Originally published in Becker’s Hospital Review
By Marcia Flaherty
Physician compensation reset.
Those three words can create confusion among doctors running small medical practices and looking to protect their enviable incomes. But adjusting pay after a private equity deal is key to remaining independent in this increasingly competitive healthcare environment.
Many physicians have spent 20 to 30 years building their practices. The changing nature of healthcare reimbursement from volume to value means that quality outcomes need to be a priority over the number of patients a doctor sees.
That means having the technology and improved workflows to produce data to demonstrate quality of care. No small task. Meeting demands of multiple payers and complying with mandated quality measures costs $40,069 per physician. Because of these and other factors, many small practitioners have employment agreements with hospitals to eliminate the hassle.
But for those who want to remain independent, making financial sacrifices on the front end could be the right choice that pays dividends — now and down the road.
Physician compensation reset typically comes into play when these smaller practices take on a private equity partner, which is occurring more and more with radiology, ophthalmology and orthopedic practices.
These PE deals ask physicians to take a lower salary in return for equity so that they share in future growth of the practice.
This concept can be unsettling for some radiologists, many who make $200,000 or more per year and have built their lifestyle accordingly.
Investing compensation for future growth
Normally, in small practices doctors take a salary and at the end of the year whatever profit is left is split among the partners. That’s great for them, but the result is that each new year the practice can start with little cash for investment in the business. And this pushes them to focus on creating greater volume of patients than the year before.
In a PE deal with a compensation reset, the doctors agree to take less in salary – still substantial — and leave some of what they would have normally taken to invest in the business. That money is used to buy equipment and improve workflows that enhance the practice’s efficiency and, ultimately, its future value.
For example, consider a hypothetical private equity purchase of a practice where 100 shareholder physicians had been paid $1 million each annually before the deal. After the transaction, each doctor would be paid a new salary of $750,000 with the remainder — $250,000 each — retained as cash flow. That creates an EBITDA value for the portion of the business being purchased by the investors of $25 million. Let’s say you factor in a multiple of 8x EBITDA, that produces a sales price of $200 million.
Each doctor would then be paid $2 million from the sale — $1.5 million in cash and $500,000 in equity shares. That $1.5 million cash out (equal to six years of the reduced compensation) is taxed as capital gains, a more attractive rate than income tax would have been. In addition, PE investors will expect those equity shares to grow at least 15% annually. For a doctor keen on working in a growing practice, who wants to partially cash out and have a stake in the future of the business, it’s compelling.
The benefits go well beyond money
Smaller practices need to achieve scale and market share to compete for patients and manage costs. Practices with fewer than 50 physicians tend to lack the infrastructure to compete effectively, as hospitals prefer to deal with fewer, large outsourced physician groups.
At the same time, the move to risk-based forms of pricing requires significant investment in back-office technology because practices have to track and manage patient outcomes to be reimbursed appropriately. It’s no longer enough just to provide the best care; practices have to prove outcomes through data analytics.
Having more cash in the practice to address these needs make them much more viable as independent entities.
Sophisticated practices that have invested in infrastructure and have 75 or more physicians can fetch compelling sales prices — between the high single digits and the low double digits. Smaller practices that lack infrastructure can be bought as a bolt-on to a larger platform practice, fetching prices of between 5x to 8x EBITDA.
Practices that want to ready themselves for sale at the best prices need to have in place the right technology, the right infrastructure and processes and a reasonable reset of physician compensation.
As scientists, radiologists can grasp complexity. In this case, we just need to apply that thinking to our business model.
Marcia Flaherty is chief executive officer of LucidHealth, the exclusive management services provider to Riverside Radiology and Interventional Associates.