The dental services organization (DSO) model has been popular in recent years with more than 25 private equity firms investing in this growing healthcare niche. Ideally, the DSO model allows dentists to focus on professional patient care, while the management company handles the administrative and back office tasks of the practice.
This allocation of duties creates economies of scale that can help grow practices and can ultimately lead to high rates of return for investors. However, an influx of cash into the market and a very small number of high profile cases involving bad actors have brought greater federal and state government scrutiny, including some states considering the restriction of DSO businesses. For example, the Office of Inspector General of the U.S. Department of Health and Human Services released a report citing questionable billing practices of Medicaid pediatric dental services in Louisiana.
While the number of bad actors is small, the reputation of the industry at large has suffered as a result. Organizations such as the Association of Dental Support Organizations (ADSO) are working hard to correct this public misconception.
DSOs, financial investors, and lenders considering a target in the dental space need to conduct fairly extensive due diligence to analyze whether the company in question has operated in accordance with applicable federal and state laws, including complex healthcare regulations and state corporate practice of dentistry prohibitions. This process can help uncover material liabilities and structural flaws that could impact the value of the business or the ability of the DSOs to operate the business after closing. Although most of the market participants in this area have only the best of intentions, the consequences of doing business with one of the few bad actors can be severe.
Here are four key considerations that frequently arise during the due diligence process. Next week's second part will focus on five more key considerations.
Corporate practice of dentistry and fee splitting
Each state has varied corporate practice of dentistry restrictions rooted in case law, statutes, and regulations, as well as an accompanying enforcement climate that narrows permissible relationships between dentists and nondentists, including management companies. Similarly, state law can prescribe parameters for the overall relationship and allocation of duties between the management company and the practice.
For example, North Carolina has a very restrictive prohibition on the corporate practice of dentistry and requires review by the state's Board of Dental Examiners of all management services agreements. Conversely, Illinois is less restrictive and statutorily allows management companies to work with dentists so long as they only provide purely business and administrative services.
Many states have prohibitions on splitting fees between dentists and nondentists whether for referrals or reimbursement for services. DSOs typically prefer to collect a management fee that is a certain percentage of collections or revenue, but some states may restrict fees based on a percentage of revenue for certain types of services, such as leasing office space or dental equipment.
Other states allow fees based on a percentage of collections or revenue, but require that the fees be justified against the cost of services provided by the management company. The alternative to a percentage-based fee is a fee set in advance, but broken out based on the cost of each service provided by the DSO, plus a reasonable profit for the DSO. Thus, whether certain methods of calculating fees violate corporate practice or fee-splitting prohibitions is a state-by-state analysis.
Ownership of assets
The corporate practice of dentistry may govern the breakdown of ownership of assets by the DSO and the dentist. In some states, certain assets, such as patient records, are clinical assets that may only be owned by a licensed dentist, whereas the DSO could own an x-ray machine in the office in certain states. Thus, the nonclinical assets of the practice will be critical to a potential purchaser's valuation of a transaction, since the DSO will either lease these assets back to the practice or use them to provide support services.
Reliance on key dentists
Smaller to midsize dental practices often rely on the reputation and high patient population of a dentist or a few key dentists. Thus, DSOs need to ascertain the future commitment and goals of those dentists to the practice, including their role after the transaction closes. DSOs prefer to work with "friendly" dentists who either have prior relationships with the DSOs or are closely aligned with the economic and clinical goals of the DSOs. In the event the DSOs have concerns of replacing a dentist in the future, DSOs may try to restrict the transfer of securities in the dentist's practice.
The DSO may also enter into independent contractor agreements or consulting agreements with dentists for them to provide certain management and other consulting services. The termination of such an agreement could trigger the transfer of ownership of the practice or other remedies. These types of transfer restrictions may be subject to state corporate practice of dentistry prohibitions.
Fraud and abuse
DSOs and potential investors and lenders should evaluate the practice's formal and informal relationships with third parties, including other dentists, nondentists, and companies engaged in the dental industry. Federal and state antikickback laws prohibit payment or inducements for referrals of services reimbursed by government or commercial payor programs unless the specific arrangements meet applicable safe harbors or exceptions. Similarly, federal and state statutes may prohibit dentists from making referrals for designated health services to entities in which the dentists have ownership interests, unless the arrangement meets certain exceptions.
Violations of both of these bodies of law can lead to federal and state false claims investigation and litigation that can severely cripple a dental practice. With these tools, states have become more assertive in combating fraud and abuse.
For example, Texas passed Senate Bill 8 in mid-June 2013 to combat Medicaid fraud. The bill specifically provided for additional law enforcement officers to focus on Medicaid fraud, set forth requirements for analyzing Medicaid expenditures, and provides for enhanced data analytics technology.
Further, private individuals can bring qui tam litigation enforcing federal and state false claim acts that can result in treble damages to dental practices. Since such individuals can retain a certain percentage of the damages, there has been significant growth in the number of qui tam actions with not only patients as potential sources of actions, but also disgruntled employees and competitors.
Next week, part 2 of this series will detail an additional five regulatory hot spots.
Barton C. Walker is a partner at law firm McGuireWoods in Charlotte, NC, who concentrates on mergers, acquisitions, and healthcare regulatory compliance. His practice includes advising healthcare providers, as well as equity sponsors and lenders, on the healthcare industry.
LauraLee Lawley is an associate in the Charlotte office of McGuireWoods who practices in the healthcare industry, representing healthcare providers in mergers, acquisitions, divestitures, joint ventures, corporate governance, and regulatory matters.
John Saran is an associate in McGuireWoods' Chicago office whose practices focus on healthcare mergers and acquisitions, joint ventures, and finance involving hospitals, ambulatory surgery centers, nephrology groups and dialysis facilities, urgent care centers, physician and dental practices, health IT companies, and medical device companies.
McGuireWoods is the eighth largest healthcare practice in the U.S., according to the American Health Lawyers Association in its annual Top Honors rankings. For more information, visit www.mcguirewoods.com.
The comments and observations expressed herein do not necessarily reflect the opinions of DrBicuspid.com, nor should they be construed as an endorsement or admonishment of any particular idea, vendor, or organization.