When healthcare providers consider their options with respect to selling their practices, many providers are entertaining the idea of selling their practices to a private equity firm. While this may seem very enticing to many providers as the purchase price is often higher than that offered by another buyer (usually a multiple of Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”)), it is important to understand how these deals are structured in order to comply with applicable law, as well as evaluate the risks and benefits associated with entering into such transactions.
How Private Equity Works
Private equity firms raise money from investors and pool that money together in order to buy privately owned businesses. The goal is to increase the value of the business beyond the purchase price by generating greater earnings and then sell the business to a third party for a larger multiple while returning a portion of the profits to the investors. Private equity often looks for a three to five times return on investment over a three to five-year period. With respect to healthcare transactions, many private equity firms attempt to either combine multiple practices in the same specialty or create a large multispecialty practice in order to control a region, compete for contracts and drive rates.
New York Limitations
It is well-established that New York law includes a prohibition on the “corporate practice of medicine.” This prohibition reinforces the basic principle, reflected in New York law, that only persons licensed to provide medical services is permitted to engage in the practice of medicine.[i]Thus, a physician may practice medicine only in his/her individual capacity, or as a member of a solo or group practice (either in the form of a professional corporation (PC) or limited liability company (PLLC) where all members or shareholders are licensed physicians themselves). Limited exceptions to this rule apply only to hospitals, clinics, and certain other entities licensed under the New York Public Health Law. In any circumstance not prescribed by New York law, a physician is prohibited from being employed by a non-physician and partnering with a non-physician in a medical capacity. Note that while New York has a rote prohibition on the corporate practice of medicine, this does not hold true across all states. States such as Delaware, Hawaii and Montana, for instance, have no laws or other guidance barring physicians from being employed by non-physicians.[ii]
New York law also has a prohibition on fee-splitting whereby it is deemed to be professional misconduct to permit “any person to share in the fees for professional services, other than: a partner, employee, associate in a professional firm or corporation, professional subcontractor or consultant authorized to practice medicine, or a legally authorized trainee practicing under the supervision of a licensee. This prohibition shall include any arrangement or agreement whereby the amount received in payment for furnishing space, facilities, equipment or personnel services used by a licensee constitutes a percentage of, or is otherwise dependent upon, the income or receipts of the licensee from such practice, except as otherwise provided by law…”[iii]
Based upon these limitations, private equity is unable to invest directly in professional practices in New York State. However, private equity can invest in management companies that manage the non-professional aspects of healthcare practices. These management companies can own the non-professional assets of a healthcare practice, including for instance equipment, furniture, fixtures and supplies. Management companies can also hold the lease for space, as well as employ the non-professional staff. The professional practice would have to be owned by a healthcare professional licensed to practice that profession in New York State. The private equity firm can designate a professional who would be the owner of a professional practice. A management arrangement would then be established between the management company and professional entity whereby the management company would be paid a fair market value flat fee for managing the entity.
Benefits and Risks
In addition to a higher purchase price, healthcare provides often reap tax benefits as the sale of assets results in capital gains tax rates which are lower than ordinary income taxes. Additionally, healthcare providers are often given equity in the management company as part of the purchase price, which allows healthcare providers to participate in the growth of the business and partake in the profits when the entity is sold to a third party. While there can certainly be a benefit to having an equity interest, there are often limitations with respect to how the equity can be converted to actual cash.
In addition to an equity interest, healthcare providers are also generally offered an employment agreement with the professional practice in order to continue to render professional services. Although the initial purchase price for the assets may be high, the compensation offered is generally significantly less than what the provider was making beforehand. Therefore, at the end of the day the healthcare provider is often just getting funds upfront with a potential tax benefit, in addition to the potential to profit when the entity is further sold to a third party. Providers need to study the numbers in order to make sure the deal works for them in the long term.
Providers also need to be cognizant of the employment terms. For instance, employment is often not guaranteed and can be terminated pursuant to the terms of the employment agreement at any time. Healthcare providers also need to be mindful of the type of malpractice insurance to be maintained, as well as potential restrictive covenants.
Although it can certainly be a huge benefit to no longer have to deal with the administrative burdens of running a practice and making investments in technology platforms, providers need to understand that they will be losing autonomy and decision making and must be comfortable with the private equity leadership team and the culture of the private equity firm. Providers should do their due diligence with respect to looking at the private equity firm’s track record with similar practices.
While a transaction with a private equity firm can be very exciting and lucrative for healthcare providers, these arrangements must be evaluated in order to ensure that they make sense for the provider and are compliant. To that end, it is in the best interest of the provider to retain a team of professionals specializing in health care – attorneys and accountants– to ensure that the details of the private equity transaction are appropriate and in the best interest of the provider. Although an offer may be appropriate for some providers, it may not be as desirable for others. Providers also need to recognize that if an offer seems too good to be true, it generally is.
About the Authors:
Mathew J. Levy is a Partner of the firm and co-chairs the Firms corporate transaction and healthcare regulatory practice. Mr. Levy has extensive experience in, defending healthcare professionals in actions brought by State licensing authorities and the Federal agencies (OIG, Medicare, OMIG, Medicaid, DEA, OSHA, OCR OSHA, Hospital Review Boards, Office of Professional Medical Conduct and Office of Professional Discipline.) Mr. Levy has successfully defended numerous healthcare providers in actions involving the US Attorney’s Office investigations, Medicare Fraud Waste and Abuse investigations, Medicaid Fraud Control Unit investigations, OPMC, OPD, Medicare, Medicaid as well as commercial insurance audits including Prepayment Review, Post Payment Review, Medicare Hearings and Hospital Discipline Investigations.
Mr. Levy has successfully structured and negotiated joint venture agreements, private equity transactions, venture capital transactions, stock purchase agreements, asset sale agreements, shareholders agreements, partnership agreements, employment contracts, managed care agreements and commercial leases. Among the areas in which he focuses are coordinating mergers and acquisitions, compliance programs, ambulatory surgery centers, the establishment of diagnostic and treatment centers, HIPAA privacy regulations, fee-splitting issues, Stark law issues, fraud and abuse rules and regulations and Medicare/ Medicaid, Oxford, Americhoice, Fidelis, Healthfirst and other third-party payor settlements.
Stacey Lipitz Marder is senior counsel at Weiss Zarett Brofman Sonnenklar & Levy, PC with experience representing healthcare providers in connection with transactional and regulatory matters including the formation and structure of business entities, negotiating and drafting contracts and commercial real estate leases, stock and asset acquisitions and general corporate counseling. Ms. Marder also has experience advising healthcare clients on a wide range of regulatory issues including Stark, the Anti-Kickback Statute, fraud and abuse regulations, HIPAA, reimbursement and licensing matters.
Weiss Zarett Brofman Sonnenklar & Levy, P.C. is a Long Island 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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[i] N.Y. Educ. Law § 6522, See People v. John H. Woodbury Dermatological Inst., 85 N.E. 697 (N.Y. 1908).
[iii] N.Y. Educ. Law § 6530(19)