Practice Acquisitions: Key Legal and Regulatory Considerations for Private Equity Firms and Physicians

April 04, 2022

Since 2016, there has been an overall sharp trend upwards in both the size and volume of health service transactions. After recovering from a dip in 2020 due to the outbreak of the COVID-19 pandemic, 2021 saw more than a 50% growth, with a particularly high upswing in acquisitions of physician practices.

According to PwC’s Health services: Deals 2022 outlook report, while long-term care was the most popular subsector, it was the number of deals targeting physician medical groups that was particularly notable: over 400 from November 15, 2020 through November 15, 2021. This compares to about 200 to 250 deals per year from 2017 through 2019.

If you are interested in Private Equity and Physician Practice Acquisitions, as part of our Morgan Lewis M&A Academy, we invite you to subscribe to Morgan Lewis publications to receive updates on trends, legal developments, and other relevant areas. 

Private Equity Investment in Physician Practice Groups

Physician practices are, in essence, small businesses that are being managed primarily by physicians with a full patient load. With this construct in mind, physicians are presented with many benefits and challenges when deciding whether to partner with a PE company.

  • Benefits: One of the largest motivators is having access to capital to enable the practice to keep up with ever-changing health technologies, particularly with electronic medical systems, which are expensive investments. By partnering with a PE company, the needed capital is provided, allowing physicians to focus on patient care and quality of services. Some other positive considerations for physician practice groups include earlier and larger liquidity opportunities than retirement or physician buyouts would present; capitalizing on brand recognition; efficiencies of scale by consolidating the back office; and consolidation opportunities.
  • Challenges: The actual acquisition of a physician practice is highly complex, compounded with the pressure and expectation to grow the practice. On a more individualized level, there is the loss of ownership and control of the business aspects of the practice and fear of commercialization of healthcare. Lastly, a lot of physicians have equity stakes in the PE investment, which can be a significant portion of the purchase price consideration, and there can be uncertainty as to when and how that “rollover” equity will be realized.

Special Structuring Considerations

When structuring a transaction, involved parties should focus early on tax structuring and transaction forms, as well as commercial issues such as third-party and corporate consents, deal process, and timing. Specific to healthcare transactions, parties in certain states must be aware of the corporate practice of medicine (CPOM), a state law doctrine that prohibits companies from profiting from the practice of medicine or directly employing a physician to provide professional medical services. To effectuate an acquisition in these states—for example, California, Texas, New York, and New Jersey—alternative structures, including the Friendly Physician Model and the Foundation Model, can be used.

In a healthcare provider acquisition, consents and notices are vital. The Change of Ownership (CHOW) comes into play with the Medicare and Medicaid programs; a Certificate of Need (CON) can be difficult to obtain as well as transfer and may be needed in a physician practice transaction; and state attorney notification can vary by state, ranging from a simple notification form to a full review period from an antitrust perspective.

Deal Intricacies for Physician Practice Acquisitions

When engaging in a physician practice acquisition, the transaction timeline is often extended as compared to many other areas of M&A, as diligence and negotiation efforts can take longer given corporate recordkeeping and physicians’ patient hours during the week. Buyers should also be aware of conflicting interests within the physician partner groups, due to varied ages and/or buying/selling the “family business.” Other aspects to take into consideration are converting the structure of a PLC and S corporation into an LLC and the varying state laws governing the change, as well as practice management documents.

Four Key Stages of a Physician Practice M&A Transaction

  1. Letter of Intent: As with non-healthcare areas of M&A transactions, the letter of intent (LOI) can be important and beneficial to the buyer and seller. For the buyer, the goal of the LOI is to get the seller under exclusivity. More often than not, these types of acquisitions are less competitive and the buyer may get a longer exclusivity period, as the due diligence process will take longer. For the seller, the LOI provides an opportunity to gather as much detail as possible on the terms of the transaction, such as sale price, employment agreements, covenant terms, etc.
  2. Due Diligence: By performing due diligence, involved parties mitigate risk by identifying early-on healthcare-related compliance issues. In transactions where the buyer plans to obtain representation and warranty insurance (RWI) coverage, or the buyer is obtaining debt financing, comprehensive legal due diligence and accompanying reports are required. However, even when RWI coverage and debt financing are not in play, organized and thoughtful due diligence can be critical.
    • Key regulatory issues will vary based on physician practice specialty, such as ortho, GI, women’s health, substance abuse, and hospital-based specialties. Diligence should be customized by specialty.
    • Healthcare regulatory due diligence typically consists of the following: written diligence requests for documents and information; engaging experts to conduct billing and coding review and fair market value evaluations; and management interview with physician owner or practice administrator.
    • When performing healthcare diligence, common areas to review include assessing an existing full or partial compliance program, reviewing payor agreements, analyzing fraud and abuse risk, reviewing at billing and coding programs, confirming necessary licensure/CPOM, and evaluating privacy compliance.
    • Physician practices should conduct due diligence for their non-healthcare items as well, including, most notably, employment and employee benefits matters, corporate and material contracts, real estate, intellectual property, and others.
  3. Transaction Documents: In the primary transaction document, rollover equity is often a huge component of any physician practice acquisition, since buyers need the selling physicians to remain invested in the practices post-sale or otherwise risk having them leave or retire. Buyers will want to consider early on what percentage of rollover they expect selling physicians to maintain, who the rollover participants will be, and how best to structure in a tax-efficient way for both buyer and sellers. The acquisition agreement must also give due consideration to purchase price adjustment mechanics, sufficient representations and warranties and indemnity obligations, and appropriately tailored restrictive covenants. Perhaps even more negotiated than the primary purchase agreement is the new set of employment agreements created for the selling physicians, given they are often coming from a place where they were the sole owners in charge of everything. For a PE company, another important set of transaction documents is the practice management documents, including the management services agreement. This includes making sure physicians are aware of associated management fees, as well as the Directed Equity Transfer Agreement. Other documents and attachments effectuate the provision of administrative and management services on a non-clinical services basis.
  4. Post-Closing Obligations: For a PE firm, some healthcare-related items on their post-closing list should include notifying government agencies of a “change of information” filing (often within 30 days of closing) as well as relevant notifications to licensing agencies and commercial payors. Buyers should closely track due diligence recommendations stemming from the preclosing due diligence process, and build a plan to cover themselves from a compliance and legal perspective, but also set up themselves up for success in future exit transactions.