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Saving private practice? Navigating the legal and ethical minefield of physician-private equity deals

While physicians face incredible pressures to consolidate or receive investment to survive, there are ethical, legal and practical considerations doctors must seriously consider before deciding to take private equity. How can they get the investment they need to keep their doors open without ending up drowning in litigation? 

A growing number of physicians are opting to partner with a hospital or healthcare system to weather the bumps associated with medical practice: In 2019, over half decided to become employees in lieu of hanging a shingle. However, those doctors choosing to retain the autonomy of owning their practices are increasingly turning to private equity investment to infuse their businesses with capital and operating resources while providing an alternative way to profit from ownership and have an exit strategy.

Private equity has invested exponentially in United States healthcare delivery over the past twenty years. According to an article published in this month’s Health Affairs, the valuation of private equity deals in the U.S. healthcare sector was over $100 billion in 2018 — a twentyfold increase from 2000, when it was less than $5 billion.

What is the impact of private equity on the practice of medicine, and how can dealmakers avoid running afoul of their legal and ethical obligations?

“First, do no harm” or “Greed is good?”

Prof. Peter Jacobson Health Law and Policy at University of Michigan School of Public Health has long been concerned about private equity investment in healthcare and its impact on doctors’ commitment to their ethical obligations.

“As a general proposition, private equity is unlikely to foster health care’s tradition as a mission-based enterprise,” Prof. Jacobson said in an interview. “Instead, it is likely to put further pressure on nonprofit firms and physician practices to operate as essentially for-profit entities.”

While a California bill that sought to rein in private equity was shelved on Tuesday, federal oversight of private equity’s impact on the delivery of medical care is just ramping up.

“It’s past time for a bright light to be shined on how private equity in our health system affects patient safety, costs and jobs,” said House Ways and Means Committee on Oversight chairman Rep. Bill Pascrell in a March special hearing. Federal Trade Commissioner Rohit Chopra has gone so far as to call them “vulture investors,” and Senator Elizabeth Warren has promised an investigation into PE’s influence on the quality of medical care in nursing homes.

Following the money to specialty practice

Private equity firms have taken a particular interest in specialty physician practices, acquiring 355 physician practices from 2013 to 2016, according to research published in JAMA.

According to the Coalition Against Surprise Medical Billing, many of PE’s favored specialties are those that are most likely to lead to surprise bills for out-of-network care, which they argue can have significantly harmful financial impact on patients while delivering large gains for investors. 

Practices in oncology, ophthalmology, dermatology, orthopedic, urology, gastroenterology, and radiology are particularly attractive to private equity firms because of the opportunity to consolidate practices and generate increased revenues from ancillary services. While last year’s effort to combat surprise billing mostly failed, policymakers are concerned about the impact on healthcare costs associated with this trend.

For example, an analysis of commercial claims from the Health Care Cost Institute (2012–17) published recently found that by 2017 one in eleven dermatologists practiced in a private equity–owned practice, and at 18 months post-acquisition, prices paid to private equity dermatologists for routine medical visits were 3–5 percent higher than those paid to non–private equity dermatologists. Patient volume also increased, with PE-acquired dermatologists seeing up to 17 percent more patients than their non-PE dermatologist peers over the first two years post-acquisition. Braun’s analysis also found that PE targeted larger practices that saw more commercially insured patients than other practices, increasing their profit margin per patient.

Navigating the legal minefield

Despite these national trends, Breazeale, Sachse & Wilson LLP partner Clay J. Countryman says that while Congress and Biden administration may “bluster,” resulting in some legislative or regulatory action, specific oversight is likely to continue happening at the state level, where oversight varies widely.

Private equity firms generally create specialty-specific management companies that acquire the assets of a physician practice within that specialty through a combination of cash and restricted ownership in the management company.

However, according to Baker Donelson’s Michael Clark, as more states develop strong prohibitions against the corporate practice of medicine (CPOM), private equity firms may want to structure the transaction such that a physician practice continues to hold the practice assets — and for each party to hire separate counsel seasoned in CPOM restrictions.

To get around these issues, Patrick D. Souter and Andrew N. Meyercord of Gray Reed & McGraw LLP write that private equity terms may use a “friendly medical practice.”

This structure, known as a Friendly PC model, employs the physicians in the practice and is formed by one or more physicians licensed in the state where the medical practice is located, affiliated with the management company.

An alternative is the Captive PC Model, which provides for an agreement separate from the management services agreement that requires the physician-owner to transfer ownership of the Captive PC to another physician who is allowed to own the entity under state law. This model is frequently used in states that maintain strong CPOM laws that limit the ability of a layperson to own or control a medical practice.

However, whether as a Friendly PC or a Captive PC, they advise that physicians should ensure that the arrangement does not result in the management fee rising to the level of fee-splitting by charging above what is considered fair market value and commercially reasonable, or the management company controlling the practice decisions that should fall within the exclusive purview of the physician.

Protecting physicians’ interests

Given the risks associated with private equity investment, Countryman, who specializes in representing physicians in mergers and acquisitions, has three main recommendations for physicians considering private equity:

“First, I would focus on limiting the scope and duration of any non-compete covenant, which would be in the purchase offer or employment agreements,” Countryman said in a phone interview. “That’s to protect the individual physician in case they don’t like how things are working out 6 months or a year later.”

Countryman advises doctors to tightly rein in the number of years, geographic restriction or scope of services being restricted under the covenant, and while he acknowledged this may be challenging to negotiate, “it can keep you from having to move from your home state if things do not work out as planned.”

Second, he recommends keeping the physician’s practice entity in place.

“In this structure, the private equity firm buys stock or a membership interest in the physician’s LLC entity, then physicians continue to participate in the board or governance structure of that entity and their employment agreements could also be with their own entity,” Countryman said. “A positive thing about that is that if they do unwind or separate later on their practice entity is still in place and they could continue the practice in the name that is known in the community.”

Finally, Countryman advises physicians that pursue acquisition to focus on unwind provisions in the transaction documents that would allow them to unwind and buy back their practice.

“There are a lot of keys,” Countryman said, “but these three protect individual physicians, which get them comfortable with the transaction, and protect the overall practice potentially.”

Photo: nito100, Getty Images

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