PE versus Hospitals for $500, please, Alex…
Q6- How is a hospital purchasing a pediatric practice different from a PE purchase?
One key distinction is Stark Laws. While there are many ways around initial limitations when a hospital purchases any practice, the general approach is that the payment for the practice cannot be seen as an inducement for referrals. Basically, the hospital cannot be viewed as paying physicians crazy amounts of money so they get their referrals. Personally, it’s not as big a deal for pediatrics as cardiothoracic surgery or orthopedics. But it is a compliance issue that needs to be satisfied.
In addition to the due diligence surrounding the prudence of the investment, the hospital has to do additional compliance work to make sure the purchase price is justifiable AND the compensation for the providers after the purchase meets the “fair market value” standard. This is a fairly gray area, in my opinion, as I’ve personally seen a wide interpretation of such “market research” to suit the hospital’s needs. Additionally, the hospital sometimes has to justify their acquisition of the practice via its own “Community Needs Assessment”- which is a laughable process that allows for shoddy “market research” to suit its needs.
To determine the reasonableness of the purchase price, they may hire a third party to provide an opinion. For compensation, the hospital will consult with recruitment firms and review national surveys to make sure the compensation going forward are within industry norms. Again, both have a lot of wiggle room.
Here’s where selling to a hospital gets stinky…in addition to giving up your autonomy and being subject to their bureaucratic way of doing things, the initial purchase price is generally limited to the “book value” of the practice (thanks to Federal Stark Laws). I’ve personally seen several deals where the amount was not at all impressive. Adding to this is the reality that pediatricians do not refer much business to hospitals versus surgical specialties. The reality is that since the “downstream” revenue a pediatrician provides to the hospital’s bottom line is negligible, pediatricians cannot command a purchase premium like their surgical colleagues. What’s interesting about Stark Laws is that while hospitals cannot consider the value of your referrals when determining your purchase price or compensation, such information CAN be used in evaluating the merits of the investment. It’s splitting hairs but remains an important distinction.
Even if selling to a children’s hospital, they would rather, in general, structure a deal with as high as possible ongoing compensation in exchange for a lower initial purchase price. The expectation should be that the hospital will pay “book value” of your practice and provide a market-supported compensation package. Most offers I have seen show a significant increase in ongoing compensation as the hospital has better contracts with payers- which allows them to net out more compensation to the provider, even after the fluff of higher benefit costs and additional cost allocations. There are a variety of “affiliation” arrangements floating out there where practices receive minimal, if any, up front compensation in exchange for higher expected annual salaries/compensation.
There is a fairly new thing (last 5-7 years) popping up more that I’ve only seen the details on a few times. These involve “joint ventures” between a hospital and a pediatric practice. Basically, it creates a new entity jointly owned by the hospital and the physician group- which then provides maneuverability in terms of how much can flow back into the pediatrician’s pocket (initially and annually). I’m not the expert on this and only mention this as an option to consider asking about.
In general, unless there are some unique features of the transaction or there are simply no other options for the owners of the practice, a pediatrician selling to a hospital is asking for the lowest upfront payment in the market to buy your practice primarily due to the Stark limits.
Private Equity (PE) has much more latitude- driven by their analysis and financial goals after evaluating the practice’s financials via a due diligence period. They are not limited by Stark Laws or “fair market” value for compensation unless the same PE firm happens to own a hospital in your area (not likely, but possible). In general, PE firms also can provide flexible upfront or deferred purchase price payments via stock/equity options as well as rain as much money as they want without fear of government objections (aka fines and penalties).
While the hospital may have a consistent methodology to determine how much to pay the practice and the ongoing compensation, the PE firms are only limited by their desire to purchase a given practice. In a single market, the same PE firm could pay one pediatrician 4 times their annual earnings and another 10 times simply based on their desire to have the second pediatrician on their team. Hospitals are much more predictable within a given market thanks to government involvement whereas PE firms are wildly variable based on their appetite for risk and fixation on having a specific practice listed on their website, etc.
If given the choice between a hospital and a PE firm, I’d go with a PE firm. Worse case, the loss of autonomy is potentially greater with a hospital. Depending on the PE firm you go with, they may focus on a given specialty and provide more options to provide feedback/influence on their strategic plan.
Quoting a friend of mine from this evening…“Pediatricians have [been] giving their practices away for nothing for far too long and finally someone is valuing them [properly]…much like the ice cream shop” (reference to my analogy in last night’s webinar.
All the above assumes that there are no FTC/monopoly concerns- which is another whole ball of wax…