New research from UBS reveals there is a great investment opportunity in the healthcare sector for private equity (PE) firms. Today, there are more than 146,000 private healthcare companies compared to the 2,700 that are publicly traded, according to the report.

This large pool of private healthcare businesses is drawing more attention from PE because of their growth potential. Specialty, independent practices in particular have received increased interest due to often being highly fragmented and having under-scaled operations in need of capital. And that’s where a management services organization (MSO) comes into play.

What is an MSO?

An MSO, sometimes referred to as business services organization (BSO), is created within healthcare practices to fulfill a variety of functions that benefit physicians, patients and investors.

Four overarching areas that MSOs address include: quality, patient satisfaction, revenue and costs. MSOs take on much of the administrative burden of running a healthcare practice, allowing physicians to focus on care and preserve clinical autonomy, and helping to navigate the complex challenges of healthcare billing and reimbursement.

Overall, MSOs can vary greatly in their form and function, and are created to be “unique to the risk bearing entity or medical group it is designed to serve,” according to Cope Health Solutions.

What role do MSOs play in M&A activity?

When an independent practice chooses to move forward in a deal with a PE firm, the entities can form an MSO, which provides both the crucial management assistances but also, “entails separate valuation and an investment independent of the practice” by the firm.

In a typical transaction structure, according to CGH Journal, when an MSO is formed the physician partners receive proceeds from the initial investment, shares of ownership and compensation going forward. As the purpose of an MSO is to improve the clinical quality and strengthen the overall practice, they often increase in value and generate new equity for any future investors.

MSOs also help PE firms follow regulations during the acquisition of a medical practice. Although it differs state-to-state, many prohibit the “corporate practice of medicine,” which creates hurdles for PE firms looking to invest directly. The physicians are required to maintain ownership of the practice, so the PE firm sets-up an MSO to provide corporate services to the clinical practice which is still owned by the physicians.  The PE firms acquire all non-clinical assets, including the real estate (or have the lease assigned to them), allowing the MSO to control the assets of the practice.

MSOs do not always involve ownership of the healthcare practice they serve and can operate as an independent resource that solely provides help with management tasks and clinical operating challenges.

The Rise of PE Healthcare Investment

The pandemic slowed PE activity globally in 2020 – but not for healthcare. In fact, PE deal volume in the healthcare sector rose 21% resulting in a total of 380 deals.

This increased volume does not appear to be a fluke, either. Looking ahead, the PE healthcare market may continue at this rate as deals that were tabled or backlogged during 2020 reach closure in 2021.

Last month, a PE group completed the largest leveraged buyout of the last decade, purchasing medical supply giant Medline Industries for $34 billion. According to Fierce Healthcare, “The mammoth deal signals investors’ appetite for megadeals may be rising after a long lull in large leveraged buyouts following the 2008 financial crisis.”

As PE activity in the healthcare sector continues to rise, it’s crucial to understand the role of MSOs – their purpose, how they function and the potential impact they have on future acquisitions.