By Alan H. Sonnenklar, Esq. & Seth A. Nadel, Esq.

Faced with the growing challenge of finding attractive investment opportunities, private-equity firms have increasingly turned to the healthcare industry to bolster returns for themselves and their investors.  In 2017, according to one estimate, the disclosed value of healthcare-related private equity deals reached roughly $42.6 billion.  Despite fundamental uncertainty in the healthcare market – much of it driven by the political climate – healthcare spending in the United States has grown faster than GDP for decades, and $3.5 trillion was spent on healthcare in 2017 alone.  With figures like these, it is not surprising that private equity firms would be focused on continuing to find ways to profit from the provision of healthcare goods and services.

Much of the recent growth in healthcare investment spending has focused on so-called “retail health care” – freestanding healthcare providers and facilities such as ambulatory surgery centers, urgent care facilities, and dental clinics.  In a striking contrast, while overall private equity deals have dropped almost 20% since 2014, the number of transactions involving retail health care have increased more than 30% according to some studies. 

The expanding presence of private equity in the healthcare marketplace, together with the related involvement of out-of-state investors traditionally unfamiliar with the unique regulatory framework in which the local healthcare industry operates, has compounded the complexity inherent to structuring and closing healthcare transactions in New York and other states that maintain historic restrictions on non-physician ownership of healthcare providers.  As a result, physicians and investors pursuing healthcare-related transactions need to pay particular attention to the many regulatory risks and roadblocks presented by these transactions, ideally at early stages of discussions.  This is particularly true in deals involving out-of-state private equity investors, who, despite their general business acumen and investment experience, often tend to be unfamiliar with the unique local regulatory framework in which healthcare facilities and providers operate.  Moreover, while private equity firms are faced with the prospect of increased deal costs or an unprofitable investment if a transaction is not structured in a compliant manner, physicians and other licensed professionals expose themselves to penalties such as loss of licensure, and termination from Medicare and commercial third-party payor plans, if a transaction is not properly structured.  Such risks are in addition to the generally applicable criminal sanctions and civil monetary penalties to which all participants in a non-complaint transaction are potentially subject – both investors and physicians alike.

Among the most important regulatory challenges faced by private equity firms and physicians in structuring healthcare transactions in New York and many other states is the long-standing legal prohibition against the “corporate practice of medicine.”  The corporate practice of medicine doctrine has traditionally limited the ability of non-professional individuals and entities from maintaining an ownership interest in healthcare facilities and providers.  Generally speaking, non-physician investors such as private equity funds are limited to ownership of management companies, administrative services companies and/or real estate entities (“MSOs”), and cannot invest directly in a healthcare provider such as an urgent care provider or large multispecialty practice.  Moreover, MSOs are typically restricted in their ability to participate directly in a percentage of the revenues generated by the healthcare provider, or to benefit directly from any growth in patient volume by the healthcare provider.  Rather, the revenues permitted to be generated by an MSO are often limited to the fair market value of the services, equipment, supplies and office space provided by the MSO.

Other regulatory hurdles faced by physicians and private equity firms considering healthcare transactions in New York and other states involve prohibitions such as the federal Anti-Kickback Statute, State and Federal Stark Laws, and the Medicare and Medicaid Anti-Markup Law, all of which must be considered when structuring the business relationships and the flow of funds within any healthcare transaction. 

In addition to the regulatory complexities involved when contemplating a private equity deal, physicians are faced with the typical business risks inherent to transacting business with experienced investors.  For example, in most private equity transactions physicians will be faced with decisions regarding the initial valuation of their healthcare practice or facility, the ownership percentages to be maintained by the physicians in the MSO, the levels of control over their practices or facilities that will be afforded to the physicians following the closing of the transaction, the ability of the physicians to remain owners of the MSO on a long-term basis and to participate in any growth and expansion experienced by the MSO, and future exit strategies.  All of these items, especially the valuation issues which often require specialized advice from outside financial consultants, need to be carefully evaluated by physicians and other healthcare providers considering participation in private equity transactions. 

Given the unique issues and risks faced by healthcare providers contemplating a transaction involving private equity funds or other outside investors, it is recommended that all participants in the transaction obtain competent legal counsel and financial advice, as early in the exploration and negotiation process as possible.

Weiss Zarett Brofman Sonnenklar & Levy, P.C. is a New York law firm providing a wide array of legal services to the members of the health care industry, including corporate and transactional matters, civil and administrative litigation, healthcare regulatory issues, bankruptcy and creditors' rights, and commercial real estate transactions.

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