Healthcare M&A: The Case for Private Equity Investment in Medical Practices
The business landscape for medical practices and healthcare providers is more complex than ever before. Evolving regulations, increased political attention, and a global pandemic have put the nation’s spotlight squarely on the healthcare field. And while the public may be focused on providers’ ability to serve patients sufficiently and efficiently, individuals operating medical practices are left to worry about how they can still remain profitable in this new and challenging world.
Even before COVID-19 turned much of the healthcare space on its head in 2020, providers and independent medical practices were increasingly turning to private equity investment as a way to mitigate these risks. In fact, healthcare saw more than 300 private equity deals in 2019 totaling more than $78 billion – the highest values ever recorded, according to findings from Bain and Company. These trends are nothing new, however, as private equity activity in healthcare has been steadily increasing for nearly a decade. Owners of medical practices have been realizing the benefits of selling off a partial or majority stake in their business for some time.
However, that doesn’t make the decision to sell an easy one. For providers concerned about their ability to serve patients while remaining profitable, getting private equity involved comes with plenty of questions. Is it better to sell to a private equity group or to a nearby hospital? How much independence is lost by selling to a private equity group? Are there any regulatory issues? How are these deals typically structured?
After overseeing countless healthcare transactions over the years and counseling medical practices on how to navigate the complexities of private equity investment in a way that benefits the physician-owners and patients alike, we have developed a list of several factors to consider before deciding if private equity investment is the right move for your practice.
1. Selling a medical practice to a private equity group removes administrative burden and allows physicians to focus on the practice of medicine.
It’s safe to say that most physicians are interested in their field not because they have a strong desire to run a business, but because they have a passion for medicine and serving patients. But by owning a practice, these doctors are left to handle the burden of managing a business and its employees, ensuring that business is profitable in the short and long term, and of course, practicing medicine.
By selling a practice to a private equity group, who then often installs a Management Services Organization (MSO) to provide day-to-day operational support, doctors and staff are left to focus solely on the practice of medicine. Meanwhile, the MSO provides the practice with non-clinical administrative services or practice management tools, such as billing, accounting, management, human resources, non-clinical personnel and even the simple tasks of purchasing office supplies and equipment and providing office space.
2. Benefits of selling to a private equity group often outweigh the benefits of selling a practice to a hospital or other health system.
When it comes to selling a medical practice, owners have a handful of avenues they can pursue. One that many initially consider is selling a practice to a local hospital or other health system. And while this may seem like a logical option, it does come with some downsides.
By selling to a hospital, a medical practice will almost assuredly lose the control they once had over how their practice operates. Typically, hospital management will take over and run the practice in a way that fits their pre-defined business model. Additionally, hospitals face more regulatory hurdles than private equity firms mainly in the form of self-referral prohibitions and tax-exemption issues.
Lastly, but perhaps most importantly, the potential sale price is often significantly higher when selling to a private equity group versus selling to a hospital or health system. Typically, a health system will structure an acquisition by simply offering to purchase a medical practice’s fixed assets and offer long-term employment arrangements to the selling physicians. In contrast, private equity groups have significant investment capital and can offer much higher purchase price multiples of the practice’s Earnings Before Interest, Taxes, Depreciation and Amortization, more commonly referred to by its acronym, “EBITDA.”
3. Private equity investment offers multiple ways to structure deals.
From different forms of investment to the size of the stake purchased, private equity deals in medical practices can vary wildly depending on a number of factors. Forms of investment can include purchases of equity, debt, assets or contracts. Additionally, some private equity groups may decide to form a joint venture or new business, again, depending on the specific medical practice and the private equity group’s risk tolerance.
One common misconception about private equity deals is that the buyer always purchases a controlling interest or majority stake in the business. However, that’s not necessarily the case. Some private equity groups prefer a minority stake if the proper controls are in place, and it keeps physician-owners more involved in the success of the practice. Again, terms can differ greatly on each deal and should be ironed out well in advance as part of the letter of intent (LOI).
4. Regulatory issues, including Corporate Practice of Medicine Laws, must be considered as part of any transaction involving a medical practice.
Assessing all regulatory requirements well in advance is a critical step in any acquisition. For transactions of this type, the stakes are even higher. From fee-splitting laws, securities laws and licensure requirements, to highly complicated insurance and self-referral or Stark Law, there are many issues that must be addressed to ensure federal, state and local compliance.
Corporate Practice of Medicine Laws (CPOM) are intended to protect the public and physicians from abuses that could result from the commercial exploitation of a medical practice. These laws vary by state but they typically prohibit non-licensed persons, including business entities, from employing physicians to practice medicine on their behalf and often require medical professionals to practice through certain types of business entities. In essence, this means that even if a private equity group takes a majority stake in a business, CPOM laws help physicians retain control of the practice.
5. Private equity investment gives practices the capital to modernize or upgrade their offering, benefiting existing patients and increasing patient populations.
An unfortunate reality of operating a medical practice today is that few possess the capital on hand to modernize their practice to keep up with newer technologies and services, especially in the area of information technology. This ultimately limits their profitability and ability to attract new patients.
With private equity investment, practices can usually upgrade technology, which then allows physicians to assess and improve patient outcomes, join Accountable Care Organizations and other population health initiatives, recruit younger physicians, and overall grow the practice.
Making the decision to sell all or some equity in a business is not easy. There are a number of factors that should be considered before coming to any agreement with a potential buyer. That said, private equity investment in the healthcare field has continued to deliver significant returns for owners with little downside to staff or patient populations. Retaining expert legal counsel who can guide sellers through the decision and eventual structuring, negotiation and documentation of the transaction is an important step in ensuring the best possible outcome for all stakeholders.
Read additional articles in our Convergence: M&A in Healthcare series:
Healthcare M&A: What Decision Makers Need to Know Before Partnering
Healthcare M&A: Unlikely Alliances in Healthcare: Payors and Providers Are Teaming Up to Create Value
Our transactional know-how is fueled by our extensive M&A client work. Over the last few years, Buchanan Ingersoll & Rooney has led 40+ major healthcare deals valued at more than $20 billion.