PPM deals are one of the hottest trends in the current transaction environment with healthcare professionals. 

In this episode of The Corner Series, McGuireWoods’ Geoff Cockrell is joined by fellow partner and chair of the firm’s Healthcare Group, Holly Buckley, along with Justin Chamblee. Justin is the President of the Coker Group, a healthcare consulting firm that advises leading healthcare organizations on a wide range of financial, transactional, and operational solutions.

Tune in to hear Geoff, Holly, and Justin discuss physician compensation in the PPM context, including provider compensation in structuring PPM transactions, provider compensation models, regulatory constraints, such as the Stark Law and the Anti-Kickback Statute, and retention and recruitment in the market.

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Corner Series, a McGuireWoods series exploring business and legal issues prevalent in today's private equity industry. Tune in with McGuireWoods partner Geoff Cockrell as he and specialists share real-world insight to help enhance your knowledge.

Thank you for joining another episode of The Corner Series. I'm your host, Geoff Cockrell, partner at McGuireWoods. Here at The Corner Series, we try to bring together dealmakers and thought leaders at the intersection of healthcare and private equity. Today I'm thrilled to be joined by two guests, my partner and friend, Holly Buckley, who's the chair of McGuireWoods Healthcare Group, and Justin Chamblee, president at Coker Group who we've done many, many deals with over a number of years and are good friends of ours. But maybe to start us off, Justin, if you could introduce yourself and Coker before we get into some questions here.

Yeah, that's great. Thanks so much, Geoff for the invitation to participate in this today. Just a quick intro on Coker, a healthcare consulting firm, work in about 40 states a year and really focus heavily on the provider enterprise and how that has changed over the years. Historically, of course, did a lot with the private medical groups then transitioned into working with health system-focused medical groups. And now as the landscape continues to change, find ourselves doing more and more with private equity-backed entities.

This is Holly Buckley. I am a partner and the department chair of the healthcare practice at McGuireWoods. I spend a lot of time in my practice working with both private equity funds, private equity-backed portfolio companies, as well as traditional players in the healthcare space such as hospitals and health systems, physician practices, ambulatory surgery centers, and a variety of others. Very happy to discuss this exciting topic to today, and the topic is physician compensation in the PPM context. And it's a topic that Justin and I have had interesting discussions around both philosophically and with respect to actual situations. And we thought it'd be fun to get with Geoff and do a podcast on the topic because I think there's so many different angles to look at this from. So I'm going to initially kick over to Justin and Justin's going to give a few thoughts on how he views provider compensation coming into play when structuring PPM transactions.

Yeah, thanks, Holly. And I'm sure what we consider exciting may not necessarily be what others do, but it truly is something that for those that are playing in the space are dealing with on a regular basis. And by way of background, I mean if we think about traditional medical practices, there really is no net income, meaning most medical practices see provider compensation as being synonymous with net income. And therefore when we think about PPM transactions, we've got to create net income through what we call a compensation scrape. And so just using a very simple example of a group that may have $5 million in earnings before partner compensation, let's say there's 10 providers in this group, each physician is earning roughly $500,000 a year. If we scrape or create a scrape of $2 million, the go forward EBPC, or earnings before partner compensation, is still that $5 million. In essence, we've divided that between $3 million of ongoing compensation and $2 million of true net income then becomes the synthetic EBITDA that we can base a transaction off of and create some upfront value. And so how those elements come into play, specifically surrounding the compensation scrape and not just what is happening at the time of transaction, but then how the compensation pool is treated prospectively is very pertinent as relates to the success of PPM transactions.

And Justin, historically those go forward models had been pretty purely production related, where the upshot of that if you're a provider is that you might get a little bit of lift on your take home pay based on improved contracting or maybe some administrative duties being relieved and allowing you to produce more, but it was just going to be kind of on your own back. But the modern models that are all much more heavily net income based have been pretty transformative. How kind of present in the market are those net income based versus raw production based from where you sit?

Great question, Geoff. From a pure overarching healthcare environment standpoint, I mean we still see a heavy, heavy emphasis on production based models in the health system landscape. But when we move outside of the health system landscape and look more so in the PPM world, most if not all of the models truly are net income. I mean there's a profit motive and therefore the private equity groups don't want to take risk by paying only on work RVUs and then having to hope that it drives bottom line performance. And so we see the net income based model or some means of tying the compensation pool back to EBITDA as being a key element of practically all PPM transactions that we come across.

The net income models are often referred to as income repair models with the idea being that unlike a production based model, if you can improve net income of the relevant subset of the business, that your take home pay could be improved, you expand or hire mid-levels or do other things. In your experience, and I'd be curious for your take on this as well, Holly, how often is that income actually repaired versus more theoretically repaired?

Holly, I'll let you shoot first and then I can respond.

Yeah, I think it's really, really variable and I think some of it has been folks have learned a lot in hindsight. But I think you've got to look really carefully at the outset of signing on for one of these models in terms of whether the nature of the market and the growth potential can even facilitate income repair. So areas where you could have really good opportunity for income repair, where maybe initially the platform has very few ancillaries, very few mid-level providers, and the opportunity to have a meaningful employed non-partner workforce that isn't there at the time of the transaction. So let's say you've got a group of 10 physicians, all of whom are owners, zero or very few employed folks, low ancillaries. There's going to be really good opportunity there to repair the income, especially if you can grow by acquisition and increase the overall size of the platform.

If you already have a platform that's relatively well-built out with ancillaries and mid-levels and there's a relatively short path to partnerships such that you're not going to have employed practitioners who are adding to the top line but not taking a share of the profits, then it's going to be very dependent on whether or not you can see income repair. And so I think we've seen some platforms be very successful at it, and then we've seen others that just don't have the right ingredients where it was probably always going to be a struggle.

And I would agree completely with Holly what you said, and it is truly variable and it depends on the current build out of the platform. I mean, if we're truly growing the platform by simply adding more physicians who are going to participate economically, similar to the initial platform, I think it's going to be difficult to create that income repair. It has to come through other means of profitability to in essence enhance what I'll call same store compensation if you will. And so it does vary.

I think what we see oftentimes is the income repair is not happening as quickly as the physicians would like it to, especially when we are getting into the early stages of building out a platform, we actually may see performance dip a little bit due to additional costs that are being pushed down or additional infrastructure related costs that we're building out to create the further platform growth. And I think that initial period where maybe we're not even seeing income stability, we're actually seeing reductions is the period that is most trying because the physicians have already taken a pretty hefty scrape and then are not necessarily seeing the same incomes that they were hoping to. So having that long-term vision and continuing to re-emphasize the long-term vision of what we're trying to create is key.

Holly, you mentioned ancillary service revenue as being a potential area of increased revenue as you scale a practice following a transaction. There's a lot of different views of how ancillary service revenue should be shared amongst the providers. What are you seeing as some of the leading models of that and what are some of the regulatory constraints?

Yeah, I'm going to answer your question in the reverse order, but where you have a physician practice that's participating in federal healthcare programs, you've got to be very mindful of both the Stark law and the Anti-Kickback Statute. And the Stark law being a strict liability statute dictates that those ancillary services that constitute designated health services, so imaging ,lab, PT, injections, have to be shared in a very particular way, otherwise you can run afoul of the Stark law and then each claim and reimbursement is prohibited under the Stark law. So I don't know that there's a lot of differing opinions in terms of that piece of it, but then there is after that when you say, "Well, provided we're compliant with the group practice definition and the in-office ancillary services exception, we can distribute those designated health service revenues amongst the physicians who are going to be eligible to participate." And that's one decision, who gets to participate.

And then provided you have pods of five or more physicians, you can distribute it either in a safe-harbored manner, which is going to be equally or based on personal productivity excluding DHS, or you can distribute it in a non-safe-harbored manner, which is not following one of those methodologies but distributing in a manner that isn't based on the volume or value of referrals. We most commonly see either the equal split or based on productivity or some combination of the above, but we frequently see other models as well that are totally permissible. And then there's the whole kind of non-DHS ancillary question. How does that work, which I think we'll maybe talk about a little bit later. And the primary ancillary that falls into that bucket is ambulatory surgery center facility fees.

And Justin, as you look at those models, how they're sharing it, what's your perspective on some of the different approaches within the regulatory constraints that Holly has mentioned, how do people think about some of those revenue sharing models? And then a follow-up question, as you look at kind of these EBPC structures, it always strikes me that they could be kind of drafted widely or narrowly so that you're connecting the provider much more closely to areas where they can impact it versus say a whole state or a large geographic region. How are you seeing folks approaching those two things?

Geoff, I think we see first off, to the extent we can create pods that are more locale-specific following rule of five methodology, we do want to see and encourage locale-specific dynamics because that's truly where you have the ability to enhance in effect performance. When we see more national-based sharing arrangements, we tend to see performance actually suffer because there's not as direct correlation between the impact that a physician can personally have and the financial benefit associated with it. When we get into very specific income sharing methodologies, our recommendation is always trying to keep it as simple as possible, yet accomplish the desired impact. Oftentimes simply due to the simplicity, we see a lot of equal share models. I don't necessarily think that is always the best way to go, but is something that we see quite frequently.

The scrape, especially following a private equity or other financial sponsor transaction means that a portion of the revenue running through a practice is not going to be available to the providers. The practice is still competing for talent in the market. What's the impact of that scrape on retention and recruitment? Justin, we'll start with you.

Oftentimes what we see is the desire to scrape a lot, maybe there especially in high income earning specialties. So we've done some work in the fertility space and in those instances that the desire for a scrape, in terms of the magnitude of the scrape, is pretty high. And what we have had to look at is what are the long-term ramifications of the amount of scrape, meaning in certain instances that we've encountered the scrape is so much that the prospective compensation of the partner physicians is lower than what it is going to require to recruit and retain to the market.

And then you get into some pretty interesting dynamics as relates to having to pay providers, new providers and less experienced providers, potentially more than the existing partner level providers. And I think that creates some unsustainable dynamics. Or if we are trying to limit what we can pay new providers based on the scrapes that the partners who establish the platform are being paid under, we may not be able to successfully recruit and retain. And so our key thought and recommendation is you've got to take that long-term perspective as relates to where you're setting the scrape, not just what we're trying to take off the table today, but the ramifications of that scrape prospectively as we try to build out the platform.

But I think, Justin, there's a challenge that buyers run up against, which is the scrape reduction is directly correlated to purchase price, and so the purchase price is being set based on the scrape, and I think for a lot of sellers, the higher upfront purchase price has a lot more flashing lights around it than the go-forward scrape. And so it's a psychological issue that buyers have to deal with when they're setting up transactions to try to set a long-term chart course that's going to work while also winning the deal.

Yeah, absolutely. And the other dynamic that comes into the scrape are generational perspectives, meaning older physicians are much more willing to take a larger scrape than younger physicians who are still trying to service student loan debt establish themselves from a personal standpoint. And so there are a multitude of factors that come into the scrape dynamics. Holly, as you mentioned, just the flashiness of the deal and the value of the upfront money, which if it is not substantial the group may look at the alternatives such as a traditional hospital transaction as being just as valuable, but then also how do we create agreement within the group in terms of the different perspectives that may exist as to the desire and need for ongoing income.

One of the issues that presents in the context of a transaction is how to navigate the providers who are not quite partners. In a typical practice, you work for a number of years and then you buy in and become a partner, let's say 30 grand to buy in or something like that, not a ton, and that's going to entitle you to some enhanced compensation through distribution or just enhanced compensation. And then when you retire, you get your 30 grand back and then there's this one magic moment when being an owner in that practice is going to translate into $4 million or $5 million in a sponsored transaction. And if you weren't a partner at the time of the transaction, solving for that timing miss can be a profound issue to navigate. Holly, how do you see people thinking about the almost partner in the context of a transaction?

Yeah, so I think once everyone's realized the time machine is not an option and we can't roll back the clock and elevate the associate to partner at a point far enough out from the transaction that it works, then there's kind of the difficult pathway of, "What is next and how do we keep these folks with the platform?" And I think there's a few different options. The best option that I've seen is some type of transaction bonus that can be either born by the sellers, the buyer, or a combination of the two that's paid out through the practice, and the associate physicians can then use that bonus to potentially buy equity at fair market value.

I think a lot of the other options tend to have a lot more regulatory hair with it in terms of you can't really gift equity or there are some serious challenges with gifting equity that make that pretty prohibitive. And the post transaction platform looks very different as you mentioned, Geoff, so it's a very nuanced issue that's very fact specific based on the nature of the platform and how it's put together. But it is one that's somewhat fraught with different regulatory risks, and so it's one you should ideally confront far enough out from the transaction that you don't run into the issue at all.

One topic that I encounter difficulty with kind of existing EBPC model platforms is challenges surrounding complexity. I'm a big believer that in almost every context simplicity would be your friend, but that's not always the pathway that people go. One of the drivers of that is often a desire in the context of the transaction to have the go-forward, how they're dealing with compensation post-transaction other than the scrape look like how they were doing it before. Justin, how do you think about the topic of A, complexity and B, whether or not a platform should continue with how they're giving up income pre-transaction?

Agree completely with the idea of simplicity and that is any provider compensation arrangement, whether it's within a platform in hospital-based arrangement, simplicity is key. We always say it needs to pass the napkin test, meaning we can sit down together over coffee, on the back of a napkin sketch out the compensation arrangement, and there's some semblance of understanding there. Secondarily, we are firm believers in the idea that a lack of understanding breeds a lack of trust once again pointing to the need of simplicity. What we see oftentimes is within transactions, not a ton of attention is placed on the actual mechanics of the income distribution methodology. And we believe there needs to be a lot because the focus and how successful the income distribution methodology is will dictate how well in many respects the platform can function prospectively. And so just because there's a model that has been in place doesn't mean that it is the model that should be in place historically or prospectively.

What we see oftentimes is broken models exist, and if we truly want to align the vision and the mission of the platform prospectively, we need to make changes to the model to make sure that all the incentives are aligned prospectively further as we think about tuck-in and bring other physicians onto the platform and presumably adopting a similar compensation methodology, the time to fix it is now, not necessarily as we add even more complexity by adding other physicians to a broken model. And so to summarize, we feel like a good bit of time needs to be spent as part of diligence in looking at the model and seeing if tweaks need to be made. And then secondarily, making sure that whatever model's in place, whether it's a legacy model or a new model, is truly aligning the vision and the mission of the model with what the platform is trying to accomplish.

And Holly, how are you seeing platforms approach that, especially from the perspective of a tuck-in, do you see folks valuing uniformity or is it the BD team trying to get a seller to yes, and the path of least resistance on that is to tell people that, "Yeah, we'll keep doing it the way you were." How are you seeing people approach that and do you have a thought?

Yeah, so I think in general, larger groups, pretty established groups tend to be very wed to their historic way of distributing their income. And so I think a lot of the process of a buyer getting to know a seller, not a lot of it, but a significant part of that is often around how distributions will be made in the future. And some of the time that's a promise that it's going to be exactly the same. It's kind of interesting just how much affection the physicians seem to have to their comp distribution model. I think where there are smaller transactions that happen to have onesie, twosie groups join a bigger group, they tend to get absorbed into the compensation model of that bigger group. And part of that is what I said earlier, where if you're distributing ancillaries, you need a pot of five or more, so there really isn't an option for them to do something different.

But where you're adding a group to a platform who's maybe in a different geography, maybe there are very established practice in that own right, I most commonly see them have some kind of different compensation distribution plan, and they're going to be generally the same. It's most of the time the partner physicians are getting paid for their own personal productivity less expenses and then some portion of the ancillaries and they're going to be distributed using a certain methodology. That's the basic formula. But the way that they do it, and at what point the splits happen, that's where you can have variation and then whether it's going to be based on production or equal or some combination or some other metric. And so I most commonly see physician practices coming into a platform, if they're big enough and well-developed enough, they often want to keep their own methodology. I don't often see groups agreeing to go to a totally different distribution methodology.

And I would concur with that. I think there is a correlation between the size of the group and the amount that they are wed to their historical methodology, whereas transactions of smaller groups, there may be less appetite to continue that methodology forward, especially if there is some consternation by a contingent of the physicians with it. But that correlation does exist where the larger the groups have more well-established models that likely will manifest themselves in the same manner post-transaction.

In the context of a transaction, the scrape is obviously creating the purchase price. That puts a lot of pressure, especially when you're changing the compensation apparatus that if next year from revenue and expenses perspective looks like last year the new model needs to create the same scrape that you just paid for. How much attention do you see folks paying to that modeling and how do you think about the QofE process as it relates to these scrapes, Justin?

I think the scrape is going to occur, period, and oftentimes what we see is the prospect of compensation is being tied to a percentage of EBITDA based on the amount of scrapes that occurred, and therefore the scrapes that we created as part of the transaction process is truly going to occur prospectively under the new model, where there's more consternation, especially tied to the QofE process, is unanticipated or unintended dynamics that are popping up wherein the QofE made certain assumptions and in order to maintain the continuity of the group relative to the results that are occurring, whether we actually did see a decline in EBITDA that is putting even more pressure on go-forward compensation beyond the scrape or other dynamics, that's where we see a lot of focus tied to what the QofE said and what is actually manifesting itself. But because of the fact that we did a pay heavy upfront purchase price, we want that scrape to continue to occur, but there is ongoing pressure surrounding what is happening with EBPC prospectively and what was anticipated or what's not. Holly, I don't know if you want to elaborate on that in terms of some of the things that you specifically have seen?

Yeah, I mean we've seen examples for sure where at some point post-close the platform realizes that there's a divergence between the QofE and the actual performance, and it's generally been tied outside of external forces where it's internally driven, it's through things not being appropriately accounted for in the go-forward comp plan, maybe it's an expense issue and the expenses haven't been properly captured. There can be a number of ways that this come up, but it can create some awkward dynamics because at that point, the platform essentially needs to work with its physicians who are both owners in the platform generally, and employees and kind of the lifeblood of the business and say, "Hey, we need to adjust your compensation to decrease it so it ties out to the QofE." And so those can be very difficult conversations and require good, strong relationships and a lot of, I think, discussion and data sharing. And I've seen platforms get there and get to a new model, but it's certainly a less than ideal discussion to have.

And where I've seen a lot of pressure on that is what perhaps was budgeted for associate physicians prospectively, those that are not participating per se in the transaction, what we budgeted for them from a QofE standpoint versus what it may end up needing or those physicians needing to continue to see their income grow and maintain happy as part of the platform, that's where we see a lot of pressure, which then does cause us to revisit some of those initial QofE assumptions and try to put ourselves on a better pathway prospectively.

These EBPC models are so central to provider based transactions, and I think this discussion has drawn out the numerous and varied complexities that can arise. We could talk about this all afternoon, but I think we'll call it there. Justin, thank you for joining us. We think super highly of the Coker Group and look forward to working with you on a bunch of things. And Holly, thanks for joining, you're always welcome.

Thank you for joining us on this installment of The Corner Series. To learn more about today's discussion, please email host Geoff Cockrell at gcockrell@mcguirewoods.com. We look forward to hearing from you. This series was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this series, you acknowledge that McGuireWoods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in this installment. The views, information, or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.