Private Equity in Healthcare: Legal Challenges and Best Practices for 2025 with Andrew Bab

26:38It's a structural device. Yeah, a device, structural device. Yeah. And look, these have been around for a while, but they've become a little bit more ubiquitous in the pharma space than before. It's also become sort of the thing, hey, my next door neighbor, big pharma guy just used this. I want to use it too. It's that kind of thing. Yeah, yeah, yeah. What else have you seen in terms of just deal structure across healthcare? It's always interesting because I do these quarterly roundtables, heads of corp dev. Yeah. It's always the folks in healthcare that have the most like intricate structures of their deals.

27:08You just sort of like learn a lot from it. But I'd love to hear just what have you seen. The two kinds of structures that you see a little bit more of. One is on the friendly physician structure. Many states, most states have what are called CPOM laws, which are corporate practice of medicine laws. They generally mean that the only people that can practice medicine are licensed doctors. So you can't have, in many of these states, you can't have corporations owning a medical practice because they would have and be able to exert too much control over the practice of medicine by the doctor. So there are these CPOM rules that are a spectrum of them across the country.

27:45So how do you do this? Because we often see private equity in particular coming in and looks like they're buying these practices, whether they're anesthesiologist practices, just physician practices, dental practices. How do you do that where there's CFOM law? The structure that's developed is an MSO structure or friendly physician structure whereby you've got a company, a structure of a managing services organization, MSO, that enters into contracts with a physician practice. And that contract basically says that all of the back office stuff, the leases, salaries, perhaps, other decisions that don't implicate clinical decisions are done at the MSO level, the management services organization level.

28:31That's meant to be a benefit to the practice because doctors would rather be practicing medicine than running their business. And in exchange, basically all the earnings of that practice get paid out to the management services organization as payments for these services. The key physicians in that practice tend to then, as part of the deal, the acquisition by the P firm comes in and buys, not buys, but creates and therefore owns the MSO. And many of the physicians also generally have an interest in that MSO, and that's where the money is flowing. And the physician practice itself continues to be managed by, run by doctors, certainly the clinical piece of it.

29:10What you typically do is you'll get what's called a friendly physician, which is a doctor that you know, that you trust, who will actually own the physician practice. He will have the equity. He can be removed by the private equity firm if they don't like what he's doing. But that's how it's done. And how much power the MSO can have, how much money can go out door back to the MSO, like salaries, can they go out? California is very stringent on these kinds of things. As an example, for instance, the management services organization can't make a decision with respect to which MRI device to buy. That's considered clinical decision that the doctor has to come up with.

29:48That's an interesting structural approach. Another thing that we see, it's not that common, honestly, but I tend to see it more in healthcare for whatever reason than in other industries, which is these partnerships between the private equity buyer and a strategic buyer, which is coupled usually with a complicated put-call agreement. The idea here is that there are many ideas, but one of the ideas is that the buyer, the strategic buyer of that healthcare company, they want to own the company at the end of the day. They have a call right on the private equity's interest and the private equity guy wants to exit because their horizon is usually three to five years or whatever it might be.

30:27And their business model is to be able to exit at that time at a profit. So they have a put right at a certain time to put their interest to the corporate buyer, strategic buyer. Part of the idea from the strategic's perspective is they may not know how to manage or rationalize or do a good job of it, the healthcare company itself. And that's the expertise of the private equity firm is what they're buying. And the idea is that over the next three years, the private equity firm will work to make that business more efficient. It will lend its expertise on how to run that business to the strategic, which is often in a different, sometimes contiguous, but different sector, subsector.

31:07You know, everybody gets what they want. So that's another structure that I've seen a number of times used in this space. So a call right basically gives you an option to buy. Yes. And then a put right is basically an option to sell. So in this case, the strategic would have the right to call the option to buy the PE's equity. Equity, right. And the PE firm would have the right to put, to sell, to force the strategic to buy its interests. These are very complicated papers. After how many years, at what premium, what do you have to do during the time? What's the calculation of the put call price?

31:45How's it valued? What happens if there's an antitrust problem when you're trying to push it onto the strategic? So there's a lot of stuff there that needs to get worked out, but it seems to work well. Sounds like a future podcast. Just on these things? Yeah, just on these things. It's an interesting topic. So we got some interesting insights on deal structures. We talked a lot about regulatory. I'd love to talk about the holistic process. And I'm thinking broadly. I talk a lot about buyer-led versus seller-led. You always look at the traditional model that we think of as seller-led, the bank process, he's driven by the sell side.

32:19But a lot more trends emerge around buyer-led where just Cheejix, for example, are very proactive about finding proprietary deals from the beginning, but then also very proactive about planning integration and having more control over the timelines so they produce better outcomes. You're on the legal side. You see a volume of these deals, both banked and non-banked. What's your take? What do you see as a difference? And I'm almost like it's two parts that go back to what we just talked about. Is there a regulatory difference between the companies that have a more seller-driven process versus a buyer-driven process?

32:53And then do we have also the structural components that may be different when you're running a seller process with some compressed timelines versus more of a buyer-led approach? One thing that we're M &A practitioners in general are going to need to focus on more, there's a lot of these regulatory changes and a lot of these things going on. These deals are going to start to take a little bit more time and not so much time between signing and closing, though there will be that, but also preparation. One example folks are focused on is the change in the HSR rules. HSR is Hart Scott Rodino. It's the antitrust form that you need that both sides need to file when they're doing a merger and can't close their deal until approval from the antitrust authorities has been given.

33:36And everybody knew how to do that. And you say in your agreement that you have 10 days to get that on file and there's a bunch of provisions. But the antitrust authorities have just overhauled that form and made it far more complex and require far more information and thought than it had before. The resources that are going to be required are going to be substantial. Companies are going to want to think ahead before they enter into an agreement because you're going to want to make sure that you can actually answer the questions on the form. That is, there are not going to be issues in the form that you have the information.

34:09It's just going to take so long. You're going to want to start doing that in advance. Now, what does that mean for the question you've asked? It seems to me that it means that it could mean that seller auctions, processes that are aimed at speed, may be a little bit harder to do because you need to focus on this. And those kinds of transactions that strategic buyers anyway want to do are more naturally suited to this kind of let's get prepared in advance. Now, a seller gets prepared from his side, from its side, often in advance, but it's hard to do that when you don't know who the buyer is. That's one thing.

34:45I mean, there will be increasing amount of buy-side diligence. And along with that, buy-side diligence that will require more looking down the road than perhaps we have in the past. There are state statutes now, Massachusetts is an example. DOJ gave a speech that said, look, we're concerned about private equity in connection with companies that might have healthcare companies that might be liable for False Claims Act liability. We're going to go after PE firms. We're going to go after sponsors. And if they knew about those sorts of problems and didn't fix them, we're going to hold them liable.

35:22We're going to try and hold them liable. And Massachusetts now has a statute that says something like that. So what does that mean? I mean, I think that means that private equity buyers in particular are going to need to be very careful about these kinds of issues. They can't put their heads in the sand, not that they have in the past, but they can't going forward. And they're going to need to make sure that, because inevitably you're going to find problems. You're going to find in many of these types of companies, there's going to be something that could be deemed a false claim. And you're going to need to stop those practices.

35:51And you're going to need to figure out how to integrate the company, how to run it going forward, to make sure that you, as the monitor, you're not actually down the trenches making these claims. you're above, you've got to make sure that you're comfortable, that there's no pressure on doctors to make false claims, because if you do, that will potentially provide greater reimbursement or something like that. On the buy side, at least on the private equity buy side, there's going to be a little more focus on app firm diligence, but more focus on the integration and how you address some of these regulatory concerns going forward, particularly in health care.

36:24The more complicated of the deals gets because of these advancements in the regulatory side, the more you need to be buyer-led and just really get ahead of it and be proactive on it. That's right. How about the deal structures? We talked about some of these different deal structures that are pretty common in healthcare. Do they sort of apply again in like auction versus a proprietary deal, where if it's a proprietary deal, you'd have more flexibility to come up with these different structures versus an auction, it tends to be, we just want certainty to get this much money and call it a day. That's absolutely right.

36:58Now, sometimes in an auction, if your auction includes private equity, as well as corporate potential bidders, you could think about putting them together in deals where that's happened. It doesn't happen that often, but yeah, a proprietary deal. And as about some of the deals that have this put call structure, they've all been, ones I can think of have all been proprietary deals, usually ones that the sponsor comes up with, but I guess not necessarily. So yeah, I think some of these more complicated deal structures, it's hard to put that in an auction draft. They could certainly evolve once you've narrowed down the list of potential bidders or you've come side of one single potential bidder.

37:36It's possible that the structure can evolve into a what see for more proprietary side. I did a deal very recently where we sold, it was an auction, it had a private equity buyer, and our client decided that it would go exclusive with that buyer, by which I mean that it will only negotiate with that buyer. So it was an auction turned into basically an exclusive proprietary deal. The private equity firm took advantage of the fact that it had exclusivity and started raising all kinds of different issues that we needed to structure around. Many of these were, frankly, retrades. You do have to be a little bit careful about it from that perspective as well.

38:14But to your point, proprietary deals are much easier to structure with some tailor-made ideas, tailor-made constructs. Yeah, generally it gives you more options to structure the deal. Okay, so the bank process, what are the things do you see in terms of conflicts of interest that come up in a bank process versus a proprietary? How are those things managed, especially when it comes to these real headlining, high-stake M &A transactions? Yeah, when talking about investment bankers, There really is not much of a difference between auctions or, I mean, the same conflicts can arise. The conflicts that you see with investment bankers, they're really twofold.

38:50The conflicts the investment banker itself might have, but there are also conflicts that the board might be involved in where you might have a special committee. And in that case, there have been a slew of cases where the investment banker might be viewed to have aided and abetted a breach of tertiary duty by the board as a result of certain things. but because there was a board conflict. Talk about some of the recent cases. There are a couple of very recent cases that have honed in on disclosure of conflicts as an important aspect, particularly in a going private transaction. Because in a going private transaction, you've got this, in a real going private, where you've got a controlling stockholder who's buying out the minority.

39:32You have generally heightened fiduciary duties called entire fairness. So it's, the board has to be more careful And the standard of judging the board is the board's action is much higher than the business judgment rule or even revel. So it's the highest standard of care. There's a case called MFW that says that in that context, if, and there are nuances here I won't get into, but basically if you have a properly functioning special committee that's independent, has the power to say no, has advisors who are independent and the deal is agreed to or approved by a majority of the minority stockholders based upon good information, then you can get out of this high standard of care and go back to sort of a lower business judgment rule standard.

40:19So people try and do that. That's a good thing. What's happened with these cases, what bankers have typically done of companies, they've said, look, bankers have said, I don't want to have to disclose to the world everything about my relationship with you or my relationship with the buyer. One of the cases, the investment banker had a$500 million investment in the funds managed by the buyer, and they were representing the special committee, the seller. There was a clear kind of, at least you could see that as a conflict. The lower court said, no, I don't think there's really a conflict here that's that important because the bank at$500 million is only point, it was 0.1 or 0.01 % of the bank's investments in Toto.

41:06To them, why do they care? The Delaware Supreme Court said, no, you've got to look at it as part of the mix of information that the shareholders are getting. While the bankers and the company might say, okay, look, if the SEC tells us to put this in when they review the thing, we'll put it in. But if not, we won't. But the court said, hey, you didn't do that. You didn't disclose this. So the vote by the majority of the minority is not really valid because they weren't properly informed. They're not properly informed. The MFW protections don't apply. And we go back to that heightened standard of care.

41:38So because of the banker's decision not to disclose, the banker's client got a bum deal, had to be judged at a much higher standard of care. The use of the word may, there were a couple of cases where The bankers in their disclosure and the proxy said, we may have engagements currently with the buyer. They did have engagements with the buyer. So may wasn't an appropriate word. And that use of that word was sufficient to create all kinds of problems. So I guess the first point is disclosure of conflicts, which is becoming more important. What ends up happening on something like that? Like you can't find a deal.

42:16So you're right. What happens is that there are cases that will hold liable. You launch a claim against the board, frankly, for a breach of fiduciary duty, or you do it before closing. It's more typically done before closing, after the announcement of the deal. You can block the deal. There's always a question once the deal closes, does the stockholder who is suing on behalf of the company derivatively, does that stockholder still have standing to sue? So lots of questions. It's a good question, and people address it. But typically, these things are broad. as soon as the proxy statement comes out and the plaintiff reads that.

42:52That's one thing. Another issue that we've seen, something called the Foundation Building Materials case. What that case was about was it was also a transaction. It was also sort of a go private transaction where there was a tax receivable agreement. And that's just an agreement. I could spend another session on that. But it's an agreement between some of the legacy holders of the company and the company, which provides some tax benefits to the legacy holders. And on a change of control, there will also often be an acceleration of those and therefore a big payment at that point to those holders of that TRA, tax receivable agreement.

43:34Those people also happen to be, by the way, shareholders typically of the company as well. And the banker's engagement letter in that situation said, OK, look, the total value of this deal is going to be the sum of the acceleration payment under the TRA plus the purchase price for the company. Because you can imagine that the purchase price will go down the higher the required payment out to the TRA holders goes. But the court said, look, in that case, the banker is actually incentivized not just by getting the best price. He's incentivized by getting a high payout value on the TRA, which goes to the controller who holds that TRA and holds those controlling shares.

44:20The banker was in a very conflicted position, was not deemed to have been independent in the sense of representing the interests of the public shareholders who don't own the TRAs. And that was an issue which people need to be focused on, I think, now. There's been a lot of focus on different types of conflicts. Again, we could have another session on aiding and abetting liability of investment bankers. There are cases where the breach of fiduciary duty by the board was the result of actions by the investment banker that were not known by the board. But the board is still tagged with breach of fiduciary duty.

44:56And the bankers then tagged with aiding and abetting that breach of fiduciary duty. But that's probably not. They're pretty cool. They're like things, you know, you just don't come across day to day. So it's interesting to hear about them. Why is everybody picking on private equity and especially in health care? I don't know. I don't know. I agree with you. I don't know. There's a lot of reasons that a lot of things are going on. There's enormous political pressure from people like Elizabeth Warren and others who can't abide private equity and make a lot of noise about it. There are congressional investigations as a result of this.

45:30There's been a number into private equity, particularly in the health care space. We've talked about some of these state laws that have come out that have attacked private equity and are laser focused on private equity. There's a view that in health care, what we're looking for are three things we're looking for because it's a public good in some sense. Unlike beverage companies, which aren't really public goods in the same sense, health care companies, you want to make sure that costs are low so people are able to pay for health care. You want to be able to make sure that there's good access to health care, to particularly people in rural areas or poor areas who generally can't get it.

46:10And you want the quality of care to be excellent. Private equity's business model is to make money. They go in, they cut costs. But those who challenge private equity in this space, that's what they say. Sponsors have no incentive to think of the well-being of the patient base. They're just out to make a buck. They could put pressure on the doctors or whoever type of business it is to make money. And that, in turn, makes doctors cut corners, makes them seek higher reimbursement, to seek reimbursement for more tests than are necessary because more profit there. That's where this challenge comes from.

46:52I don't think there's any particular body of research or evidence that shows that's true. There are certainly examples of where you could certainly infer that it was the fault of the private equity owner. But look, it could also be we have a shortage of nurses. That could also be the rationale. And what's the difference between a private equity firm in this context and any for-profit buyer? They're all there for profit. That doesn't mean that they aren't very well aware. And frankly, the firms that I've worked with are very focused on patients' health, on access. They're actually very concerned about these things.

47:29It's a question of balancing it properly. And I just don't think there's a lot of great evidence that private equity doesn't balance it properly. Just give you one quick anecdote, which is old now. This is not a new phenomenon, but we represented a private equity fund years ago that bought an ambulance company. And the day that it closed, that deal closed, tragically, a woman who was in one of those ambulances didn't make it. And the press came out saying, here's a great example of why we shouldn't have private equity owning healthcare companies. Wow. That was the same day they actually closed on the deal.

48:06It was clearly not the fault of the private equity company in any way, shape, or form, but there's a lot of perception. Yeah, they're the scapegoat, I guess, in the industry. They are a substantial scapegoat, yes. Andrew, what's the craziest thing you've seen in M &A? Well, there are two things I'd mention. One is just, I've never encountered someone like this before. I was representing a private equity firm in the acquisition of a fitness-type company. It was owned by a bunch of siblings. There were about five or six of them. You know, we negotiated, we did the diligence, we negotiated, it was whatever it was, three months to get to a signing.

48:41And we were finally then, got our approvals, we're ready to close. The lead sibling comes up to me and says, we have a little bit of a problem. Now, you know that it's the seller that wants to sell as quickly as it can, because if in the interim there is a problem with the company, the buyer could walk. But the seller comes to us and says, we've got a problem. My sister is a little bit superstitious. It turns out that Mercury is currently in the house of Orion. And that is a very bad omen for financial transactions. So we can't close the deal now. We got to wait. And we had to wait 10 days until Mercury found its way out of the house of Orion.

49:25And I've never in my life encountered something like that. But the other thing, on a less whimsical note, was just, I don't know if it's crazy, was just an enormously complicated deal with enormous number of moving parts. I was a DLI data representative, TPG, and I was Carson on the acquisition of the company Kindred, which was a public company, a home health and hospice company. We had to negotiate around all kinds of regulations. We were splitting it into two pieces. Humana came in and was a strategic partner in that deal. We talked about put calls. We had one in that deal. The lessor for the hospitals.

50:05The lease was immensely complicated, and we had to negotiate around that. So I could talk for a long time about that deal. But in my practice, that was the most complicated, challenging, and really craziest deal that I've ever worked on. The extremities of complexity and then deals getting delayed by 10 days from superstition. There you have it. A day in the life of the M &A practitioner. I appreciate you taking the time to have this conversation with me, helping you become a better M &A scientist. It's certainly my pleasure and I hope it's been helpful. Anytime. Learned a lot about healthcare-specific deal structure and regulations.

50:41Those of you still with us, you are a true M &A scientist. I appreciate you sticking through the interview. Always welcome the feedback. Connect with me on LinkedIn. I can't handle my email anymore. It's out of control. But reach out to me, LinkedIn. Love getting topic ideas and just connecting with folks, chatting about M &A. Until next time, here's to the deal.

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