C (3:04)

Yeah, it's a great question. So over the past few years we've seen an increased regulatory focus on PE backed arrangements in health care. And so, you know, just from that perspective, getting any sort of fair market value documentation is critical. But we've seen, you know, PE firms being fined for improper billing and coding done at the practice level because, you know, quote, they should have been more aware of what was going on all the way to, you know, fines against improper management fees. So really investigators are looking to go after and penalize PE firms not just their investments or not just practices. So there's obvious liability there. When it comes to a PE backed relationship with a physician practice, it's important to document a compliant and arm's length arrangement. Historically, the primary concerns have been, as I mentioned earlier, around not violating corporate practice of medicine and fee splitting prohibition. These are really put in place to ensure that no corporation impacts clinical decision making. And so there's two things that we've seen regulators look at with respect to that and that's one, the management fee and two, provider compensation. So when it comes to the management fee, that often serves as the vehicle for return on investment that a PE firm is going to look for. Therefore, to avoid any exposure, it's imperative to make sure that that management fee is set at fair market value if it's not. At fmv, you run the risk of a regulator arguing that a corporation's really running the practice and therefore you violate corporate practice of medicine. On the physician comp side, this is more of an emerging focus. You know, I can tell you back when I was doing these deals, you know, 2013 through 2016, no one really cared about the physician comp piece. It's really, in the past couple of years we've seen a keen focus on this. Attorneys are really pushing for physician compensation to be consistent with fmv. This can be kind of difficult in a PE backed arrangement because normally providers have below market compensation rates because they're sacrificing a portion of their take home pay for that upfront sum that the PE is investing into. But the thought is to demonstrate that the arrangement truly is arm's length as well as creating an environment that retains providers, it's important to pay FMV for the services being rendered. So therefore you know those two concerns. It's really important to make sure that you have the necessary documentation, oftentimes in the form of fair market value to mitigate any regulatory exposure.

A (5:36)

Thank you. And it's so interesting. And the transactions where a private equity driven sponsor buys a large practice and then as a management fee going back and forth, right. This question about is that really a management fee or does that really mean that the private equity fund is running the practice? And in many states private equity fund can't run or own a practice and thus being able to defend that it's truly a management fee versus ownership is really important. Is that a fair assessment?

C (6:04)

That's exactly right. So, so that's the importance of documenting that your management fee that you're charging, as you said, oftentimes hefty is set at fair market value. Right. It's a market level return for the services being rendered, but it also serves as that vehicle of return for an investor making a large investment into a physician practice.

A (6:32)

Thank you. And then the physician comp side, a lot of those private equity funds felt like they had more flexibility that did not for profit health systems in buying practices or compensating physicians. Can you talk about that a little bit and where that may or may not be true and why compensation, fair market value is so important even when private equity funds are buying or sponsor companies are buying practices or paying physicians?

C (6:55)

Yeah, absolutely. So I think that, you know, the traditional stark and anti kickback concerns may not be as relevant here as they are with say a health system establishing physician compensation. But it's more so of market retention or provider retention if you go in and you make this large investment on an upfront deal many times, and we can look to the 1990s for experience here, but you'd have these investments made and the providers would be like thank you, I'm done. And they'd walk away. Well, what are you left with? You have no providers that are helping you generate revenue and you just made this large investment. So, so the idea is the comp to establish and again mitigate risk more on the management fee side and the corporate practice of medicine side. A key factor there can be saying that, well, the providers are still making fair market value compensation and I'm, I'm creating an environment that it, it makes the providers want to stay, they're not receiving compensation, that it's really not worth their time, they want to go do something, they want to Leave and join another group, whatever it is. Showing that, you know, physician compensation is set at a fair market value range is very important because it allows for that picture to be painted right that, that the providers are being paid well. You're not causing undue course as a corporation, you're not an owner in that business and that the providers are still making a reasonable market level of comp for the services they're providing.

A (8:36)

Thank you very very much. And then Chris, to turn to you, when you look at sort of post closing financial reporting and monitoring investor confidence, talk a little bit about how sort of post close financial reporting and monitoring investor confidence it can support strategic objectives like audit readiness, portfolio oversight and positioning for future exits. I know it's a bit of a mouthful, but talk about, talk about how you sort of like continue to monitor the financials, the situation, all these kinds of things makes you much better prepared for exits and operating the business going forward, certainly.

B (9:17)

So I think I tackle that question from two angles. First, you mentioned audit readiness and generally speaking, most of our clients have a CPA firm performing annual or quarterly audits that usually will dictate whether a transaction requires a purchase price allocation under ASC 805 or 958805 if tax exempt. This helps the client and the auditor really understand and accurately record the value of both the intangible assets and the tangible assets, as well as residual goodwill on the balance sheet. Even if the client is in a startup phase and doesn't have an auditor as of yet, it's still a good idea to go through this exercise on some level. I did have a client recently that did not have so more of a startup phase client, did not have an auditor, was going to hire one in the next year or two. They did a smaller transaction and came to me and asked, hey, is it okay if we bypass the purchase price allocation since there's no auditor requiring us to do it? And my advice to them was that, you know, when they do hire an auditor, that firm will likely look back at these types of transactions and investigate how asset values and goodwill were determined. And if it does not meet the audit standards, then that auditor will require them to do a retroactive analysis. And doing this for as long as I have, I can tell you that it's much, much easier and efficient to do a purchase price allocation at the close of the deal than it is a year or two later. When you're looking back, you know, at past economics and the deal terms and trying to wrap your arms around what the asset values Would have been a year or two, you know, in retrospect. So I always advise them to, you know, at least have some form of allocation methodology on their transactions.

A (10:57)

But just to touch on this as well, on audit readiness and so forth. I mean, some of these practices have been living in the cash basis and they move to accrual. That transition is a big, a big sort of undertake by the accounting and consulting firm to move you from cash to accrual to prepare for audit. As you move into the sort of private equity sponsored environment, you've got audit issues, you've got bank issues, a lot of, a lot more people you have to report to. And having things in the right shape makes that just so much easier. And the amount of time put on administrative shoulders, if those things are not in better shape at a later date, can become overwhelming to somebody who's actually trying to run the business. Is that a fair statement too, Chris?

B (11:38)

It absolutely is. I think it's easy just to run the day to day practice and push the administrative responsibilities or tasks out until they're required or necessary. But sometimes that can accumulate and build, you know, as the practice grows. You know, if you have an auditor come in or any outside party that wants to look at the historical financial background and it's not kind of buttoned up, you know, it, it just causes a lot of work and it really, it probably interferes with the day to day running of the practice when something like that occurs. So it's, it's important to be mindful, you know, in the present tense in terms of appropriate accounting. Especially when you said switching from cash to accrual, there's a lot that goes into that.

A (12:21)

No, 100%. And I, I cut you off. You were going to say something else about positioning for future exits and portfolio oversight.

B (12:26)

Yes. Yeah. So I, I think in terms of monitoring and long term planning, it's, it's safe to say that most investors monitor their, the performance of their investments over time. But getting a bit more granular, we always recommend doing some level of periodic testing, you know, indefinitely lived intangibles that, that could be a trade name, something like that, or, or goodwill on the balance sheet after an acquisition is performed, it really helps to understand how the business has improved or declined over the year and if it has declined, whether or not the value of the assets recorded, including the goodwill, need to be adjusted. So understanding this will, you know, inform whether the investment is progressing to the desired state of a planned exit. And also, you know, maybe even more importantly, whether an early exit is warranted if the value of the business is, is in a state of decline. So I wouldn't say you have to do a formal goodwill impairment analysis under ASC350 every year for, you know, some of these physician practices in a PE setting, but having some sort of annual analysis performed to, to kind of gauge the current state of the business. And if you have recorded assets on the, on the books and the business is in, like I said, a state of decline, then those, those asset values and goodwill adjustments may need to, to be adjusted downward. But that's more of an accounting exercise. But from a higher level perspective, it, it's informative to, you know, how the business is doing. And when you're thinking, hey, we have a three to five year exit here, are we growing, are we staying steady, are we declining? Do we need to make adjustments to our investment plan? That's kind of important. So it's really just a, you know, an annual or periodic monitoring and it's.

A (14:07)

Become more important, particularly as the larger PE funds have to report to their investors ongoing valuations every quarter as to what's going on in their portfolio. And the one thing that private equity funds and investors don't like is surprises. And so the more that you're on top of what valuations look like, the better off you are. And nobody who's an investor like see the private equity portfolio going in the wrong direction, but you have to have those valuations in place and ready for those.

C (14:34)

Correct.

B (14:35)

Yes, that's accurate.

A (14:36)

Chris, we've talked a lot about portfolio oversight, audit readiness. We've talked just a little bit about positioning for future exits. Can you take one second on just sort of interim, constantly watching this financial oversight and seeing what's going on to make sure that the portfolio, the private equity fund, the sponsor, the company could be positioned well to think about future exits. Just give us a moment on why this is so important to thinking about exits too.

B (15:07)

Sure. So I think when you acquire a business, you're doing some sort of recording on the balance sheet of the assets of the acquisition and probably recording goodwill. I was talking from a financial reporting perspective. That's part of the monitoring process is if looking at an annual impairment test and testing how the business has improved or declined year over year and then making appropriate adjustments to the value of the assets or goodwill that were recorded on the books from the transaction. That's part of the process of doing an annual test to see how the business is performing. I think you have generally a three to five year exit date from a PE firm perspective when they're making investments and in order to track whether or not they're progressing towards that goal, you know, in the three to five year period, they can use that annual, you know, kind of impairment test or analysis, performance analysis to, to identify whether or not adjustments need to be made to the operations of the business in order to achieve that exit date or if something has happened fundamentally with the business that is, you know, causing a state of decline, whether or not they need to make an early exit. So it's all kind of just the, the ongoing monitoring process which we recommend should be done probably annually.

A (16:21)

No, thank you very much. I think that's right. I just have to stay close to the business, understand the business, see what's going on with it to make sure you can make adjustments, pivots, look at timing, look at other combinations have to be done, whatever it might be. Couldn't agree more. And then Holden, let me ask you some of the most common post close risks in healthcare transactions. And how can aligning fair market value and compliance frameworks help investors to proactively manage some of those risks?

C (16:46)

Yeah, again a great question, Scott. So going back to what Chris was saying, you know, the typical private equity hold period is going to be, you know, three to five years in an ideal setting. So really the, the risk is it's not just making sure the transaction is compliant. You have to make sure that for the next three to five years of your hold period that you've, you've created a compliant framework and program that's going to be followed because regulatory scrutiny isn't going to go away because a transaction's occurred. Right. It's, it's ongoing kind of review and assessment. But, but thinking about post close risks, just from an investor standpoint, obviously the biggest concern for any investors that they lose their investment. So when you're, when you're talking about a healthcare practice, that means losing your physicians. They're the ones that are generating revenue for you. So all we have to do, as I mentioned earlier, is look at the 1990s to see that this is a real concern and can happen if you don't the right framework in place. So to combat that risk, what we've seen many PE firms seek to do as, as I say, is get as many hooks as possible into their providers. So most commonly that's going to take the form of income repair. So as I mentioned, providers give up some portion of their earnings during the transaction. But through higher revenues or lower costs, PE firms aim to get the providers back to where they were or even at a higher point, at least it's part of their promise. There's often rollover equity for the provider. So in many transactions, providers are allowed to roll over a portion of that purchase price into the management company or new venture. So in that instance, the providers are anchored to the practice, they're focused on its growth. And if the arrangement's successful over that three to five year time period, the providers get upside too. And really that last hook that, that I look for is for the junior physicians. They're the ones that, you know, usually have a difficult pathway to partnership. We hear about this all the time. But these acquisitions can actually fast track equity opportunities that will also keep them connected to the practice. By continuously rolling equity in the MSO over those three to five year hold periods, they have real financial upside in the success of that practice. So they, they're committed to it, they want it to succeed. They're going to stay along, right? Aside from that other post, closing risks include weak compliance programs. So as I mentioned previously, we have some. We've seen fines levied against PE firms specifically for practices that had improper coding policies. We've seen PE firms be held liable for charging management fees outside of fmv. Regulators are really looking at PE health care investments. You need to make sure that you're creating a compliant framework and program for your investment.

A (19:37)

Thank you very, very much and couldn't agree with you more. And I hearken back to the 90s. I was around them, which is so sad and embarrassing. But I remember all these deals blowing up back in the day, the physician practice management deals blowing up, like 30 companies that went public, 25 of them went broke. So it happens and it's a tougher environment. And even today in practice management deals, particularly in the lower margin deals where there's higher debt on them, there can be plenty of risks. So trying to stay closely tied together and manage them well, really, really important.

C (20:08)

Right?

A (20:09)

Chris and Holden, I'll ask you for a minute each, any further thoughts that you'd like to share that we didn't touch on, that we ought to talk about Chris, let me start with you and then we'll turn to Holden.

B (20:20)

I don't have a lot more to add from a financial reporting perspective. You know, a lot of the purchase price allocation stuff doesn't really apply for physician practices unless you're rolling up a significant amount in one specialty. But to the extent you do have a more robust accounting requirement and have to start recording assets in goodwill, I would just continue to suggest that you have some sort of allocation methodology, even if it's not a formal ASC805 purchase price allocation. You know, I've had clients that prior to being clients of mine would just record things at book value and sweep the excess, you know, from a purchase price perspective into goodwill. And over time, you know, that might be a fine solution in the present tense. But over time, you know, if you have an auditor come in or some other governing body come in and you know, want to kick the tires on the balance sheet and discover that that there isn't a proper allocation methodology in place, then that could actually result in a sizable goodwill impairment adjustment which no investor wants to see or have occur. So that's all I really have from a financial reporting perspective. But I'll turn it over to Holden from the FMV side.

C (21:35)

Yeah, I mean, I think the final thought that I'd want to part is that investors really need to be careful when they're entering into these arrangements. You know, healthcare is a highly regulated industry and there's a lot more to it than, you know, other industries. So you really have to be in the know. You have to have the right guidance, the right counsel to help you through a transaction and even, you know, not just the transaction, but setting up a compliant program post transaction to ensure that you're avoiding regulatory scrutiny.

A (22:11)

Thank you very, very much, Chris over Holden Godad. I want to thank the two of you for joining us today on the Becker Business and the Becker Private Equity Podcast. It's always great to talk to yourselves and to leaders from VMG Health. I've got the highest regard for VMG Health. We've literally been working with VMG Health for 30 years now, which is so embarrassing to put myself that age date on my work with vmg. But it's amazing what you folks do. Thank you for joining us today on our podcast. Thank you very, very much.

C (22:43)

Yeah, thank you for having us.

B (22:45)

Yeah, our pleasure.