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10 ways private equity investors evaluate addiction treatment centers

February 13, 2017

In recent years, there has been a flood of private equity (PE) investment into the addiction treatment community, fueled in large part by the Affordable Care Act’s requirement that health plans cover treatment for substance abuse disorders, including for those patients with pre-existing conditions. However, investors are entering a market with numerous variables and considerable grey area, as the qualitative and quantitative differences between addiction treatment operations can be vast. Below are 10 things private equity groups look at to ensure a significant return on their investment in the addiction treatment sector.

1. The “skeletons”

Priority #1 for an equity investor is to perform the diligence necessary to uncover problem areas, and this is certainly true in the addiction treatment space, where legal noncompliance is commonplace (though often unintentional). Payers are increasingly conducting reviews of behavioral health and substance abuse treatment program providers and are looking for cases of fraud and abuse. Many providers are cutting some type of corner. PE groups want to find that corner early and identify a feasible and cost-effective solution. The diligence may even result in the seller lowering the purchase price.

2. Marketing relationships and patient inducements

A fundamental question that a potential investor needs to ask is: “Where are the patients coming from?” Many addiction treatment providers have taken to entering into marketing/consulting agreements with independent contractor companies and individuals serving as call center or marketing/sales representatives having direct contact with patients for the purpose of recommending the treatment facility to those patients. Paying any person or entity who or which has direct contact with patients themselves and recommends a specific facility to them in exchange for a fee for the recommendation is a likely violation of the federal Anti-Kickback Statute, unless safe harbors are met. Laws also differ at the state level.

Some providers take steps to induce patients to seek treatment at their facility. This includes, but is not limited to, providing transportation, gift bags and on-site store vouchers. At a minimum, the availability of these types of benefits should not be advertised to the general public or referral sources. If a facility is engaging in this type of inducement, and advertising it widely, it will raise an immediate alarm.

3. Contract or out-of-network model?

Some providers contract with the major health plans, and others do not, and this is an important distinction. Providers are seeing significantly increased efforts from payers that are attempting to avoid paying out-of-network providers. This comes in the form of records requests, recoupment demands and SIU investigations. Illegal kickback relationships are also scrutinized, with payers often refusing to issue authorizations or single case agreements while the investigation process plays out.

Depending upon the payer mix at a given facility, this economic gamesmanship can be devastating. At the same time, facilities are having difficulty becoming in-network providers as insurers keep their networks small.

4. Thorough documentation review

Is the operation up to standard in its documentation? Faulty documentation is one of the most common causes of nonpayment and/or administrative investigation. If the provider’s documents are disorganized and noncompliant, you will want to know this from the outset. Contracts must also be vetted by experienced healthcare diligence counsel.

5. Length of patient stay

What is the average length of a patient’s stay at a facility? Turnover rate can certainly impact the value of an equity investment in a substance abuse treatment facility. Although most facilities plan to provide treatment for 30 to 90 days, or sometimes longer, these stays are not guaranteed and patients might leave at any time. Facilities with high turnover rates often have other underlying problems.

6. Lab testing

Drug testing labs are experiencing an increase in fraud investigations from health plans related to urine drug testing (UDT). This often involves close examination of the relationships between addiction treatment facilities, physicians, marketers and laboratories. When looking to invest, PE firms will carefully consider the frequency, type and duration of UDT. What is the charge for UDT? Does the provider have a business relationship with the lab?

There is high risk of financial self-dealing under many lab arrangements, and if this is not addressed right away it can invite significant litigation. Common ownership of labs is certainly possible, but it requires specific structuring to avoid kickback allegations and prevent potential joint liability of the treatment center for laboratory matters.

7. Compliance with zoning and licensing

Rapid growth within the addiction treatment and sober living sectors, as well as increased media attention due to some recurring concerns expressed by frustrated communities, have led many states and municipalities to rethink their approach to substance abuse treatment and explore new modes of regulation. For example, the topic has become a lightning rod within many Southern California coastal communities. Arguments over residential treatment centers have recently evolved into litigation as the issue continues to spur local regulatory challenges and incite great passion.

Before PE firms invest in an operation, they will seek to understand if there are any zoning or licensing issues that, if left unresolved, might result in administrative sanctions or litigation.

8. Collecting co-pays and deductibles

Is the facility organized and timely in its collection of co-pays and deductibles? Knowing the goal is to maximize the value of your investment, it is imperative for PE firms to discern whether the operators’ collections infrastructure is sound.

9. Medical directorship arrangements

This is an increasingly scrutinized method to pay kickbacks to referral sources. Fraudulent medical directorships are easy to spot and have become a “hotbed” risk area in very recent years. It is critical that bona fide involvement by the director can be substantiated, which means actual recordkeeping of their clinical and administrative activities. Directors who are not immediately recognized by staff are a clear giveaway.

10. The uncertain future of the Affordable Care Act

While financing options for these services continue to improve as a result of the Affordable Care Act (ACA) and the Mental Health Parity and Addiction Equity Act (MHPAEA), the lack of available behavioral health service options is creating a growing demand.

President Trump’s selection of Tom Price to head the Department of Health and Human Services has created considerable uncertainty as to the potential repeal of the ACA. For example, a proposal previously floated by Price allows for pre-existing condition exclusions in some circumstances. The ultimate fate of the ACA remains to be seen, but early indications suggest that there will, at a minimum, be significant tweaks.

This uncertainty means risk for potential private equity investors if they believe that center operators will be hesitant to expand operations, or hire new staff, given that there might be a dramatic reduction in the income stream (i.e. if mental health and addiction treatment is no longer an essential health benefit).

Citizens, politicians and the media are raising the profile of the addiction treatment community, and even the slightest misstep could result in front page news.  Fraud and abuse investigations and lawsuits are becoming quite frequent. Some providers have been put in the tenuous position of refusing patients the care they desperately need or assuming the risk of providing care that will never be reimbursed.

In this current climate, those who wish to invest in an addiction treatment facility are now paying close attention to items above. In order to ensure full compliance with the law, and maximize return on investment, purchasers will be diligent, asking the tough questions, and asking them early.

Ron Lebow and Kelly M. Hagemann are members of Michelman & Robinson LLP, a national law firm.

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