What private equity's focus on health care means for you

A Law Review Q&A

Health care providers are no stranger to regulatory compliance. Health care is one of the most heavily regulated industries, and adhering to state Corporate Practice of Medicine (CPOM) laws and ensuring compliance with fraud and abuse statutes are evergreen issues. However, the emergence of private equity (PE) firms as health care strategic partners in recent years has pushed providers to view these issues through a new lens.

To learn more about the legal and strategic implications of PE investment in health care provider organizations, we spoke with Jennifer Malinovsky, a partner at Nelson Mullins Riley & Scarborough, L.L.P.

Q: Before we get into any legal discussion, why are we seeing an uptick in PE investment in health care? What sectors are seeing the most activity?

Jennifer Malinovsky: I'll start with the sectors where we have seen the most activity, then get into why that may be the case. Since about 2012, we've seen a lot of PE interest in ophthalmology, orthopedics, dermatology, behavioral health, imaging, and urgent care. And while the actual target group can vary, a lot of activity has centered on physician groups.

There's no single explanation as to why these sectors are seeing the most activity; provider and PE activity both are very deal specific. However, I do have a few thoughts on why these practice areas may have greater PE interest. First, many of these sectors receive a relatively higher proportion of commercial as opposed to government reimbursement. This relatively higher reimbursement rate, and relative freedom from government regulations, likely make these sectors more attractive to PE firms.

Second, many of these practices are synergistic with more lucrative ancillary services. For example, rather than a practice of general physicians who deliver E&M services, these specialties are naturally positioned to benefit from synergies with an ASC, imaging center, or even product sales. PE firms can therefore leverage these synergies to build economies of scale or cut costs in a streamlined manner.

Third, PE views health care as relatively recession-proof. While reimbursement programs or delivery structures may change, there will always be the need for health care.

Finally, PE sees physician group investment as an opportunity to overlay more efficient and effective management across practices that have quality physicians, good community reputations, and strategic geographic locations, but may lack efficient individual management.

As practices think about investment from these groups, what are the major compliance issues that need attention?

Malinovsky: Again, there are a few different issues. On a state level, first and foremost, is adherence to the Corporate Practice of Medicine (CPOM). Requirements vary on a state-by-state basis, which can present challenges for PE firms that acquire practices in different states and thus may need to structure acquisition arrangements in different ways. In addition, states have varying laws on fee-splitting, facility licensure requirements, and noncompetes.  

On a national level, many of the high-profile compliance issues still apply. Physician groups need to be aware of Stark Law and Anti-Kickback Statute which may affect referring practices and how revenues are rolled up. 

None of these are new regulations; both providers and PE firms just need to view them through a different lens.

Q: In that case, how are arrangements structured to avoid violating these regulations?

Malinovsky: One common approach is for the PE firm to establish a separate management company that the firm then owns or buys into. Typically, the PE-owned entity buys the non-clinical assets and provides all management-related services to the practice through a management services arrangement (e.g., administration, billing, collection, etc.). The practice, on the other hand, retains ownership of certain clinical equipment and supplies. It will continue to employ or contract with the clinical providers, and will retain oversight over and responsibility for patient care delivery. State laws also often dictate specific matters over which the practice must retain control, such as marketing and payer contracting.

To address CPOM issues, in many cases PE firms draft their documents to align with the most restrictive of the state laws in which they operate. The idea here is that if they successfully satisfy the requirements in the strictest state, they'll satisfy the requirements elsewhere.

Q: What are the keys to a successful relationship between a physician group and a PE firm?

Malinovsky: Both the PE firm and physician group should be aware that arrangements are NOT one size fits all.  PE firms trying to create synergies with their existing portfolio will seek out physician groups that complement those assets. Similarly, physician groups need to examine their own strategic priorities and consider PE firms that will help them make progress on those priorities. I would caution physician groups viewing PE purely as an infusion of capital and encourage them to ensure that any relationship is mutually beneficial from both a financial and strategic perspective.

From the start, it should also be clear to what extent PE firms will manage the practice. Some partnerships will solicit equal participation from PE and clinical management and leverage the expertise and experience of key physicians to help manage and grow the larger enterprise. In other cases, the PE firm may want to simply benefit from a practice's financial success with the expectation that the practice will keep current course and the PE group assume all management and administrative roles. Either way, successful relationships revolve around setting and agreeing on common goals and expectations on the front end.

Q: What other factors should organizations considering PE investment take into account?

Malinovsky: Practices exploring a potential sale to a PE firm should first and foremost ensure organizational structure, licensure, financials (including consideration of one-time extraordinary expenses) and provider/vendor contracts are in line before any negotiations progress. A practice which appropriately positions itself for a potential PE relationship is more likely to recognize higher value. Similarly, it's important to consider any potential tax and financial consequences of this kind of arrangement. In some cases, the PE group might buy everything out on the front end while in other arrangements, payment may be split into two parts – at initial purchase and when the practice is re-sold.  Neither one is better per se, but they will impact the practice in different ways.

It is also important to remember that PE groups generally want continued participation from providers from a clinical perspective for a period of time following purchase. After buying a practice, the firm will look to build synergies with their existing assets and will need practice buy-in to do so.  So while there are cases where PE purchase is the first step of an exit strategy, keep in mind that any impact may not be immediate.

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