Vasilios "Bill" Kalogredis.

I have been representing and advising physicians for decades. Early in my professional career, almost all physicians coming out of training put out their own shingles and established a solo practice. Some joined smaller groups. A few went into academia. But, the Philadelphia area had very few large medical groups. Things evolved over time so that most physicians decided to join practices as opposed to starting from scratch.

But, it has only been in the past few years that big financial players such as private equity firms (PE) and venture capitalists have become actively involved in the medical practice space. PE folks are looking for ways to make huge returns on investment over a short timeframe (aren't we all?). Most are looking to "flip" things within an average of five years.

Generally, PE values medical practices as a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization). In simplest terms it means—how much is excess cash flow from operations at the end of the day. That is what drives things.

It truly becomes a numbers game. More EBITDA is created by "normalizing" the remuneration of the owner doctors. In other words, it recognizes that some of what an owner doctor earns is as a "worker bee" and the rest is as an owner (e.g., profits generated from other physicians, physician extenders and ancillary services, for example). In most PE deals, the doctor's remuneration is normalized (reduced) to market compensation for a nonowner physician with his/her specialty and experience. They also look for other ways to reduce operating expenses (often by centralizing management, IT and billing and consolidating space). Other sources of revenue are also sought (such as ancillary services which a smaller practice would not be able to support). The excess cash flow is profit for the PE investor.

PE will often buy the biggest and strongest practice in a particular specialty and area and use it as the springboard to bringing other local, but smaller, practices under the umbrella of the initial practice acquired. One example related to PE's acquisition of the "largest ophthalmology practice in town (Big O). As part of the deal, the related ophthalmic-centric surgery center (ASC), majority owned by the Big O doctors, was also purchased by PE. Once that took place, smaller ophthalmology practices (in numbers of doctors and dollars) were brought into the fold. In some cases, the newer doctors brought in sub-specialty expertise (such as retinal, for example) which Big O did not have internally. It also more readily allowed for the addition of other eye care professionals (such as optometrists) and services (such as an optical shop). It also allowed for the geographic reach to be expanded.

PE deals can result in huge purchase price numbers (with much of it usually at favorable capital gains rates for the seller). But, that must be balanced against the anticipated drop in future compensation.

Sometimes a portion of the purchase price may end up in rollover equity. What that means is that the practice transaction may result in a portion of the purchase price being paid in cash at closing, with the rest being applied to maintaining a material (often 20% or more) equity interest in the practice or in the entity owning/managing the practice. With the rollover equity, the selling physician maintains "skin in the game" and the potential upsides and downsides of that. Some doctors want them. Some do not want that risk.

I have advised many physicians, dentists and podiatrists relative to transactions such of those described herein. I am very honest with them and have recommended to many that PE was not the right fit for them. For others, it has made sense. When dealing with a group practice, it can get tricky, since the priorities of each member can be quite diverse. That can make arriving at a consensus difficult, if not impossible.

The yes or no decision for each doctor is personal. It is based on many factors such as one's years to retirement; exit strategy desires; personal and practice finances; health; willingness to "stop being the boss," but now having a boss, etc.

If and when a medical or dental practice you know is even considering a deal with big players, such as PE, it is important to put together an experienced and capable advisory team (including strong legal counsel, of course) to properly evaluate things and help all the way through the process.

There is a lot of complexity. The documents are many and voluminous. They may include asset purchase agreements, employment agreements, management services agreements, agreements relative to any rollover equity interests, real estate-related documents (it is not unusual for the seller to own the practice-related real estate) and more. There are many financial, tax, legal, practical and personal things to be considered as well.

It is not the right choice for every doctor. But it can be the right choice for many doctors.

Vasilios J. Kalogredis is chairman of Lamb McErlane's health law department. He represents many medical and dental groups and thousands of individual physicians and dentists.