By Anne Sumpter Arney
For the owners of a medical practice, an investment by private equity is a way to obtain value for their practice and facilitate a retiring owner’s exit from private practice.
Tennessee law restricts the ownership of a medical practice and employment of physicians to certain licensed medical providers and facilities, which significantly limits the number of potential buyers for a medical practice. To comply with this restriction while still pursuing investment opportunities, private equity investors developed a transaction structure that allows an outside investor to share in the profitability of a medical practice through a management services organization (MSO). Although the MSO structure creates the opportunity for physicians to market their medical practice to a broader spectrum of buyers, these transactions are not always successful from the physician’s standpoint.
Any MSO transaction involves the medical practice selling all of its non-clinical assets to an affiliate of the private equity investor while leaving the medical practice entity in place to employ the physicians and bill for their medical services. The MSO then provides to the medical practice the non-clinical assets and services (including billing, lease of equipment, lease of space, and other general management services) in exchange for a management fee. In the MSO transaction, the selling physicians may retain ownership of the practice entity but, pursuant to the terms of the management agreement, they will have little authority over non-clinical aspects of the practice.
The MSO transaction is successful for the selling physicians if they get fair value for the assets of their medical practice, are able to continue to provide quality patient care, and are fairly compensated for their services. Whether these requirements are met will depend on what is required by the transaction’s documents. Any MSO transaction is a document intensive process and although many of the terms in the documents will look like unimportant boiler plate, a seller should carefully review all of the documents beginning with the letter of intent (LOI).
The LOI is the initial term sheet setting forth the key elements of the proposed transaction, and it will be the document which guides the entire transaction. The importance of a well-negotiated LOI cannot be overstated. The terms outlined in the LOI will be developed and detailed in the purchase agreement, management agreement, and other agreements documenting the transaction. The parties may defer negotiation of an issue to a later stage in the transaction but if an issue is a deal breaker for the selling physician, it should be clearly addressed in the LOI. Once a particular term has been negotiated in the LOI, the selling physician will not have much leverage to change the deal to more favorable terms.
Establishing a fair purchase price is a selling physician’s first step to a successful sale. It is important to have an independent valuation by an experienced practice appraiser prior to agreeing on a purchase price. The purchase price may be paid in a combination of cash, promissory note, or equity in the private equity purchaser. Keep in mind that the equity portion of a purchase price is almost always in a private company – meaning there is no market for future sale – and the future value is speculative. Further, the actual amount received by the selling physician at closing may not be the same amount as the stated purchase price. Once a price is set, there are several potential adjustments to the amount paid at closing. These adjustments may include deductions based on failure to have an agreed upon amount of cash or receivables in the practice at closing. In addition to adjustments to the purchase price at closing, the buyer may require an agreed amount of the purchase price be placed in escrow at closing and held back for a period of time as security for payment of any post-closing claims that the buyer or a third party may have against the practice.
The purchase agreement will include representations, warranties, and covenants of the practice and the selling physicians. These are promises about the practice, and the selling physicians may be required to stand behind them personally. A mistake or omission in these representations may result in a claim against the practice or against the owners of the practice personally. To minimize this exposure, the selling physician should try to limit their liability for any post-closing and require a cap on their liability or limit the types of claims that will survive post-closing.
The terms of the employment agreement will significantly impact the success of the transaction from the physician’s standpoint. It will govern how he or she practices medicine and how he or she is compensated post-closing. Since the real value of the purchase to the private equity company is the reputation and patient base of the practice’s physicians, the buyer will usually require that the physicians remain with the practice for an agreed upon term, and the employment agreement may include a severe monetary penalty for the physician leaving early. In addition, selling physicians may be required to agree to restrictive covenants such as non-competes and non-solicitation agreements. A selling physician should consider the impact such noncompetition provisions could have on their ability to practice if they were to desire a change in employment following the transaction.
A sale to a private equity investor is the solution for many physicians who are ready to sell their practice, but not all transactions are the right sale. In order to be happy both with the purchase price and his or her practice as an employee rather than owner following the transaction, a physician should consider carefully whether the transaction will meet their financial and professional goals.
Anne Sumpter Arney, a health care partner in the Nashville office of Spencer Fane, has more than 30 years of experience working with many Nashville health care companies and medical professionals. She can be reached at asarney@spencerfane.com and 615.238.6360.
