisions they make related to the practice of medicine and their role in the health care world. Physician leadership in medicine, whether as doctors, practice owners or private equity partners, is essential for the country’s health care system and the business of health care as a whole.

Ericka L. Adler is a shareholder and manager of the Health Care practice group at Roetzel & Andress in Chicago. She can be reached at eadler@ralaw.com.