Part IV: Healthcare Regulatory Issues that Arise in Private Equity Transactions

This is the fourth article in our series on “Closing a Private Equity Transaction.” In Part I, the benefits of preparing for a transaction were explained, along with how best to prepare. In Part II, the letter of intent was discussed, and key terms were identified and explained. In Part III, we walked through what to expect during the due diligence process. Here, we identify the various healthcare regulatory issues that arise in private equity transactions.

The Healthcare industry is heavily regulated at both the federal and state levels, and regulatory issues will be the greatest area of concern for a buyer. The buyer will review the information disclosed through the due diligence process to confirm both pre- and post-closing regulatory compliance.

No business is perfect, and it’s not uncommon for areas of past non-compliance to be uncovered. A buyer needs to understand what they will be potentially inheriting in terms of risk. This gives the parties a chance to correct deficiencies, which may include a self-disclosure or refund, and make improvements going forward.

At the federal level, healthcare regulatory issues include fraud and abuse, privacy, and Medicare billing requirements, just to name a few. At the state level, each state determines who may own an interest in a business engaged in the practice of medicine (aka, “corporate practice of medicine”), what is required to operate a medical practice or other healthcare facility, how professional and management fees may be calculated, and what is within the scope of practice of each license type, not to mention state specific privacy and fraud and abuse requirements.

As for the impact on structuring the transaction, in states with strong corporate practice of medicine prohibitions, investors typically use a “Friendly PC” model, where the buyer acquires the seller’s assets using a management company. Under the Friendly PC model, a physician (who is either one of the physician sellers, or a physician already affiliated with the buyer) serves as the sole owner of the professional corporation. A long term management agreement is then put in place between the Friendly PC and management company, whereby the management company assumes responsibility for managing the PC in exchange for a management fee.

The fraud and abuse laws generally are intended to prohibit paying a kickback for making a referral. The Federal Stark Law specifically applies to physicians (and their immediate family members) who make referrals to entities that they have a financial relationship with for “designated health services.” The Federal Anti-kickback Statute applies to everyone and not just physicians. Both the Stark and Anti-kickback Statutes have exceptions and safe harbors that allow certain relationships if satisfied, such as:

• Personnel services
• In-office ancillary services
• In-direct compensation arrangements
• Space and equipment leases
• ASC ownership

Many states also have a Stark and/or Anti-kickback equivalent statute, which may apply to all products and not to just governmental programs. Both the federal and state fraud and abuse laws will also impact the financial terms that can be negotiated in the sale to the buyer.

To evaluate seller’s fraud and abuse compliance, and what changes may be necessary post-closing, the buyer will look at the specific business relationships in place, and assess the terms of the arrangements. For starters, the buyer will assess the methodology used by the seller to calculate amounts paid to its physicians and other providers. For example, confirming whether amounts paid are in the form of compensation, ownership distributions, or a combination of the two; and whether such amounts are consistent with fair market value and pursuant to written agreements. In a similar manner, the seller will also evaluate medical directorships, consulting agreements, leases, and marketing agreements. The same approach will be taken to understand the seller’s billing and coding practices. This will include how mid-level providers are utilized.

Federal and state licensure requirements can significantly impact structure and timing of a transaction. The buyer will confirm each aspect of the business is properly licensed. This will involve making sure the licenses are all current and accurate (e.g., all current locations identified and match up with the correct managing officer or physician) and when they expire. The buyer will closely review all licenses to also determine which require notice of a change of ownership before the transaction, and which require notice within some period after the transaction closes. Some licenses have a preclearance process, which can be helpful in ensuring everything goes smoothly. Depending upon the desired transaction structure, a new Medicare provider number or EIN (aka, tax ID number), may be required. This is typically the case when moving the business into a newly formed entity.

While healthcare regulatory issues can create concern and risk for both buyer and seller, more often than not, they can be addressed through corrective action and negotiations between the parties. Rarely are such issues “deal-killers,” and instead can be an opportunity for a deeper mutual understanding and appreciation of the business being acquired, and the parties to the transaction.

Next in the series will be a discussion of the deal points often negotiated in private equity transactions.