As a physician, you have built a successful medical practice that has served you well in the past. However, it is essential to consider whether your current model will continue to thrive in the future. This article will delve into the potential transformations your physician practice may undergo within the next five years. We will address crucial inquiries that lie ahead: Will your practice maintain its independence, or will you explore collaborations with hospital-supported physician groups? Is merging with a larger practice an avenue worth considering? Have you contemplated the possibility of selling your practice to private equity investors? Furthermore, we will delve into the financial aspects, including the capital requirements for technological advancements, infrastructure upgrades, and ancillary services. Additionally, we will underscore the significance of data analysis in optimizing billing processes, maximizing revenue collection, and evaluating provider productivity.
Mergers and Sales to a Large Practice or Hospital-Supported Physician Group
One option to consider is a merger or sale to a larger practice or hospital-supported physician group. Although this may involve some loss of autonomy, increased accountability, and greater oversight, there are several benefits to consider. You may experience relief from many administrative responsibilities, a more efficient use of clinical and non-clinical resources (labor and supplies), and improved physician production. Another benefit may be additional resources and talent to build or expand ancillary services to enhance the profitability of the practice.
The nature of the practice's profile will be influenced by the type of merger that takes place, whether it is an integrated practice model or a divisional arrangement. In single specialty groups, an integrated group practice is more common. In an integrated practice arrangement, your existing group will cease to exist in a relatively short period. The physicians will identify as partners in the merged group, and office operations will follow a common set of rules and procedures so that patients will have the same experience walking into any office within the practice. Compensation for individual partners would generally be determined under a standard income allocation formula.
Divisional mergers are frequently observed in multi-specialty groups, offering joining practices a greater degree of autonomy. Divisions would, in many cases, separately compute net income, which would then be shared among the division partners in a regulatory-compliant manner. Common practice overhead for billing expenses, and practice management salaries and benefits would be allocated to the divisions under an agreed-upon formula.
The purchase price for a practice merging with another practice or health system will generally be significantly less than that of a private equity transaction. In some cases, there will not be any upfront purchase price, only the promise of increased profits based on more efficient operations, enhanced services and resources, and better payor contracts. The merging group trades off the upfront payment for increased individual partner compensation.
In a private equity (PE) transaction, the selling partners will see a reduction in their annual compensation, offset to some extent by a higher purchase price, and future profit opportunities in the management company created as part of the PE transaction structure.
In a merger into a hospital system, the hospital will create a captive professional corporation (PC) that will employ the physicians. Be aware that even the former partners of the old practice will be employees in the hospital’s physician practice entity. Additionally, ancillary services and profits are provided by the hospital. In a merger into a larger private practice, these would remain in the practice.
Selling to private equity
An alternative to merging with a hospital or larger group practice is selling your practice to private equity. This option allows physicians to retain ownership and a certain degree of autonomy while benefiting from the financial support and expertise of private equity investors. Unlike hospital acquisitions, private equity investors are primarily interested in a practice’s current and future cash flow. PE investors will only be successful if a practice can significantly increase cash flow through expansion and improvement of non-clinical efficiencies.
In a sale to a PE investor, the physician practice entity stays in place and continues to be owned by one or more of the original partners. In many states, including New York, the corporate practice of medicine prohibits non-physicians from owning a medical practice. The PE investor will also form a management services organization (MSO) that will contract to provide all non-clinical services to the practice, such as billing, management, and non-clinical labor.
These services are delineated in a management services agreement (MSA) between the practice and the MSO. It is important that the contracted fees for these services meet fair market value standards to avoid regulatory issues. Generally, PE investors will value and pay a multiple of normalized earnings before interest, taxes, depreciation, and amortization (EBITDA) for a practice. EBITDA represents the net free cash flow of a practice. The sale price is typically allocated between an up-front cash at closing payment, an earnout payment (more common in the post-COVID years) and an equity investment in the MSO.
Post-acquisition, the PE financial sponsor and the physicians will own the MSO. In addition, after the acquisition of the practice, physician compensation will be reduced to a fair market level, which will provide the cash flow required for the MSO management fee and simultaneously build value in the MSO. Additionally, unlike a sale to a hospital or a larger group practice, physicians, through their equity ownership in the MSO, can continue to participate in the upside of additional sales transactions when the PE investor sells the MSO. A “second bite of the apple” typically occurs within five years of a private equity fund's initial investment.
The PE investor's focus typically lies in establishing an initial platform centered around a single specialty or multi-specialty group that presents substantial opportunities for ancillary revenue sources, such as oncology and hematology, orthopedics, or gastroenterology. After the initial transaction, the newly formed entity will look to acquire other smaller practices to continue to build scale. Those subsequent acquisitions are valued at smaller EBITDA multiples than the initial transaction but are still attractive to the smaller practices looking to join a bigger platform.
The future of physician practices is dynamic, with various paths to consider. Whether you choose to remain independent, explore a merger with a hospital-supported group, or engage with private equity, it's essential to assess the capital requirements, analyze the data, and evaluate the potential benefits and trade-offs.
If you have any questions on how to navigate these options strategically and position your practice for success in the evolving healthcare landscape, reach out to our Healthcare Transactions professionals or Blake Spina at firstname.lastname@example.org
Our specialists are here to help.
Get in touch with a specialist in your industry today.