Novel Physician Practice Spin-out Model Gaining Traction with Health Systems and PE

What’s Trending: Market Conditions Offer an Opportunity for Mutually Beneficial Partnerships

Where private equity-backed opportunities for physician practices once may have meant a conflict or even an adversarial relationship with a health system, a new model is sparking discussion because it benefits all parties amid today’s market dynamics. ?

The number of physicians employed by health systems has risen sharply in the past few years, now accounting for more than half of practicing physicians, especially specialists. However, a seismic shift is occurring, with a slow-down in net-new hospital-based physician employment. At the same time, private equity-backed options for physicians continue to proliferate as they look to health system practices to grow their businesses. ?

A friendly physician spin-out model can create sustained value for physicians, private health equity platforms, and health systems.??

Why It Matters?

Spin-outs of health system services are nothing new. The industry has seen many cases of ancillary services (such as lab or imaging), revenue cycle services, ambulatory clinical sites, and other high-value functions outsourced to specialized operators. But friendly physician spin-outs are more significant and novel.??

This physician spin-out model transitions health system-employed physicians into a different practice capitalized by private equity. The spin-out can include a subset of specialists or the entire medical group, and the receiving practice can be existing or newly created for the purpose of the spin-out. The capital structure of the receiving practice is designed in a way that enables the health system to participate in the ownership and/or management entity.?

Current market trends are serving as an impetus for both health systems and private equity platforms to begin partnership-oriented discussions:??

• Physician consolidation has grown to historic levels. Today, health systems employ approximately 52% of all physicians nationally. While the trend is not new, it accelerated dramatically during the pandemic. Prior to 2020, approximately 47% of physicians were employed by health systems. By 2022, that number grew by 5 percentage points. Chartis research suggests that the consolidation focused on specialties that were economically valuable to health systems, including oncology (57% employed by health systems) and cardiology (59% employed by health systems). “Health systems have an appetite to find new growth avenues,” said Nick Herro, Director at Chartis. “Through a partnership strategy such as this, health systems can participate with experienced sponsors in a new value creation opportunity that extends beyond their core physician practice model.”?
• Health systems are facing mounting financial challenges. Staffing issues, inflation, and obstacles to driving pricing growth have led to tenuous financial pictures for many of the nation’s largest health systems. During the past 12 months, health system operating margins have fallen to -1.7%, from 1.05% and 1.35% in 2019 and 2021, respectively. “While there are multiple ways to quantify and harness the value of employed physicians, many owned practices operate at a loss, given high compensation levels that may outpace revenue,” said Herro. “Health systems also are realizing they may not need to directly employ physicians to derive the desired value from their alignment.”? ?
• Regulatory barriers for independent physicians are loosening at the federal level. The Centers for Medicare and Medicaid Services has demonstrated willingness to move high-value cases off the inpatient only procedure list, creating opportunity for ambulatory surgery center (ASC) growth outside of hospital outpatient department settings. “We also continue to see state governments loosening their own regulations,” added Herro. “In several recent cases, states have loosened certificate of need laws that had previously acted as barriers to ASC growth opportunities, such as North Carolina’s move to relax requirements and South Carolina’s recent move to repeal them entirely.”?
• The whitespace of acquirable physician practices is shrinking, and the cost of acquisitions is increasing. More small practices are aligning with aggregator platforms and many newly minted physicians simply opt for health system employment earlier in their careers. Meanwhile, valuations are growing to untenable levels, fueling private capital’s desire to find unbanked, lower-cost points of entry. “Many health systems have not maximized the economic value of their physician enterprise,” said Herro. “That leaves a value creation whitespace that private equity platforms are seeking to address.”?

A true partnership model creates more sustained value to patients, physicians, sponsors, and the health system. Executing such a model involves a jointly facilitated spin-out with continued structural and economic alignment between the health system and the de novo practice. It also is materially de-risked compared to an asymmetric approach of hiring physicians away from the health system practice because it solves for the most important risks around referral sources.?

What’s Next?

Private equity platforms and health systems exploring a spin-out opportunity should consider the following:?

1. A partnership-based physician practice spin-out strategy is worth evaluating—and soon. Investors are quickly aggregating many focus specialties, and those aggregators are realizing the market’s limitations in terms of tuck-ins. In turn, many investors are considering this approach to build their businesses. Meanwhile, health systems have an increasingly urgent need to create greater sustainability amid mounting market pressures.? ?
2. Sculpting these new practices and partnerships must be done carefully. Physician spin-outs must be designed in a way to avoid harm to the practice’s volumes as they’re often enabled disproportionately by the broader health system’s practice. If not approached with care, parties risk losing value. Health system partnerships are complex, difficult to navigate, and often long in duration. The greatest benefit is possible in a mutually developed spin-out with a 3-way arrangement among the investor, physicians, and health system. ? ?
3. The stakes are high. The total addressable market this approach can unlock is considerable. Within health system-employed practices exist a myriad of specialists, each with their own value proposition to the market and private capital-backed practices. Any practice model needs to deliver sustainable value—especially in the form of high-quality, accessible patient care.?

This new model for physician practice spin-outs can help all parties better achieve their business- and mission-oriented goals for a more sustainable future.?

ABOUT CHARTIS??

Chartis is a comprehensive healthcare advisory firm dedicated to helping clients build a healthier world. We work across the healthcare continuum with more than 600 clients annually, including providers, payers, health services organizations, technology and retail companies, and investors. Through times of change, challenge, and opportunity, we advise the industry on how to navigate disruption, pursue growth, achieve financial sustainability, unleash technology, improve care models and operations, enhance clinical quality and safety, and advance health equity. The teams we convene bring deep industry expertise and industry-leading innovation, enabling clients to achieve transformational results and create positive societal impact.?Learn more.?

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