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The Dangers of Private Equity Firms Buying into Medical Practices and Why Those Marriages Are Designed to Fail

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To a medical practice with struggling revenues, or one positioned for significant growth but without sufficient liquidity to make that happen, interest from a private equity firm can be exciting.  Invested funds can help pay off debt, grow the practice, and—most alluringly—result in a huge pay day for its physician owners. 

Many physicians become blinded by these benefits and enter into private-equity transactions without fully considering the consequences. 

A thorough pre-transaction review of a private equity investment contract often reveals glaring holes, many pitfalls, and onerous terms—usually, all stacked against the physician.  But For those physicians who are already stuck in a contractual relationship with a bad private equity investor, a Houston business litigation lawyer may be their only help. 

 

What’s Wrong with Accepting Funding from a Private Equity Firm? 

Not all private equity investments are bad. Some genuinely do result in newly opened doors, new growth opportunities, and handsome pay days for doctors. 

But physicians and medical practices must tread carefully when being courted by private equity investors and fully understand how control of the practice will likely change after the transaction. 

It is natural for physicians and private-equity firms to have divergent interests after the transaction, which leads to friction between the physician owners and the private equity owners.  Physicians want to make money but will always put patient care above profit.  But the goal of many private equity firms is to earn a substantial return on their investments—patient care be damned. 

Private equity groups assuage physicians by promising them that the physicians will retain full control over the clinical aspects of the practice.  The contract will also be drafted with seemingly broad provisions that prohibit the private equity group from interfering in clinical decisions.  

However, private equity firms are clever enough to evade these prohibitions. At a minimum, they will seek full control over “non-clinical” management items such as hiring new staff, managing and purchasing equipment and assets, having influence in marketing, and making other significant non-clinical business decisions.  And while private equity firms cannot directly involve themselves in clinical areas of the medical practice, they will indirectly exercise that control through other means.  A common tactic employed by private equity groups is to give doctors millions of dollars in up-front money but retain the contractual right to claw that money back in certain situations.  For example, a private equity firm may retain the right to force a doctor to pay back millions of dollars in its sole discretion, or if the physician is terminated for any reasons from his token position with the private equity group.  It is easy to see how, in such a situation, a physician is at risk of becoming the puppet of the private equity firm even for clinical matters. If the private equity group wants the physician to implement revenue-increasing clinical tactics at the expense of patient care, and it can force the physician to pay back millions of dollars on a whim, the physician is likely to simply do as he is told without pushing back.   And the private equity group will simply argue that it is not interfering in clinical decisions, because—at the end of the day—the physician made the clinical decision.  

As the private equity firm increases its management foothold, the physician slowly loses control of his or her practice. The physician is an employee of the private equity firm. The time and money they have spent building their practice may be held hostage by the private equity company, especially when disagreements arise. 

Promises of substantial equity returns dry up, and the original owner of the practice — typically a physician — can end up with more problems than they know how to deal with. 

 

What Is the Financial Impact on the Medical Practice? 

The doctor who originally owned the medical practice may find themselves on a slippery slope. Funding from private equity firms typically requires that a doctor sign a noncompete agreement. This agreement prevents them from working elsewhere should the relationship with the private equity firm end—another stick that private equity groups use to keep physicians in line. 

Money from any increased revenue is scraped away from the business and used to benefit the private equity firm. The promises of huge payouts down the road never come to fruition, because the private equity firm’s direct control over the business aspects of the practice and indirect control over the clinical aspects will eventually drive revenue into the ground. The doctor is left with fewer assets and operational funds to run the business, resulting in a practice that may be underwater or out of business within a few years. And, the physician and practice may be left holding the bag for legal or regulatory consequences from decisions implemented by the private equity group. 

As the decline in revenue becomes more evident, the private equity firm may seek to bring other practitioners into the mix to improve profits. However, this further dilutes the physician’s equity and eliminates many of the benefits that led the physician to do the deal in the first place—regular, hefty distributions and a huge payday if the practice is sold down the road.  Before they realize it, physicians may find themselves with no equity nest egg to rely on and nowhere else to go.    

 

Are You Experiencing Difficulties with a Private Equity Investor in Your Medical Firm? 

Private equity acquisition of physician practices has significantly increased over the past decade. Private equity firms have refined their operating models to gain even more profit, and it is often devastating to doctor-owned medical practices.  

Sound familiar?  If you have been saddled with draconian obligations in a “bad business marriage” with a private equity group or management company, there may be a silver lining. Working with a commercial litigation lawyer in Houston can help you understand your rights and determine your options. Schedule a consultation with the skilled Houston business litigation attorneys at Mahendru PC to learn more.