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Want to sell your practice? Look beyond the hospital

The good news is that this author believes the future is bright for physician practices if they know how to structure their business operations and have a vision for participating in new payment methodologies.

The bad news is that many physicians are simply giving up under the weight of heavy government regulations, restrictions on historical practice strategies and the cost of maintaining electronic medical records and other basic tools necessary to operate a medical practice.

To many physicians the easy out is simply selling to the hospital and allowing the hospital to manage the physician’s medical practice.  The physician believes that the hospital will pay some cash, be responsible for all regulatory compliance and administrative costs and enable the physician to simply practice medicine without dealing with any of these issues.  Depending upon the hospital, the physician might be right.

However, before a physician gives up and simply sells to a hospital, it is important that the physician understand that there are a variety of business strategies that can help the physician reduce practice stress and achieve a lump sum cash payment without selling to the hospital.

Currently, management companies and equity funds are jumping in to the business of medicine.  These companies utilize an entrepreneurial business approach to maximize opportunities for providing quality medical services while capturing available revenue.  These organizations are looking to partner with physicians to leverage the knowledge and talents of the physician regarding the care of patients while utilizing business strategies that have proven successful in healthcare and other industries.

This author represents a management company that runs a highly profitable Accountable Care Organization (“ACO”).  As understood by physicians reading this article who are familiar with ACO arrangements, very few ACOs make any significant returns if they make any money at all.  This management company helps the physicians coordinate all aspects of the healthcare delivery process including scheduling, use of nationally recognized care protocols, innovative payment arrangements and post visit patient follow up utilizing business systems adopted from other industries.  The strategy for making an ACO profitable will be the topic of another article.

Another physician owned management company this author represents is directly negotiating with self-insured employers and commercial payors to develop bundled payment arrangements across the spectrum of patient care events.  By fixing the facility fee and allowing physicians to receive a fair market value fee for services rendered which is increased in the event of complications, this management company incentivizes physicians with bonus payments if the overall programs saves the payor money.  Again, this bundled payment/shared savings strategy will be the topic of a separate article.

Other management companies and equity funds are looking for physician practices that want to be part of a larger business strategy to reduce stress and obtain lump sum cash payments based upon a multiple of profits.  Under this arrangement, the physician practice forms its own management company owned by the physicians who own the physician practice.  The physician practice assigns all of its non-physician employees to the new management company and pays the management company for all administrative services historically performed by the physician practice plus an additional “profit” payment.

Although the cost of this “profit” payment, by definition, reduces the funds that are otherwise available to pay the physicians’ compensation, because the physician owns both the management company and the physician practice, the physician is simply putting the profit from the management company in one pocket while putting his reduced salary in the other pocket.  The combined total from both pockets is the same amount of money the physician made before he or she set up the management company.

The theory behind this arrangement is that any “profit” in the management company can be sold to equity funds and other buyers at a multiple.  For example, assume a physician earns $300,000 per year through his or her practice.  Also assume that the physician must generate $600,000 in revenues in order to pay all of the practice expenses to achieve the $300,000 compensation.

Under the management company approach, the first step is to set up a management company owned by the physician and have the physician’s practice pay to the management company $400,000 for administrative expenses.  As a result, the physician will only make a salary of $200,000 through the practice.  However, the physician receives $100,000 in profit from the management company ($400,000 paid in minus $300,000 actual expenses) so the combination of the profit from the management company and the reduced salary through the practice gives the physician the same $300,000 at the end of the year.

Recently, equity funds have paid between a four and nine times multiple for the stock of these management companies to obtain the “$100,000” annual profit.  This allows the physician to sell the management company to a third party but not sell the practice.  Thus, if the physician can sell the management company at a six times multiple of profit, or $600,000, the payment will be taxed at capital gains rates leaving the physician $480,000 in the bank.  Had the physician not used this management company strategy and simply paid 50 percent ordinary income tax on the $100,000 as salary, how long would it take to accumulate $480,000?  The answer is 10 years.

The acquiring equity fund will use a variety of business strategies to increase the amount of money the physician makes through the practice which will, in turn, increase the amount of money the physician pays to the new management company.  Where this strategy works, the physician enjoys the benefit of capital gains on the sale of the management company while having a business partner manage the medical practice to achieve increased annual compensation.  This strategy is becoming an excellent alternative to selling the practice to a hospital because the hospital will fear paying a multiple of profits to the physician practice due to the federal anti-kickback legislation.

The examples set forth above are designed to give physicians a taste of the opportunities available in the marketplace and to demonstrate that physicians have more choices than simply selling their medical practices to hospitals.  Obviously, multiple legal issues not discussed herein must be properly handled to make these arrangements work.  However, given that hospitals can no longer utilize provider based billing for new practice acquisitions and new legal cases are restricting the amount of funds hospitals can pay to physicians as compensation, investigating the opportunity created through these alternative business strategies is a must for physicians who want to excel in the future business of medicine.

Schultz, Randal LRandal L. Schultz is an attorney with Lathrop & Gage. He can be reached at 913-451-5100 or rschultz@lathropgage.com.

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