Deferred Consideration in Physician Practice Sales
Deferred consideration is frequently used in physician practice sales to bridge valuation gaps and allocate post-closing risk (and upside) between buyers and sellers. Commonly structured as earnouts, deferred consideration arrangements can be effective, but also raise a number of practical and regulatory considerations for physicians who continue to be involved in the practice following closing. In particular, selling physicians must remain mindful of the extent of their ability to control whether an earnout is “earned” and remain compliant with applicable fraud and abuse laws. Similarly, to the extent that the selling physicians own medical office space that the buyer desires to lease after closing, the structure of any related real estate arrangements must comply with fraud and abuse laws.
Preserving Influence Over Earnout Drivers
Appreciating the degree to which selling physicians retain (or do not retain) influence over the metrics that determine whether deferred consideration is ultimately paid remains one of the most significant challenges that physicians encounter in evaluating an earnout proposal. Earnouts are commonly tied to measures such as net income or EBITDA and can be materially affected by a buyer’s post-closing decisions regarding staffing, compensation, payer contracting, capital expenditures and overhead allocations. Absent contractual protections, buyers retain broad discretion in these matters.
Selling physicians should carefully consider whether transaction documents preserve an appropriate level of post-closing involvement. This may include defined management roles, approval or consultation rights with respect to significant operational decisions, or covenants requiring the buyer to operate the practice in a commercially reasonable manner. CMS guidance addressing the meaning of “commercially reasonable” arrangements under the Stark Law offers useful context in this regard. Similarly, sellers should insist on full transparency regarding the formulas and calculations used to determine an earnout. For example, in a transaction in which a selling physician’s earnout is dependent on post-closing EBITDA, the seller should (at the least) be provided a written explanation of the EBITDA formula to be used, expressly including any unconventional adjustments or normalization concepts.
Fraud and Abuse Considerations for Deferred Compensation
Sellers must also evaluate deferred consideration structures through the lens of applicable fraud, waste and abuse laws, including the Stark Law and the Anti‑Kickback Statute. In many transactions, selling physicians remain employed by, and/or continue to provide services to, the buyer following closing. In these circumstances, earnout‑based payments are often incorporated into post‑closing compensation arrangements and must satisfy the requirements of an available Stark Law exception.
While the Stark Law’s Employment Exception is frequently used, it is not the only potentially applicable pathway. In group practice settings, the Stark Law’s in‑office ancillary services exception (the IOAS Exception) may be used, particularly where deferred consideration or compensation structures include shares of ancillary or other designated health services (DHS) revenues, incident‑to services or group‑level profits generated by the practice.
The distinction is important because the IOAS Exception permits group practices greater flexibility in structuring physician compensation. Unlike the Employment Exception – which requires compensation to be consistent with fair market value and prohibits consideration of the volume or value of referrals – the IOAS Exception allows group practices, if all regulatory requirements are satisfied, to distribute profits from DHS and pay productivity bonuses that are based on a physician’s personally performed services and/or services incident to those personally performed services. Careful structuring and detailed documentation remain critical for ensuring that the applicable group practice, supervision, location and billing requirements are met.
Real Estate Arrangements Require Separate Analysis
In addition to compensation considerations, practice sale transactions frequently involve real estate arrangements in which selling physicians retain ownership of a medical office building or other office space and lease it to the buyer following closing. Lease arrangements can promote practice continuity (by avoiding a location change that may interrupt operations) and create an additional revenue stream for a physician seller, but such leases must independently satisfy applicable fraud, waste and abuse requirements. Lease terms should be set in advance, be commercially reasonable, reflect fair market value rent, and not consider the volume or value of referrals or other business generated between the parties.
Conclusion
Earnouts and other forms of deferred consideration can be useful tools in physician practice transactions. By addressing control over earnout drivers, structuring post-closing compensation to fit within available fraud and abuse exceptions/safe harbors, and ensuring that real estate arrangements independently comply with applicable standards, physicians can reduce the risk that deferred consideration prompts post-closing disputes or regulatory exposure.
