The influx of private equity (PE) into ophthalmology has brought practice ownership models into sharp relief. Group practices often have a senior partner with a controlling equity interest and one or more junior partners with minority ownership. The structure can work well when things are stable, but misalignments often emerge when it comes time to sell.
PE usually offers the senior partner a big payoff and a clean exit, although sometimes with a requirement to stay invested and work for up to five years — but always with a big cash payment. When this happens, the practice is valuated at a specific price, and the equity stake for the junior partners becomes valued at a specific amount. At this point, the junior partners can find themselves in a catch-22 situation. They are usually able to convert some of their equity to cash, but they give up control of the practice after the sale to the new owners. PE firms usually require the junior partners to stay invested, meaning they don’t receive full payment for their equity. They are also required to sign restrictive noncompetes, for which they seldom extract fair market value.
Ironically, the new owners are challenged to attract new top-level talent into the practice after they buy it. Top talent often demands equity ownership, and working only for a salary may not fit with their ambitions.
On the other hand, not selling to PE can risk the senior partner’s ability to cash out. The practice may not generate enough cash flow to allow the junior partners to match the PE offer. What was once a harmonious collaboration can quickly devolve into misaligned interests and conflicting motivations between the retiring senior partner and his or her junior partners who are still in mid-career.
The unhappy ending should not be a surprise. It was destined to happen all along. Group practices were not designed to be sold; they were designed to grow and provide an environment for the partners to practice and derive economic benefits by working together. What the design did not often include was a retirement plan.
HOW DID WE GET INTO THIS MESS?
The history of group practices is relevant. Before the 1960s, group medical practices were relatively rare. The advent of Medicare and third-party reimbursement led to the rise of HMOs, PPOs and, more recently, ACOs. Medical reimbursement policies drove physicians to seek economies of scale. Group practices formed as an alternative for physicians who wanted to stay in private practice.
In general, group practices typically formed around a senior physician who took on younger and often less business-minded physicians. The junior associates typically started out as employees and, if all went well, received the opportunity to buy into ownership over time. Buying ownership generally meant paying the senior partner a higher percentage of collections for a period of time in exchange for stock “equity” in the practice. The stock ownership entitled the junior partner to share in whatever profits were left over at the end of each year after expenses and salaries were paid.
Group practices generally work well — until someone tries to exit. Of course, problems can arise earlier, for example when the overhead contribution plans are not well designed or when the ownership agreements do not provide ways for physicians to leave the practice before retirement. Nevertheless, this group practice model has become the predominant ownership model for group practices.
Recently, faced with the mass exodus of senior partners, the group practice model has come under pressure.
PE firms have identified ophthalmology as a “growth sector” — meaning they feel they can run our businesses more profitably than we can. The has led them to put historically unprecedented valuations on large, successful, “platform” practices. PE firms are looking to “roll up” group practices and use them as a “platform” to absorb smaller practices to create a large network. The economies of scale are compelling, so the PE firms are able to offer attractive buyouts.
These valuations often make it unaffordable for the junior partners to buy out the exiting senior partner as they had expected to do. Rather than sell the practice to the junior partners who helped build it, many senior partners are making deals with PE firms for profitable exits.
Cashing out can work well for the senior partner, who is retiring from practice and wants to maximize the sale price. But the practice’s value relies on the junior partners staying on. When they stay, they no longer work for themselves — they work for the executive who the PE firm puts in place. Patient interests can take a back seat to profits, physician autonomy can be compromised and, moreover, the physicians who went into private practice to avoid working for a large corporation now find themselves working for a large corporation.
|New physician||Mid-career||Retiring physician|
|Physician-partner practice||Pro: Job security, support in starting practice.
Con: Expensive to buy in. Low likelihood of control. Vulnerable to ownership changes.
|Pro: Stable practice structure, economies of scale.
Con: Minority ownership. Vulnerable to ownership changes.
|Pro: Captures income from junior partners, controlling interest. Opportunity to capture value if practice sells to PE.
Con: Exit strategy vulnerable to junior partner’s cooperation.
|Shared-access models||Pro: Easy entry into practice. Access to marketing and management services.
Con: Costs may be higher than desired. Lack of independent brand equity.
|Pro: Easy “divorce” if decide to strike out on own.
Con: Lack of control over infrastructure.
|Pro: May be the owner of the shared access center, deriving income from other physicians’ activities.
Con: Lack of ownership of tenant physician practices may reduce valuation at time of sale.
|Cooperatives||Pro: Easy entry. Shared overhead. Other physicians aligned to support new physician’s growth.
Con: Equally sharing overhead may result in reduced income in early years.
|Pro: Economies of scale. Security that the practice will not be sold mid-career.
Con: Sharing profits interests may reduce income in middle years.
|Pro: Sharing profits interests allows tapering activities while maintaining income.
Con: No cash-out on exit. Simply leaves practice behind.
|Independent physician association (IPA)||Pro: Access to experienced management team and economies of scale.
Con: Financial risk in starting own practice.
|Pro: Economies of scale. Control over practice and personal destiny.
Con: No income protection.
|Pro: Economies of scale. Control over practice and personal destiny.
Con: No ability to capture revenues from junior physicians.
|This chart shows the pros and cons of each practice ownership model discussed for physicians at various stages of their careers.|
Alternate ownership models are emerging for private practices. These include:
- Shared-access models. Physicians share facilities, staff and services but maintain autonomous control and ownership of their own practice.
- Cooperatives. Physicians contribute equally to overhead and share “profits interests” in different business units, such as the clinic, ASC and optical shop. Diversifying profit sources over different business units tends to offset unequal utilization of overhead. In this model, the physicians do not own equity but also do not risk being packaged and sold over time.
- Independent physician associations (IPAs). These joint-ownership firms provide management services to independent physician practices. Services include human resources, billing, contract negotiations and group purchasing. Having practices centralize these functions provides economies of scale and negotiating power while allowing physicians to stay in independent private practices. To access full benefits of banding together, practices may have to sell their operations to a common entity so they can bill and contract under a single taxpayer ID.
Well-established practices often have no alternative but to forge ahead under their current structure (unless they join an IPA). This may be why shared-access models and cooperatives remain relatively underutilized, while IPAs are proliferating. A study published in Health Affairs by Casalino et al. in 2013 reported that over 23% of private practices with fewer than 20 physicians participate in some way in an IPA.
An optimal practice ownership model provides competitive practice economics for today while anticipating the need to allow physicians to retire at some time in the future. It also aligns the interests of retiring physicians and those who are mid-career, while attracting top talent from the new physician pool.
No single model may satisfy all these requirements, but the emergence of alternative models suggests that the conventional approach of the physician-partner practice model may soon be obsolete. OM