Lawyers are not known for their exceptional math skills. In fact, if you polled law students across the country, you would likely hear an overwhelming number of folks state that they chose law because there is no math involved…or is there? While many areas of law require minimal financial acumen, mergers and acquisitions is not one of them. In fact, as M&A and business attorneys, we wear our finance caps almost as often as we our lawyer hats. And in no area has this been more prevalent than in structuring dental or management service organizations (DSOs/MSOs). As discussed in past articles, the legal nuances involved in structuring a DSO or MSO are plentiful. We must account for the separation of clinical and non-clinical entities and their respective duties and assets, as well as implement a Management Services Agreement (MSA) that properly defines the relationship of the parties. The MSA must be carefully crafted to ensure there are no issues around the Corporate Practice of Medicine Doctrine (CPOM) or fee-splitting prohibitions. The latter concern (fee-splitting) is what has us sharpening our pencils and dusting off calculators. Getting the management fee right could mean the difference between a successful MSO arrangement and one that is non-compliant and subject to legal scrutiny.
What is Fee-Splitting?
“Fee-splitting” is a term that sends – or should send – shivers down healthcare providers’ spines. Without getting too far into the weeds, the prohibition on fee-splitting stems from both the federal Physician Self-Referral Law (aka Stark Law)[1] and the Anti-Kickback Statute[2] and is also enforced at the state level. With limited exceptions, the idea is that the paying of referral fees by healthcare providers to unlicensed third-parties (and vice versa) impairs the provider’s ability to make objective medical decisions. On the surface, this certainly makes sense. Providers should be practicing independent of outside influence. If a financial arrangement exists that incentivizes third-parties to refer to certain providers, it could result in abuse of the healthcare system. However, a major drawback of the prohibition is realized when attempting to structure DSO or MSO arrangements, particularly as it pertains to the setting of management fees.
Management Fee Calculation Methods
Though we leave the actual accounting of management fees to the CPAs and financial experts, it is important to get familiar with your state’s legal protocols on management fee calculations and what is - or is not - allowed. Generally, there are three methods to calculate management fees depending upon the jurisdiction:
1. Flat Fee – In many states, DSOs or MSOs have no choice but to implement a flat management fee, as the use of a percentage of revenue is precluded by the aforementioned fee-splitting regulations. This fee can be extremely difficult to formulate, particularly if the DSO or MSO arrangement is for a new practice and has no historical data from which to pull. For practices that have been up and running for some time, a deep dive into the financial statements can inform the DSO or MSO of the monthly spend for management, marketing, HR, IT and other services that will now be provided by the management company. For new practices that lack historical data, this can be a total shot in the dark. The key is to allow flexibility in the MSA to take a look back after some period of time - say, quarterly or annually - and make adjustments as necessary.
2. Percentage-Based – In some state, although the fee-splitting prohibition is alive and well, the regulations may allow for a fee predicated upon a percentage of revenue, as long as it is not based upon the specific referral of patients. In other words, if the fee is truly based upon management services provided and there is no underlying referral relationship agenda, a percentage may be allowable. As noted above, DSOs and MSOs must proceed with extreme caution when attempting to implement a management fee based upon a percentage of revenue and consult an attorney familiar with that respective state’s regulations.
3. Cost-Plus – A final method of arriving at a management fee is to utilize the “cost-plus” method, which determines a flat fee and layers on a premium. In this instance, the flat fee is again based upon historical expense data (if it exists, otherwise pro forma analysis) and then adds on a mark-up. While the dental or medical practice may not love the “plus” component going to the DSO or MSO, the idea is that the management company should more than make up for that premium by the value they deliver…that’s what we are told anyways!
The Fair Market Value Requirement
As a final rule of thumb, federal and state regulations require that the management fee be one of “fair market value.” What is fair market value (FMV) you may ask? As us lawyers like to say, it depends! The underlying theme is that the management fee should not be gouging the practice. This is again a subjective area, but historical expense data would tell a practice whether or not a fee meets the FMV standard.
A Group Effort
As discussed in prior articles, the importance of building a strong team of advisors applies yet again. The determination of what management fee to implement in a new DSO or MSO typically involves significant collaboration between your legal and financial teams. At Marti Law Group, our first step in beginning the DSO or MSO structuring process is a kickoff call with the client, their respective CPA and any other financial executives or advisors they want to bring in. Through collaboration, we are able to structure a compliant and functional DSO or MSO that works for both the practices and the management company. If you need assistance with establishing a legally-compliant DSO or MSO, please call us at (860) 552-7770 or email info@martilawgroup.com.