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Sale to Private Equity - Part 2

This is the second part of a three-part series of articles pertaining to the sale of physician practices to private equity firms. The first installment addressed the environment that is encouraging such sales, as well as the purchase price of such sales. This second installment pertains to tax considerations and allocations of the purchase price, and the third installment to the deal structure, and the pros and cons of such sales.

Prior to the COVID-19 crisis, physicians were selling their practices to private equity companies at an ever-increasing pace. While those acquisitions have slowed, the pace will likely quicken as health care begins to normalize. Accordingly, it is important for physicians to understand the reasons, elements and pros and cons of such transactions.

Avoiding Double Taxation

When selling a practice to a private equity firm, the deal can be structured either as the sale of assets or the sale of the owner’s ownership interest in the practice.

Sometimes, a private equity firm will purchase an owner’s ownership interest if the target practice is a platform practice. In other words, the private equity firm may want the target’s tax i.d. number and its relationship with payors to allow the private equity firm to enter the market in a particular medical specialty. 

However, if the target is a tuck-in, to be bolted onto an existing platform, it is likely that the acquisition will be structured as the purchase of assets, because the private equity firm will not want to be saddled with the liabilities of the target practice, which liabilities follow the purchase of an owner’s interest, while those liabilities generally do not follow the purchase of assets. 

If the target practice is a C Corporation, the sale of assets is a problem, because the practice itself will have to pay taxes on the purchase price, and then taxes will also have to be paid by the owners of the C Corporation when the proceeds of the sale are distributed to the owners.

Such double taxation can be avoided if the target practice is an S Corp, and, in fact, there is no reason why any physician practice should still be a C Corp.

Accountants will sometimes advise their physician C Corp practices not to convert to S Corp status because of something called built-in gain. While built-in gain is created upon the conversion of a practice from C to S, the problems associated with such built-in gain vanish after five years, and, therefore, the sooner a practice converts, the sooner it can be sold without double taxation. 

One type of physician practice has been successful in avoiding double taxation even when it is a C Corp, namely, a physician practice that has a solo owner who does not have a non-compete with the practice. Such owners can allocate the purchase price to themselves and call it personal goodwill. However, practices with multiple owners who have non-competes and are still C Corps will not be able to avail themselves of that alternative.

Creating Capital Gains

Often, one of the driving factors of selling a physician practice to a private equity firm is turning ordinary income into capital gains. 

The foregoing can best be explained by an example. If one assumes that a physician is presently earning $600,000 per year and pays approximately 40% of that amount in federal and state taxes, that physician is taking $360,000 home each year, and over five years, would be taking $1,800,000 home (5 x $360,000 = $1,800,000).

If one assumes that the private equity firm asks that physician to work for another five years, but at a 30% reduction in salary, then that physician would be making $420,000 over each of the next five years, and, again, assuming a 40% combined federal and state tax rate, that physician would be taking $252,000 home each year, or $1,260,000 over the five years.

By agreeing to work for $420,000, instead of $600,000, and assuming that all other variables stay the same, then the physician’s 30% cut in pay creates $180,000 of additional earnings before interest, taxes, depreciation and amortization (EBITDA) for the practice. If the private equity firm pays the physician 7 times that additional EBITDA, then the purchase price would be $1,260,000. However, the combined state and federal capital gains tax is only 25%. Therefore, the $1,260,000 purchase price would generally leave $945,000 of cash for the physician.

Accordingly, agreeing to sell the practice for $1,260,000, plus agreeing to work at $420,000 per year, would result in the physician taking home $2,205,000 over 5 years ($945,000 + $1,260,000). If the physician did not make the sale, the physician would net $1,800,000 by retaining his or her $600,000 per year salary. In this example, selling to private equity nets this physician an extra $405,000, or an extra 22.5%.

Allocations Among Physicians

Once a physician practice’s EBITDA has been normalized, and a purchase price has been agreed upon, a question that often arises is whether that purchase price is paid equally to all owners or whether some owners should be paid more or less than others. Similarly, there may be some non-owners whose continued participation in the acquired practice is critical, and some amounts of the purchase price might have to be allocated to them also. 

Allocating money among physicians is often one of the most sensitive aspects of any transaction with private equity, and often requires the most creative lawyering on behalf of attorneys representing physician sellers.

Rollover Equity

All of the foregoing has assumed that all of the purchase price being paid by a private equity firm to a physician would be paid in cash. While every deal is different, and some deals may be all cash or no cash the average deal often involves the payment of 75% of the purchase price in cash and 25% of the purchase price paid in what is called rollover equity, which is an ownership interest in the new practice going forward.

An attorney for a physician group that is becoming the platform practice of a private equity firm may be able to negotiate certain sophisticated concepts affecting rollover equity. However, an attorney for a physician group that is to be tucked in or bolted on an already formed practice will basically only have the job of explaining these sophisticated concepts to his or her client. 

These concepts will include tag-along and drag-along rights. When the private equity company resells the physician practice, will the old physician owners have the right to tag along and remain owners or will they get cashed out at that point? Similarly, will the private equity firm have the ability to drag along the owners whether they want to remain owners or not?

Although once a physician sells his or her practice to a private equity company, it is not customary for the private equity company to be able to call on the old owner to put in additional capital to the practice; such capital calls are sometimes part of a deal, especially in regard to a platform acquisition, recognizing that additional capital may be needed to purchase tuck-in practices. 

Likely, the physician owner’s interest in the practice will continue to be diluted as the practice is sold and resold, and sometimes the physician owners will want the ability to invest additional money if they like the subsequent acquirer. 

While rollover equity could turn out to be of extraordinary benefit to the physician selling his or her practice, the most sensible way of viewing rollover equity is that it is nothing more or less than a lottery ticket. Just as one would be happy to accept a lottery ticket from someone, and that lottery ticket might turn out to be very valuable, physicians should be happy with the sale of their practice even if the rollover equity turns out to be a valueless lottery ticket. 

Once physician revenue stabilizes after the COVID-19 crisis, all of the environmental factors, such as money attracting money and market fragmentation, will still exist, and, therefore, the volume of private equity physician acquisition deals in the future will remain significant.


Barry F. Rosen
410-576-4224 • brosen@gfrlaw.com

A version of this article was published in The Daily Record on December 16, 2020.


December 14, 2020




Rosen, Barry F.


Health Care