Shifting compensation models after physician practice M&A

Historically, selling physicians have agreed to the following most commonly used compensation methodologies.

• Percentage of collections. Buyers might agree to compensate a shareholder physician based on a percentage of professional collections, allowing the shareholder to share in the collection risk that all businesses face.
• Percentage of collections, less drug costs. In certain specialties where drug costs are high, such as cosmetic dermatology, buyers might agree to compensate a shareholder physician based on professional collections less injectable drug costs.
• Dollar amount per relative value units. This arrangement compensates the selling physician based on an agreed-upon measure of productivity and does not pass on any collection risk.

Each of these options has its advantages, such as simplicity of calculation and incentivizing physician productivity, although some have disadvantages. Buyers should be aware of contracts that expose them to decreased earnings before interest, taxes, depreciation, and amortization (EBITDA) margins in situations where compensation as a percentage of revenue is fixed and revenue shifts toward procedures with higher supply costs.

One of the most important considerations when buyers are selecting a compensation methodology is the incentive for the selling physician to maintain or increase productivity following a transaction. Compensating the selling physician based on a measure of their own revenue or productivity achieves this goal, although it might not incentivize the selling physician to be concerned with the growth and development of associate physicians. Future growth is a matter that would have been a priority pretransaction when the shareholder was effectively compensated based on the practice’s earnings paid through distributions or otherwise.

To encourage shareholder physicians to be incentivized by the overall profitability of the practice and not just their own productivity, some buyers have shifted toward a model that compensates shareholder physicians based on a share of the practice’s EBPC.

EBPC is calculated by removing partner (shareholder) compensation and payroll taxes from earnings. Calculations might vary but EBPC typically includes shareholder benefit burden, as benefit costs in most cases would be incurred regardless of the practice’s level of profitability. During due diligence, adjusted EBPC is calculated once the financials have been adjusted to be free of nonrecurring revenue and expense and inclusive of any other EBITDA adjustments identified.

Buyers and sellers negotiate the percentage of EBPC that is to be paid to shareholder physicians, determining the shareholder compensation pool. The shareholder compensation pool might be decreased or increased as both buyers and sellers seek a balance of generating a sufficient level of EBITDA while compensating the shareholders satisfactorily. In practices with multiple shareholders, a separate calculation is used to determine how the compensation pool would be allocated to each shareholder, often based on each shareholder’s revenue as a percentage of total shareholder revenue.

Revenues generated by shareholder physicians for which there is not a corresponding cost incurred by the practice, such as consulting arrangements, might be passed through directly to the physician and excluded from the calculation of the compensation pool altogether.

Post-transaction compensation is one of many factors that could affect the economics of a transaction. When it comes to healthcare M&A, Crowe industry specialists can offer services for both buyers and sellers to navigate an efficient process.