United States: Orthopedic Surgical Practice Recapitalizations: Six Relevant Considerations

Last Updated: December 3 2018
Article by Roger D. Strode

The past decade has seen a tremendous amount of private equity investment in physician practice recapitalizations, primarily in hospital-based practices such as anesthesiology and radiology as well as "retail medicine practices" like dermatology and ophthalmology/optometry, to name a few. Orthopedics, on the other hand, has received less attention from investors, but we believe that trend is about to change, and in a significant way.

For those interested in orthopedic surgical practice investment, the following six considerations will be relevant to investors and physician practice owners alike.

1. Valuations

The market for physician practice recapitalizations remains robust, as do valuations (some as high as the low-to-mid teens multiplied by recast EBITDA). We fully expect the same level of valuation for orthopedic surgical practices, especially given the leverage and ability to generate significant cash flow apart from physician services. Many such practices own ancillaries such as interests in ambulatory surgical centers or surgical hospitals, imaging, physical therapy and durable medical equipment (DME). In addition to the above, orthopedics lends itself well to the increasing interest of the Medicare program, and many private payers, in alternative payment arrangements, such as the Bundled Payment for Care Improvement (BPCI) Initiative introduced by the Centers for Medicare and Medicaid Services (CMS) that will test a new iteration of bundled payments for 32 Clinical Episodes and aim to align incentives among participating health care providers for reducing expenditures and improving quality of care for Medicare beneficiaries. For example, the BPCI-Advanced model, introduced by CMS earlier this year, will cover 29 procedures, nine of which are orthopedic in nature including spinal fusions, upper and lower extremity major joint replacements, and back and neck procedures, etc.

2. Recasting EBITDA

In most transactions, forecasted EBITDA (free cash flow) is adjusted by:

  • restructuring physician compensation, and
  • valuing projected growth initiatives and adding these amounts to base level EBITDA.

In our experience that the greatest gains in EBITDA often come from restructured physician compensation, meaning that physician owners will agree to reduce their projected compensation to levels historically paid to employed (non-owner) physicians (e.g., 45-50% of net collections). This reduced compensation is then added to base level EBITDA for purposes of practice valuation. As discussed below, since some owners will give up greater levels of compensation than others, this disparity is, generally, compensated for by allocating more purchase consideration to those physician owners who give up a disproportionate amount of compensation. Projected growth initiatives are often annualized and a full-year's credit is can be granted for new providers who propose to join the practice. Other initiatives for which a practice will be given credit may include new clinic additions, ancillary services expansion, and changes in reimbursement.

3. Purchase Price and The Importance of Tax

As an initial matter, it is important to understand that purchase price in recapitalization transactions is usually allocated between cash and equity in the recapitalized company, with the physician owners receiving between 60 and 90 percent of the purchase price in cash and remainder in equity (so-called "rollover equity"). The tax treatment of recapitalization transactions is important and, at times, can be complex. First, and foremost, these transactions only work if the rollover equity is received on a tax-free basis so as to avoid the recognition of "phantom income" (i.e., taxable income without the corresponding receipt of cash). As a general rule, most of the cash received by the physician owners should be taxed at long-term capital gains rates. One important caveat to the foregoing relates to excess purchase price allocated to physician owners who give up a disproportionate amount of compensation. If any owner receives an allocation of purchase price in excess of his or her percentage ownership in the practice, such excess could be treated as compensation and taxed at ordinary income rates. Another consideration is the tax status of the practice. If the practice is a subchapter S corporation, care will need to be exercised to structure the retention of rollover equity in a fashion so as not to trigger any gain built into that equity.

4. The Impact of the Move Toward Outpatient Settings

Closely related to the value-based payment alternatives described above is the push by payers to encourage more effective use of outpatient settings, such as ambulatory surgery centers (ASCs). CMS regularly approves additional procedures that can be completed in an ASC setting. When coupled with improved technology, the concept of recovery care center and other technological improvements, the ASC is going to hold a prominent place in the patient care setting. Orthopedic surgery practices (or their surgeon owners) are often owners of ASCs and, as such, those groups are likely to be prized by outside investors. In many of the deals we see, outside investors seek, at least, a majority interest in the ASC and a management relationship therewith (so as to allow for financial consolidation), with the physician owners retaining a significant minority ownership in the center. Should the practice group be a co-investor with a hospital or a proprietary management company, that co-investor relationship may be restructured as part of the recapitalization deal. ASC relationships between surgeons and ASCs also may implicate the federal Anti-Kickback Statute (AKS). Those relationships will undergo significant scrutiny by outside investors with respect to, among other things, compliance with the Medicare safe harbors (e.g., the so-called "1/3 tests"), relationships with anesthesia providers, etc.

5. Ownership of Ancillaries and Legal Considerations

Because orthopedics is one of the few practices that utilize multiple ancillary services, it is critical that the relationships between those services and the physicians who refer them are structured correctly and comply with all applicable federal anti-referral laws, e.g., the federal Stark Law and the federal AKS. For example, referrals for designated health services such as imaging, physical therapy, and DME must be structured to comply with the so-called "in office ancillary services" exception to the federal Stark Law, a fairly complicated exception with strict requirements related to the structure of the physician practice, the situs, supervision and billing of the services provided, and the sharing of the profits therefrom. As noted above, ASC ownership and the distribution of profits to physician owners implicates the federal AKS. Failure to structure all of the above-described relationships in a legally compliant manner may not only subject the physician practice to recoupment of Medicare dollars, fines and penalties, but also may negatively impact the quality of its earnings, thus reducing overall practice value.

6. Diligence Will Be Important

For the many reasons discussed above, investors are likely to focus on diligence in their assessment of these practices. In addition to compliance with anti-referral laws with respect to referrals of ancillaries, investors will be interested in the use of extenders by orthopedic physicians which has the potential for creating billing problems and irregularities. Finally, while usually not considered a "physician-centric" set of issues, investors likely review relationships, such as clinical co-management or medical director arrangements with hospitals. The obvious reason for this review is to determine the legal and regulatory risk into which an investor could be buying. However, and as already noted above, this review can have an effect on the quality of the practice's earnings and, ultimately, the purchase price an investor is willing to pay.

With the coming wave of orthopedic practice acquisitions, it will be incumbent upon investors and physicians alike to be cognizant of the reasons for consolidation and the various considerations attendant to such transactions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions