Physician Practices: An Attractive Investment for Private Equity Firms

Today, almost 70% of US doctors work for a hospital or corporate entity — that is, insurers or private equity (PE) groups — according to a report from the Physicians Advocacy Institute. The report evaluated a two-year period (2019 – 2021) and determined that this ongoing trend accelerated during the COVID-19 pandemic, which saw nearly 49,000 physicians leave private practice nationwide.

Private practices have become increasingly rare. Only three in 10 doctors today are independent. Of the 48,400 physicians who took jobs with hospitals or corporate entities, 47% (or nearly 23,000) left those jobs sometime between 2020 and 2022.

The healthcare industry has seen a significant increase in hospital ownership stake in medical practices, with 44% of physicians working for hospitals in 2018 — a percentage that had increased to nearly 50% last year.

Hospitals aren’t the only entities interested in purchasing medical practices, however. Insurers and private equity groups continue to show an increased interest in the industry, too. In fact, private equity medical practice takeovers more than doubled between 2013 and 2016.

Private equity firms acquired 355 physician practices over those years.
Acquisitions accelerated from 59 in 2013 to 136 in 2016.
The most targeted areas included anesthesiology (69 practices) followed by emergency physicians (43).

It appears the trend will continue, as private equity sees the healthcare sector as a worthwhile investment. 2018, for example, saw a record 788 deals completed valued at over $100 billion. That same year, healthcare accounted for about 13% of all private equity buy-out deals globally, according to one industry research firm.

Last year saw more than 50% growth in the size and volume of health service transactions. Physician medical groups saw over 400 deals between November 2020 and November 2021, although the most popular sub-sector was long-term care.

Why invest in physician practice groups?

When you break them down to their most basic level, it’s easy to see that essentially, physician practices run like small businesses, managed by doctors also juggling full patient loads. For many physicians, it makes good business sense to partner with a private equity group.

This partnership generates needed capital to purchase the latest technology and equipment. Access to liquid accounts also enables physicians to take advantage of the digital revolution, investing in critical (but expensive) electronic medical systems.

Acquisitions can, however, pose significant challenges. The process is complex — and pressure exists nearly immediately to grow the practice, in most cases. Patients may worry about the potential of their healthcare becoming more commercialized. Physicians often hold equity stakes in a private equity assessment, driving the purchase price higher and creating uncertainty about how (and when) they might see “rollover” equity.

However, private equity investors do see the value of increasing their healthcare portfolios, and lately, many have refocused on smaller physician practice groups. Physicians also see the benefit of these private equity investments, since the capital infusion gives doctors a higher quality of life: better pay, more control over their own schedules, and improved coverage for the practice itself.

Optimizing PE Investment

Thinking about investing in a physician practice? Consider these tips, which can help smooth the way for an easier transition along each step of the process.

Pre-deal preparation

Take time to prepare before bringing a deal to the table. Research practices in the area you’re targeting. Identify and approach practices with:

Robust administrative functions — EHR, IT, and compliance/billing/payer/supply chain contracts — driving revenue
Financial strength and stability
Growth potential
High patient and staff satisfaction
Physicians willing to buy into your PE firm’s vision and strategic plan

Take time to understand potential pain points and synergies. Work with the group to map out processes to facilitate a smooth transition as smaller practices integrate into a larger group. Transparency is key. Ensure everyone on the investor and physician sides understand all of the practice’s current operational elements, from provider compensation plans to staffing, payroll to culture, and supplier and payer contracts. Clearly communicate what changes will occur once the deal is signed.

Conducting due diligence

While you’re negotiating the purchase of a physician practice — or any other healthcare entity — you’ll want to ask these questions first.

What is the business’s true value? Look at current contracts, future revenue prospects, potential IP and proprietary processes to calculate potential worth and forecast growth.
Have you identified red flags? If the practice history is a little messy, perhaps it’s best to walk away.
What does the purchase include? Specify in writing how you’ll structure the business after purchase, and make sure the deal still works for your PE firm now, and in five or ten years.
Will you need to renegotiate payor contracts? Hopefully you reviewed contracts during due diligence. Does it make sense, fiscally, to renegotiate? Or does everything look good?
How will you structure the business? Does the Corporate Practice of Medicine (CPOM) doctrine apply? A lawyer should review the business model to ensure it’s been correctly and legally set up.
Is it important to acquire a controlling interest? There are benefits and drawbacks to whether a PE firm does — or doesn’t — buy a majority interest. Weigh your options.
Will you — or someone else from the PE firm — sit on the board of directors? It’s not necessarily a requirement, but this approach has many benefits.
Will you keep — or replace — existing management? A PE firm can negotiate ‘step in’ rights to enable it to take over if the business is struggling, but generally, existing leadership brings value to the practice.
How much should physician benefits and compensation change? Or maybe they don’t need to change at all. Compare the existing plan with the current economic market and adjust accordingly.
How do I set profit distributions to the physicians? Make sure to factor how and when profit distributions are shared when you’re negotiating the deal.
How are non-compete agreements and restrictive covenants arranged? Check with the legal team to determine what makes sense — and ensure compliance with state laws, which vary.
How do we structure exit rights? PE firms want the flexibility to sell their investments quickly, if the strategy makes sense. Clarify and include these rights during the negotiation process to protect your investment.

Deal execution

This stage arrives when the PE firm and physician group finalize their relationship and form a partnership. Conduct due diligence to identify current and potential risks. Assess the earnings quality and verify the amount of working capital available. Should the deal identify exposure items, they should develop solutions to mitigate any risk and create future value. Creating an integration roadmap assists both parties understand how the practice will operate once they’ve completed the transaction.

Optimizing post-deal

The deal isn’t over once the final paperwork is signed. It takes time for the combined entity to optimize its operations. Meet regularly — even daily — for the first month to resolve issues resulting from the acquisition. Both the PE and physician leaders should review the post-acquisition plan to ensure the administrative, clinical, and financial processes operate smoothly, adjusting as needed. Identify and monitor key performance indicators (KPI). After about 90 days, leaders should plan to meet quarterly to review progress, results and identify potential concerns, adjusting plans as needed.