Anatomy of a Physician Practice Recapitalization Transaction


Ensure a smooth transition by considering business and legal issues

Recapitalizations of physician practices by private equity sponsors have increased in frequency exponentially over the past several years. There has been a convergence of private equity firms interested in developing growth platforms for certain types of physician practices, such as dermatology, pain management and various hospital based disciplines (anesthesiology and radiology) and physicians interested in pulling equity out of their businesses.

Given the complexity of the reimbursement and regulatory environments surrounding the healthcare industry, these transactions are rich in business and legal issues. The following is a brief discussion of some of these issues and how they are handled in a typical transaction.


There has been robust valuations for certain types of practices. These days, valuation multiples in excess of 10-12 times trailing 12-months’ EBTIDA (earnings before taxes, interest, depreciation and amortization) are not uncommon for high-quality platforms practices, although such multiples are sometimes generated by seeking prospective compensation reductions from physician owners. The multiples can be further justified when bolt-on (add-on) practices are purchased at multiples that are 30-40% less than those paid for platform practices, thus creating immediate arbitrage.

Deal Structure

Because of regulatory constraints, most specifically, laws governing the so-called “corporate practice of medicine” and fee splitting, most transactions are structured through the use of a management company jointly owned by the sponsor and the physician owners of the practice. The management company acquires substantially all of the business and assets of the practice and employs those employees of the practice who can be employed by the management company without violating applicable law. Physicians and other clinicians (e.g., physicians assistants and nurse practitioners) generally will remain employed by the practice. Ownership of the practice is generally winnowed down to one “friendly” physician who enters into a series of agreements with the management company designed to control the disposition of the practice and its remaining assets.

In order to capture the economics of the practice, under the terms of a management contract between the management company and the practice, all non-clinical services needed to run the practice are provided by the management company in exchange for a fair market value fee, which usually approximates the profit left in the practice after the payment of salaries, benefits and other expenses. Profit and free cash flow of the management company is then distributed to its owners in accordance with their respective equity percentages.

Equity Rollover and Governance

Physicians are usually asked to reinvest (or “roll over”) between 10% and 40% of their existing practice equity into the newly recapitalized venture (through ownership in the management company). Physician equity is often subject to put and call rights upon the occurrence of certain events (e.g., dissociation from the practice), as well as typical minority protections such as rights to “tag along” (join in) on sales of controlling interests by the private equity sponsor. As expected, the sponsor will control the board of the new company, although lead physicians are generally given some level of participation on that board (but usually in a minority position) and the sponsor’s control of the board is sometimes tempered by certain supermajority veto powers for a limited number of major items.

Diligence and Compliance Issues

Recapitalization transactions are, generally, heavily scrutinized during the due diligence process. Common concerns often involve billing and coding issues (such as so-called “up coding” or improper use of modifiers), improper use of extenders (e.g., billing services of extenders “incident to” the physician service), failure to document medical necessity as well as Stark Law and Anti-Kickback Statute violations. These issues, if uncovered, have the ability to dramatically affect the quality of earnings of the practice and can put downward pressure on the valuation and increase sponsor demands on indemnity limits and escrows/holdbacks. Thus, it is highly recommended that any physician practice considering a transaction undertake its own diligence and take stock of issues and problems before they are uncovered during the transaction process.

Legal/Structural Issues

As noted above, most deals are structured to comply with state laws governing the practice of medicine by non-physicians (or the so-called prohibition against the corporate practice of medicine). In this regard, it is recommended that careful attention be paid to the laws of the specific state (or states) in which the group practices in order to comply with the CPOM laws of that state. For example, while Florida has no specific prohibition against medical groups owned by non-physicians, it does have a detailed and comprehensive licensure process for such groups, violations of which are Class B felonies.

In addition to CPOM prohibitions, it is important that management fees paid by the practice comply with state law prohibitions against co-called fee splitting. Because of the bifurcated relationship between the ownership of the practice and the ownership of the management company, compliance with anti-referral laws, such as the Federal Stark Law and the Federal Anti-Kickback statute can be tricky and may require special attention.

With respect to the physician equity rollover, care should be taken in structuring the rollover in order to avoid adverse tax consequences to the physician investors, particularly as a number of existing physician practices are structured as S corporations for Federal income tax purposes.

Finally, because many practices involve licensed facilities and services, to the extent that those are being transferred to the new management company, there may be state law changes of ownership with which to contend.

Physician practice recapitalization transactions are fraught with business and legal issues. Careful consideration needs to be given to the interplay of these issues. Doing so will help ensure a smooth transition from practice to sponsor.


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About Author

Roger Strode

Roger Strode is a partner and healthcare business attorney with Foley & Lardner LLP in Chicago where his practice focuses on healthcare business transactions, including mergers, acquisitions, corporate restructurings and joint ventures, general corporate matters and healthcare regulation.

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