Private medical practices face growing pressure to sell out. Partners are finding younger physicians unwilling or unable to take on the burden of buying them out. As hospital systems have slowed practice acquisitions, private equity has been aggressively filling the void.
Private equity (PE) offers retiring partners an attractive cash exit and a potential future payout for younger doctors when the practice is sold again. Since someone has to pay for this, it comes at the cost of reduced compensation and increased productivity requirements for remaining doctors and staff.
Most states have laws prohibiting the corporate practice of medicine by limiting medical practice ownership to licensed physicians. Private equity gets around this by setting up a separate management services organization (MSO) that contracts with the physician-owned clinical practice. The MSO employs all of the non-clinical staff and charges the clinical practice a management fee. This fee is structured to transfer the profits of the practice to the MSO, which is owned by the private equity investors.
MSO economics turn on physician compensation. Private equity buyers will typically reduce physician compensation in order to achieve profits. Compensation is generally set to levels similar to that paid by hospital systems for employed physicians. Additional profits are generated through operational changes to drive higher patient volumes and greater physician and staff utilization.
While the investors own the MSO, physicians retain ownership of the profitless clinical practice, ostensibly retaining clinical control. The question of control over patient care has become a major flashpoint in the debate around the role of private equity in medical practices.
ESOPs as an Independent Alternative
A growing number of private practice owners are turning to ESOPs as an alternative to a PE exit. An ESOP offers many of the same features as a sale to private equity, with some key advantages. The biggest attraction is that an ESOP secures physician control over patient care by maintaining the independence of the practice for the long-term.
Top 5 Reasons Physicians Choose
an ESOP over PE
- Cash out exit
- Maintain physician control over patient care
- Tax-free sale
- Eliminate practice income tax
- Staff retention
ESOPs also offer intriguing tax advantages. With proper structuring, selling partners can defer capital gains tax indefinitely, eliminating the liability altogether for heirs upon death. An ESOP-owned practice can also qualify to pay no federal income tax (and no state income tax in most states).
What is a Good ESOP Candidate?
In general, if a PE deal can work, an ESOP deal is probably a viable alternative. The right candidate will have a critical mass of at least eight physicians plus a full clinical and administrative support staff. Leadership succession must be in place, since the ESOP does not change practice leadership. The practice should have a relatively diversified payor mix, and, if it relies on hospital and health system contracts, it must not be reliant on any single contract for survival.
Most medical practice ESOPs use the MSO structure, so the practice also needs to be able to generate meaningful profits for the ESOP-owned MSO while paying its physicians and staff compensation competitive with health system compensation for similar roles.
While not for everyone, a surprising number of private medical practices across a broad range of specialties have found ESOPs to be an attractive alternative to PE that lets owners cash out in a tax-advantaged way while preserving physician control over patient care and practice independence.
We love helping owners finding the right way to exit their ownership while preserving the legacy of the practice that they have built. If this intrigues you, talk with one of Adamy’s ESOP experts about exploring an ESOP for your medical practice.
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