The Managed Services Organization: How Private Equity and Non-Physicians Can Invest in Provider Groups

As the current wave of physician practice M&A accelerates, private equity investors and transaction attorneys are employing multi-tiered legal structures that satisfy unique healthcare-industry considerations, including the ownership requirements dictated by state-specific “Corporate Practice of Medicine” laws. Managed services organizations (or “MSOs”) are typically at the heart of these legal structures and can be useful when addressing many healthcare-specific transaction requirements. MSOs also can align incentives and allow non-physician partners to provide useful services to affiliated medical practices. Understanding the function of an MSO is critical for physician practices that are exploring opportunities to partner with private equity groups, and engaging healthcare investment bankers and attorneys who are experienced advising provider groups can help establish optimal corporate structures to unlock the value of your practice.

In most states, Corporate Practice of Medicine requirements stipulate that an entity providing medical services be provider owned.  For this reason, physician-owned practices typically are structured as professional corporations (“PCs”), professional limited liability companies (“PLLCs”), or another corporate structure that requires professional ownership. Oftentimes, in addition to providing clinical services, the PC or PLLC is also the entity that employs administrative staff and holds non-clinical assets, all of which works well as long as physicians own 100% of the practice. However, for a practice to pursue a transaction with a private equity group while remaining compliant with all necessary rules and regulations, a new LLC needs to be created within the corporate structure: the MSO.

Here’s how it works:

  1. Physician owners retain 100% ownership of the PC or PLLC, which continues to hold all clinical assets and wields independent discretion in regard to clinical operations. Physician control is important to remain compliant with the Corporate Practice of Medicine; nobody except for a practicing physician can make decisions with respect to the delivery of care.
  2. All non-clinical assets are transferred to the MSO, with which the physician practice signs a Managed Services Agreement (“MSA”). The MSA allows the MSO to collect fees from the practice to manage the non-clinical assets.
  3. A holding company is created to hold all of the ownership shares in the MSO, and the selling physician(s) are established as the sole owners of the holding company. For private equity to invest in the business, they will buy shares in the holding company from the physicians, thereby purchasing a portion of the claim to the management fee without owning the clinical operations of the business.

Here’s how it looks graphically:

Creation of the MSO and Holding Company









Credit: McDermott Will & Emery

Given the complexities of forming, negotiating, and transacting in an MSO, it is imperative that physician groups retain knowledgeable and experienced transaction attorneys and healthcare investment bankers. When the right advisors come together to help you find the right partner that can create the most value, the MSO structure for private equity investment can be an excellent vehicle for building outstanding healthcare services businesses.

Two Worlds Collide (in a good way)!

A theme we like a lot, and have had good experience with, is the intersection of healthcare services and consumer. Why?

  1. Broadly speaking, healthcare services and consumer are two huge markets: healthcare services is a $2.3 trillion market growing at 3.7% YOY and consumer products and services, broadly speaking is a $13.4 trillion market growing at 1.6% YOY (accounts for roughly 66% of GDP).
  2. From a more focused perspective (the MHT perspective), we see a couple of dynamics at play:

A) With respect to healthcare services, with static wages and the increasing prevalence of high deductible healthcare plans (especially with smaller companies), consumers of healthcare services are more discerning of where they spend their scarce dollars.  Perfect information available online has only ratcheted up the importance of healthcare providers who are digitally smart and savvy with their marketing and who also provide the consumer a good-to-great “experience.”  We’ve been fortunate to represent a couple of leading dermatology providers who provided not only great medical care, but also an outstanding experience to their patients. In the same vein as dermatology, we also like other “consumer-” facing medical services and, in particular, those with a private-pay angle, such as fertility, urgent care, orthopedics, ophthalmology and allergy specialists.

B) On the flip side, from the consumer perspective, consumers like (i) products and services that keep them out of the hospital or doctor’s office, (ii) health procedures that are discretionary, but also “permitted indulgences” (e.g., cosmetic procedures), and (iii) products and services that have a “wellness” angle (i.e., make the consumer feel better – either physically, mentally or both).

Find a company that offers you all of the above, and I’ll show you a company with a third highly attractive dynamic – the ability to create a lot of wealth!

Corporations Stepping Into the Education Void

More and more, MHT Partners’ education investment banking team notices corporations increasing internal training capabilities for existing employees and accepting alternative credentials vs. traditional college degrees when hiring new employees, citing the slow pace of change within the U.S. education system, most notably higher education.  Not only is slow change an issue among U.S. higher education, but the number of students and graduates is decreasing.  Since 2011, the number of students enrolled in higher education has declined by 2.6 million.

The problem many corporations cite is too few graduates from higher education with the requisite skills to fill open positions.  A recent study completed by The Manpower Group suggests that 40% of employers are having trouble finding workers with the skills they need.  The solutions: develop content and curriculum specific to the needs of the corporation via corporate training partners and/or increase the acceptance of alternative credentials from online learning platforms.

From an education investment bank perspective, we see strong interest in both types of providers/solutions from training partners and institutional investors.  Bisk Education, Academic Partnerships, iDesign and other online program managers (“OPMs”) are increasingly turning their attention to corporations looking to strengthen their training and professional development programs in support of retraining or upskilling existing employees.  This solution has the added benefits of increasing retention of existing employees and strengthening the professional development capabilities of corporations without the overhead of large corporate training departments.

On the other hand, some corporations are increasingly accepting alternative credentials, such as micro credentials from online learning platforms, in lieu of traditional degrees.  AT&T, IBM, Google, Apple and many others in the Fortune 500 are rethinking their acceptance alternative credentials due to the talent shortage and short shelf life of skills.  If the recent billion-dollar sale of Ascend Learning is any indication, investors are apprised of this trend and are paying rich valuations for platform investments.

What does this mean for investors?  MHT Partners believes many employers will continue to develop these solutions and capabilities in 2018 and beyond.  As a result, investors should have numerous opportunities to partner with technology and training companies in the professional training and development sector.

Disruption in the eDiscovery Industry

Electronic discovery (”eDiscovery”) refers to any process in which electronic data is sought, located, secured, and searched with the intent of using it as evidence in a civil or criminal legal case.  The size of the eDiscovery market continues to expand, topping $10 billion in value globally, as data volumes grow and its forms proliferate.  eDiscovery participants must make big decisions around technology, partnerships, and business models that could lead to their winning or losing in the market.  This environment, combined with the broader state of the economy, is driving and will continue to drive rapid consolidation.  A set of factors driving mergers is the criticality of scale in eDiscovery.

Service providers must have scale to:

  1. Drive prices lower each year, as clients expect
  2. Invest and manage data security as end client focus has been laser trained on this need
  3. Operate on three continents, driven by differing personal privacy laws and regulations in different geographies.

Beyond these factors, perhaps the most chilling to the eDiscovery market is the strategic question of how to approach RelativityOne….

It’s been approximately two years since Relativity (formerly known as kCura) unveiled a complementary SaaS solution to its namesake eDiscovery software.  Known as RelativityOne, it promises all of the functions and features of Relativity.  Now, however, the hosted SaaS data would reside in a Relativity managed portion of Microsoft Azure’s cloud, instead of multiple cloud offerings from partnering service or distribution providers. Relativity more readily controls technology updates to end users. Predictable revenue streams come in the form of license fees, as well as through fees for hosting data. This model could theoretically change the barriers to entry to the service industry – lower upfront costs, instant and over-the-internet upgrades, scalability, and decreased IT infrastructure costs.

RelativityOne’s introduction has caused consternation within the industry.  The software is the 400 lb. gorilla in the eDiscovery software space, counting, according to the company, 75% of the Fortune 500 and 98% of the Am Law 200 as users.  In the old model, their software would often be paired by clients with other software tools. Clients did not have to use all Relativity modules (e.g. processing) to provide a soup-to-nuts eDiscovery solution for end users.  Channel partners would stitch together these software tools and offer implementation, consultation, and support to their clients, often provided through proprietary platforms and/or as managed services.  RelativityOne’s introduction threatened the ecosystem, specifically Relativity’s channel partners, by moving from providing just software to services as well.  Relativity may well end up with an even more dominant hand in this industry.  There will potentially be less ability to include other software tools in solutions, valuable hosting revenue is shared (many say taxed) with Relativity, and Relativity may end up setting prices.  This doesn’t sit well with many of those partners and has created myriad second- and third-order effects.

Not surprisingly, eDiscovery providers have turned to alternatives to Relativity or have begun developing their own solutions for the steps of eDiscovery that Relativity performs in order to lessen their reliance on the industry heavyweight.  No options have arisen displacing the #1 player, as yet, but eDiscovery providers have learned their lesson not to become overly reliant on one software application.  The consolidation game has yet to play out, but suffice it to say, you do not want to be a small player left without a seat when the music stops.