Leveraging MSO Structures To Infuse PE Investment In Physician Practices

By: Anthony Law

(Estimated reading time: 4 minutes, 33 seconds)

Despite a steady five-year growth trend, the U.S. healthcare industry remains in the throes of a challenging operating environment. Industry impacts are felt from healthcare reform and continued attempts to repeal existing healthcare legislation, changing reimbursement matrices (e.g., fee for services, capitated, and value-based care), and rising operating costs.Health Services Spending Growth 2010-2018

To reduce costs and remain competitive, the healthcare industry, along with the U.S. physician group sector, has experienced an increased level of M&A and reorganization activity. In fact, hospital acquisitions of physician practices rose 128 percent since 2012.2

An Overview of Trends in the
Physician Group Sector

Medical Costs Outpace Inflation, Expected Increase in 2020Historically, physicians prefer to work alone or in small group practices. However, as the sector evolves, independent practice associations are a popular organizing strategy among healthcare providers to aggregate market power when negotiating with third-party payers. This approach allows them to realize operating synergies and gain scale to operate their practice effectively.


In the past, this trend has attracted hospitals or hospital systems as acquirers. But in recent years, private equity investor interest in the physician practice sector has been gaining steady momentum. In fact, in the past five years, the physician group sector experienced increased merger and acquisition activity and capital investment from PE.

PE firms have shown a particular interest in specialty practices such as dental (steady annuity of patient fees), dermatology (fasting growing subsector in recent years and relatively recession-proof), orthopedic (increasing demand from an aging population), and oncology. Physician practices recognize there is a direct capitalization benefit from such PE firm alignment to create a larger, more robust platform for the delivery of patient care, to reduce pressure from rising costs and administrative burdens, and to withstand a competitive environment. In short, it allows physicians to focus on delivering clinical expertise while involving a growth-motivated partner to manage the practice’s business functions.


Independent practice associations are a popular organizing strategy among healthcare providers to aggregate market power when negotiating with third-party payers.

Establishing Strength in Numbers: Transaction Structures

There are, first and foremost, legal distinctions PE and physicians must consider before reaping the clinical and business efficiencies of consolidation – clear laws that have been adopted by a majority of U.S. states to prohibit the corporate practice of medicine. Physicians tend to appreciate that the COPM statute restricts non-physicians from owning or controlling a medical practice or employing doctors, thereby ensuring clinical and patient judgment remains in the control of the physician. To comply with this regulation, the PE firm must establish a management services organization.

What is a management services organization?

A management services organization (MSO) is a legal entity established to acquire all operating assets of a physician practice. The MSO is responsible for all non-medical business and administrative functions, employment of support and mid-staff levels, as well as ownership and development of all ancillary services.

The provision of professional medical services, including contracts and employment of the physicians, remain with the practice, which is still physician-owned.

How does an MSO work?

The MSO enters into a management agreement with the medical practice and pays an agreed-upon management fee to the MSO for ongoing services rendered. Typically, the fee results in a break-even situation for the practice. It is also important to note that the fee charged by the MSO is considered ‘commercially reasonable’ and at fair market value to ensure MSO fees do not violate federal and state Anti-Kickback, Stark, or Corporate Practice of Medicine laws.

A portion of the net proceeds paid to the physician shareholders would be rolled over into a part of the equity ownership of the MSO. Thus, the PE firm and physicians share in the equity ownership of the MSO, thereby sidestepping the state regulations prohibiting non-physician entity ownership of a medical practice.

The MSO also enables the PE firm to use it as a platform to acquire other practices as roll-ups for the original, acquired practice, and leverage operating overhead.

Fair Market Value Requirements of an MSO

The acquisition by the MSO of all the operating assets of the practice creates a purchase accounting requirement under the provisions of Accounting Standards Codification Topic 805 (ASC 805), Business Combinations. ASC 805 requires a supportable basis of value for allocation of the purchase price to all the acquired tangible and intangible assets.

The tangible assets could include personal property (i.e., medical and laboratory equipment, office furniture, etc.) and real property (i.e., owned or leased land and buildings.) Intangible assets could include tradenames, certificate of needs license, payer contracts, medical records, non-competition agreements, etc. The assets acquired will depend on the facts and circumstances of the specific acquisition.

Depending on the asset to be valued, the application of the appropriate valuation approach is crucial.

  • Is a desktop approach acceptable for tangible assets?
  • Which intangible assets are considered the primary asset that would dictate using a specific method?
  • How do you determine which appraisal approach is appropriate (e.g., relief from royalty, replacement cost, excess earnings, with and without cash flow, etc.)?
  • What are the applicable discount rates to employ for the various approaches and assets?

Given the multitude of approaches and assumptions involved, it is advisable to hire an experienced and reputable valuation professional with a specialized focus on such transactions who will determine the supportable values for all acquired assets. The work product of an independent valuation firm must also meet the rigors and requirements of the audit process. Also, a properly prepared valuation analysis will help for subsequent impairment testing studies.

Depending on the asset to be valued, the application of the appropriate valuation approach is crucial.

By the same token, if a physician practice is in negotiations with a PE firm to acquire its business assets, the physician should also engage an independent valuation firm. A valuation will help the practice shareholders understand if the PE firm’s offer is in line with the overall value of the practice. An experienced advisor can also assist the physicians in understanding different offer structures. Such advisory services are especially helpful in translating the overall purchase price should the offer terms include cash, rollover equity, clawback provisions, earnout considerations, voting rights, profits interests, or other types of performance incentives.

The Bedrock of a Physician-Professional Relationship

Just as ethical principles and expert medical care are crucially important to a doctor-patient relationship, they are equally as important when a physician considers both PE investor and valuation partner relationships.

Valuing medical practice entities and determining various asset values requires extensive healthcare industry knowledge, technical expertise, and deep advisory capabilities regarding M&A. As healthcare deal activity grows in tandem with regulatory and audit scrutiny, as well as demands for investor transparency, engaging an experienced and independent valuation firm will improve the defensibility of a well-prepared valuation.

For an in-depth conversation about VRC’s experience with the healthcare industry, delivering ASC 805 analyses for several PE firms, and understanding the value implications of your MSO, we invite you to contact the article author Anthony Law or contact your VRC professional.

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1 Peterson-KFF Health System Tracker, Dec. 10, 2018; <healthsystemtracker.org.>.
2 RevCycle Intelligence, Feb. 21, 2019; Hospital Acquisitions of Physician Practices Rose 128% Since 2012; <revcycleintelligence.com>.
3 PwC Health Research Institute medical cost trends 2007-2020.