2018 marked the first year there were fewer physician owners (45.9%) than physician employees (47.4%), according to the American Medical Association. Consistent with ongoing consolidation in the health care marketplace, private equity firms and other corporate entities have increased their appetite for physician practices. A report by the Physician Advocacy Institute in collaboration with Avalere Health found that from 2019 to 2020, private equity firms and other corporate entities acquired 17,700 practices (a 32% increase) and employed 29,800 physicians, a 31% increase. During that same period, hospital systems acquired only 3,200 practices (an 8% increase) and employed 18,600 physicians (a 5% increase).
By way of background, in a private equity transaction the selling practice’s non-clinical assets and clinical assets are acquired by separate companies owned by, or subject to control mechanisms of, the private equity firm. In exchange, the physicians receive an up-front cash payment based on a multiple of the selling practice’s adjusted EBITDA and receive rollover equity in the private equity firm. Going forward, the physicians are employed and receive a salary that is about 20% – 30% lower than before and may be entitled to a nominal performance bonus. This haircut is offset by the potential for financial gain from earnings distributions and through liquidity events or subsequent sales.
Physicians typically seek to enter into these transactions because of the large up-front cash payments, the increasing infrastructure costs and administrative burdens of the selling practice, and the desire to focus more on patient care. On the other hand, some of the key forces driving private equity firms in acquiring physician practices are the availability of investment capital and continued spending in the health care industry, the ease with which efficiencies and economies of scale can be increased with additional acquisitions and add-ons, and – most important – their consistent return on investment. To increase return on investment, private equity firms seek to increase the rate at which patients are treated and to capture internal referrals to high margin ancillary services, including clinical laboratories and ambulatory surgery centers.
In a hospital system transaction, there is a broader spectrum of ways that the selling practice can be clinically integrated – from loosely integrated, to partially integrated, and to fully integrated. In a fully integrated model, the selling practice’s non-clinical assets and clinical assets are acquired by one or more companies owned or controlled by the hospital system. While the physicians receive an up-front cash payment, it is much lower than in a private equity transaction because the cash payment must be determined consistent with fair market value principles. This is because of the referral relationships as well as the potential fraud and abuse concerns and (for not-for-profit hospitals) private benefit and private inurement concerns that exist in a clinically integrated model. Another difference from the private equity transaction is that physicians do not receive any equity.
Going forward, the physicians are employed and receive a salary, typically based on work relative value units, and may be entitled to a nominal performance bonus or incentive payment. To ensure clinical integration, the hospital system will contractually require physicians to refer within the system, which typically includes all major ancillary, outpatient, and inpatient services.
Physicians typically seek these transactions because of their and the hospital system’s alignment in patient care, the improved reimbursement rates through hospital affiliation, the increasing infrastructure costs and administrative burdens of the selling practice, and the desire to focus more on patient care. Some of the main reasons why hospital systems are acquiring physician practices are the improved efficiencies associated with clinical alignment and integration, the increase in leverage in negotiating payor contracts, the advancement of shared savings, bundled payment, value-based reimbursement programs, and the desire to protect market share in the community.
Historically, hospital systems have also directly employed certain specialists, including anesthesiologists, radiologists, and pathologists. These traditional direct employment models have also been affected by private equity-backed anesthesiology, radiology, or pathology practices that contract with hospital systems to provide access to these specialist services.
From the hospital system’s perspective, the increase in private equity transactions seemingly has caused them to react. Hospital systems have sought to develop alternative structures to acquire physician practices that provide some of the benefits of both the clinically integrated hospital model and the private equity model. This may include different compensation and incentive structures. However, regulatory compliance concerns may limit how far these alternative arrangements can go.
In some situations, hospital systems have fought back against the tide of private equity transactions. Earlier this year, Nevada’s Renown Regional Medical Center hired the majority of the area’s anesthesiologists due to the hospital’s dispute with the private equity-backed anesthesia practice that provided access to its employed anesthesiologists. The U.S. Department of Justice has even submitted a statement of interest in the case raising antitrust concerns as to the restrictive covenants imposed by the private equity-backed anesthesia practice on their, now, former anesthesiologists.
From the physicians’ perspective, being acquired by a private equity firm or a hospital system does have its benefits. However, whether the motivations for entering into these transactions are fully realized by all parties is unclear.
Moreover, physicians may find that their relationship with the private equity firm or hospital system may negatively impact their independent professional judgment. While New Jersey’s corporate practice of medicine doctrine limits how much control a private equity firm and – to a somewhat lesser extent – a hospital system can exert over a physician, their goals and interests may at times be inconsistent with those of its employed physicians. This especially can be the case when those goals and interests change due to new or a rotation of investors of the private equity firm or new strategic planning of the hospital system.
It remains to be seen whether these acquisitions ultimately will benefit physicians’ relationships with patients and access and quality of care for patients.
John Fanburg is managing member and chair, Healthcare Law at Brach Eichler LLC. Edward Yun is a member and Harshita Rathore is an associate, Healthcare Law at the firm.