Weiss Zarett Brofman | Sonnenklar & Levy, P.C. | Attorneys At Law

High Quality Services And Personal Attention

Key Considerations When Selling Your Health Care Practice to a Private Equity Firm

On Behalf of | Oct 5, 2022 | Articles, Blog, Publications

By Mauro Viskovic, Esq. Email Mauro

Private equity investments in health care continue to trend rapidly upward. $151 billion of private equity capital surged into healthcare globally the past year, more than double the prior year, and more than seven times the volume of investment ten years ago.  In light of these developments, health care practices planning to sell to a private equity firm need to understand the important considerations in advance to ensure that the terms of the sale transaction are appropriate, legally compliant and in the best interest of the practice owners.

Below are 5 key issues practice owners should focus on when negotiating a private equity sale

1. Practice Value and Purchase Price:

In order to maximize the purchase price from the sale of a healthcare practice, practice owners must learn and understand how private equity firms are valuing their business.  The price is usually determined using multiple of the practice’s earnings but the private equity’s incentive to invest in the practice is primarily based on the practice’s future revenue prospects, contracts, and potential intellectual property or proprietary processes.

Upon determining the amount of the purchase price, the next step is agreeing on how the purchase price will be paid.  Practice owners should seek to have all or a vast majority of the purchase price to be paid in cash.  Most deal, however, include equity in a buyer-affiliated company as part of the purchase price.  A transaction with an equity component will require a due diligence review of the entity that is issuing the equity.  Practice owners should also negotiate for full and immediate vesting of the equity with limited forfeiture provisions in only extreme circumstances.

Some transactions will provide that a portion of the purchase price will be delayed after closing, for a period of 3-5 years.  If the buyer entity providing the promissory note for this debt component of the transaction is a mere shell entity with no assets, then practice owners should seek some form of security, such as a guarantee from the private equity firm or an affiliate of the private equity firm that has substantial assets and revenue prospects.

2. Transaction Structure and Compliance with Health Care Laws:

More so than most other industries, health care is subject to a myriad of regulations which requires that the practice owner and private equity firm agree on a structure that is both mutually beneficial and compliant with all applicable laws.  In the State of New York, a primary regulatory consideration to be considered when determining how to structure a physician practice acquisition is the prohibition against the “corporate practice of medicine”. The overall purpose of this prohibition is to prevent non-physicians from interfering with a physician’s medical judgment. Accordingly, the rule prohibits non-physician owned business entities, from owning a medical practice.

To comply with laws against the corporate practice of medicine, private equity firms often use a management or administrative services organization, commonly referred to as an “MSO.” An MSO is paid a fee for providing non-professional services to a medical practice, but does not interfere or otherwise exert control over the professional aspects of the health care practice. Please see our firm’s past article on this subject, “Understanding Private Equity Transactions In Healthcare”, for a fuller explanation of the role of MSOs in health care transactions with private equity firms.

3. Control of the Practice:

With respect to the control of the practice after closing, the private equity firm focuses on the business side of medicine and leaves the clinical decisions to the doctors. It is not unusual, however, for private equity firms to seek physician representation  among the directors and officers of the practice entity.  As such, practice owners should be prepared to negotiate strong protections with respect to all clinical decision-making authority.  This can include negotiating a requirement that existing management will stay in place and have representation with respect to the management of the MSO that will be assuming the administrative operations of the practice post sale.  Note, however, that even in situations where pre-sale management is retained, the private-equity firm may demand rights to allow it to take control of the practice if it is performing poorly. Several scenarios can trigger such action, including breaches of financial covenants in financing arrangements, failure to meet specified financial thresholds, material breaches of the MSO agreement, and more. Practice owners must carefully examine these clauses to ensure their interests are maintained

4. Post-Transaction Compensation:

In many private equity acquisitions of health care practices, there is a substantial compensation reduction for the physician-owners selling the practice. The private equity firm typically compares the median compensation for physicians in that region with what the physicians in the targeted practice are making.  As such, the practice owner and their accountant must analyze all deal metrics relative to their current compensation to make sure the deal works for them in the long term.

5. Non-Compete Agreements:

As an MSO cannot perform professional health care services, the private equity investor is reliant on the continued services of the physician selling the practice following the closing of the sale. As such, private equity firms require some form of a non-competition provision setting forth the duration and geographic scope of the restriction, to prevent the seller from taking the money, quitting, and opening up a shop across the street soon after.  In negotiating such restrictions, the practice owner’s interest is to ensure that the restrictions are as limited in time and scope as possible and are no more than reasonably necessary to protect the private equity purchaser’s investment.  Note that, with respect to enforceability, courts are more amenable to longer restrictive time periods and broader geographic areas in connection with the sale of a business than it might otherwise allow in employment arrangements.

With so much to consider, navigating the complexities of a private equity transaction calls for the care and attention that a highly-skilled and experienced team of attorneys can provide.  If you are a healthcare provider considering whether to sell your practice to a private equity firm, please contact Mauro Viskovic at 516-627-7000 or  [email protected].