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Sale to Private Equity - Part 3

This is the third 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. The second installment pertained to tax considerations and allocations of the purchase price. This third installment discusses 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.

Due Diligence

Once a purchase price is agreed upon between a private equity firm and a physician practice, the private equity firm will have its lawyers and its consultants perform due diligence on the physician practice target to confirm that the financial information being relied upon is correct, and to determine if there are irregularities that would give the buyer headaches in the future. 

The buyer’s due diligence will focus on, among other things, the physician practice’s relationships with entities to which it refers, and entities that refer to it, to make sure the relationships are in compliance with applicable law. Similarly, the due diligence will try to determine if the practice entity has any billing irregularities, including any upcoding.

In fact, although all physician practices should have vibrant compliance programs and always be structured in compliance with applicable law, it is often a private equity firm’s “due diligence police” that will uncover an irregularity before a regulator might find that irregularity. 

Therefore, physician practices that are imagining an eventual sale to a private equity company have an additional reason to comply with the law, namely to avoid a private equity company backing out of a lucrative deal because of the irregularities that the due diligence police find during their examination of the practice.

Deal Structure

The acquisition documents of a private equity firm’s purchase of a physician practice are similar to the acquisition documents used in the purchase and sale of any business. The seller will make representations and warranties about itself, and indemnify the buyer from breaches of those promises and from liabilities that pre-date the purchase. 

The parties will negotiate how long that indemnification will expose the seller, whether there is any tolerance before the indemnification is triggered, and whether some of the purchase price will be held back or placed in escrow to support such indemnification.

Organizational Structure

The law in all 50 states varies with respect to whether people who are not licensed to practice medicine may own a company that practices medicine. As a result, the target physician practice may often be purchased by a captive physician practice that is actually owned by a nominee physician, with that captive practice being subject to a management agreement. 

That management agreement will provide that money not needed to pay physicians and other clinicians is transferred to the management company, and it will actually be the management company that is owned by the private equity firm.

In this regard, it is significant to note that private equity funds are different than management companies. Private equity funds expect to receive current earnings from their portfolio companies, but their focus is to profit from the sale of their interests, while a management company’s focus is on current earnings via management.

Pros and Cons

The most significant pro involved in a physician’s sale to private equity is the potentially lucrative purchase price, especially for baby boomer owners looking for an exit strategy. 

The transaction may also provide access to new capital to support growth, offer management expertise, capitalize on brand recognition, give the practice an ability to build out ancillary services, create cost savings from consolidating back office functions, achieve other economies of scale, and perhaps allow for more favorable contracts with payors.

The cons of doing such a deal include losing control of the practice and living through a significant change in practice culture. Curiously, private equity firms often leave physicians alone to be physicians, but major decisions, such as hiring and firing or changing office locations, will no longer be made by the previous owners. In fact, it is often difficult for such owners to learn to become employees.

However, perhaps the most significant con to selling to private equity firms involves wrestling with the question of who is the next owner. Private equity firms will resell the practice and no one knows who the eventual purchaser will be. 

The eventual purchaser may be a very efficient professional manager, which would be a good outcome. On the other hand, the physician practice may turn into a hot potato, and be sold from one private equity firm to another, until a private equity firm buys the practice for too much money. Also, the first private equity firm or a subsequent private equity firm may be using debt to finance its purchases, as opposed to investors’ money, and that debt could eventually weigh down the practice in its entirety. 

There is also the ultimate risk of physician loyalty. People usually seek out a physician’s services due to the skill and reputation of the physician. If the private equity firm cannot attract and retain good physicians, then the enterprise will not succeed.

Hospital System vs. Private Equity

There are differences between being purchased by a private equity firm versus being purchased by a local hospital system. 

The most significant difference is the sale price. Hospital systems are not paying physicians multiples of earnings before interest, taxes, depreciation and amortization (EBITDA) for their practices. Hospitals are prohibited from doing so, because the extra payment may be viewed as a payment for future referrals to the hospital system. 

There is an exception to the foregoing. If the physician is actually intending to retire after the sale, in which case there would not be future referrals, a hospital system can pay some additional amounts in that situation.

Otherwise, hospital systems sometimes pay signing or retention bonuses. However, generally, hospitals only pay for the assets that they purchase, and sometimes pay for something called workforce in place. Workforce in place is basically a headhunting fee equal to a percentage of the acquired practice’s payroll, paid in consideration of the acquired practice having developed its workforce. 

Both hospitals and private equity firms will allow an acquired practice to retain its accounts receivable, and both may advance or reimburse a selling physician for the cost of the doctor obtaining a malpractice tail to cover his or her prior acts.

On the other hand, ongoing compensation may be much more generous from a local hospital system than a private equity firm. In fact, future compensation from a hospital system may even include a raise, recognizing that the hospital system may have better contracts with payors than the acquired practice. 

Ongoing compensation from a hospital system might also be based on wRVUs, which would relieve the physician from worrying whether a patient is a Medicaid patient, Medicare patient or has commercial insurance.

Hospital systems, however, have difficulties in paying acquired physicians for the ancillaries that they generate, due to certain legal restraints, notwithstanding that the acquired physicians may have historically profited from the ancillaries that they provided in their own practices. Nevertheless, hospital systems can be creative in this regard and can share some of such profits with physicians, provided that certain legal requirements are met. 

Often, there is more room to negotiate some flexibility in regard to noncompete provisions with an acquisition by a hospital system, rather than private equity firms. 

While the headaches of management are relieved by a sale to either a local hospital system or a private equity firm, curiously, hospital systems sometimes get more involved in a doctor’s doctoring than private equity firms.

While all local hospitals will not survive, many will, and, therefore, there is greater stability involved in selling to a hospital system versus not knowing to whom the private equity firm will sell the physician’s practice in three to five years.

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 January 19, 2021.


March 21, 2021




Rosen, Barry F.


Health Care