There’s no doubt that the business of behavioral health is changing. What was once a cottage industry has transformed into an investment opportunity for entrepreneurs and financiers alike. Not unlike the situation witnessed by primary care providers a decade ago, behavioral health organizations are considering mergers, acquisitions and ample opportunities to sell the practices that many have built with their own two hands.
The emerging, lesser-known options for structuring an enterprise can have treatment center owners wondering if it’s time for a change. Even more so, many are wondering if change is even a good thing.
“The treatment field used to be made up of boutique programs—family-owned and operated and closely held small businesses—and about 10 years ago, behavioral health companies started gobbling up the crown jewels,” says Jane Eigner Mintz, MA, LPC, BCPC, CIP, chief clinical strategist and CEO of Realife Intervention Solutions.
Mintz says the tug of war between profitability sought by strategic owners and mission fulfillment sought by family owners has been detrimental to the industry overall. The business lens and the clinical lens provide two truly different perspectives.
She’s concerned about a cultural shift that puts business ahead of clinical quality because it not only hurts patients, it leads to a lack of reverence for the history of the field. Established treatment centers have been doing life-saving work—in some cases for a century or more—and they now compete with corporate players that have recently arrived to capitalize on market opportunity.
However, private equity (PE) has a vested interest in building the best of the best, and maintaining quality is typically seen as a competitive advantage.
“Where those providers have clinical excellence, that’s where they’re going to win,” says Patrick Pilch, managing director and national leader of the BDO Center for Healthcare Excellence & Innovation. “And that’s certainly where the PE investors are going to go.”
The fragmented and undercapitalized behavioral health market represents about $35 billion of the $3.3 trillion U.S. healthcare system, and many successful facility owners have been approached by PE firms looking for acquisitions. PE is often seeking to make initial platform deals or buy up smaller providers that serve as complementary add-ons to the portfolio. In most cases, the goal for PE transactions is to build up an enterprise with scale.
And capital investment leads to accelerated expansion.
“The big players are going to get bigger,” says Pilch. “Even then, if you’re talking about two years from now, it’s still going to be surprisingly fragmented. It will take time to do the rollup that’s required to get to scale.”
As one example of rapid growth, BayMark Health Services now holds 167 programs in 26 states and in Canada. BayMark was formed just three years ago from the merger of two medication assisted treatment outfits: BAART Programs—launched in 1977 by a San Francisco family—and MedMark Treatment Centers—a primary care provider that expanded into addiction treatment in 2006. BayMark has been backed by Webster Capital since 2015.
Beyond an outright sale to private equity, which remains the biggest deal opportunity according to Pilch, there are some lesser-known business structures that behavioral health owners might consider. While far from being considered trends, a few unique options are emerging.
1. Management services organizations
Some family-owned treatment centers might reach a point where they begin to feel a little too successful. As the logistics of running a booming business overtake mission-driven work, owners might consider offloading the administrative burdens to an outsourced partner. Management services organization (MSOs) could be such partners.
MSOs have a fresh foothold in other healthcare segments and in time could represent an opportunity for behavioral health enterprises as well.
For example, in 1994, a team of physicians formed Network Medical Management, and it has gone on to become one of the largest MSOs in the country, handling everything from case management to accounting to marketing, while the clinicians remain solely in charge of care delivery.
Pilch says he fully expects MSOs to begin surfacing in behavioral health in the next year.
“Where the provision of care is great—you’ve got a great clinical enterprise but the back office is not as strong, not as efficient—that’s where it’s ripe for opportunity,” he says.
If a collection of 10 operators would get together to combine their administrative functions, for example, they could have enough scale to separate the back office from the clinical side. Even a not-for-profit provider could structure a foundation model with a for-profit MSO, Pilch says.
“If these MSOs come in, I’d like to see if they could take the back-end business away and put more money into clinical service or clinical training because that’s where we’re letting people down today,” Mintz says.
2. Employee stock ownership plans
Many small-business owners want to see their corporate vision continue after they’ve retired. A trust might provide an option to maintain an owner’s legacy.
The employee stock ownership plan (ESOP) is a retirement plan, much like a 401(k). However, its structure allows a company’s stock to be held in a trust for employees. Employees can have shares of stock allocated to their account as a benefit.
For the original owner of the business, an ESOP can be a gradual or complete exit strategy in lieu of selling the company to a third party.
“The trust is allowed to pay fair market value for the stock, so it can be a great liquidity vehicle for an owner, while preserving the culture of the business,” says Michael McGinley, director, Prairie Capital Advisors.
McGinley says the treatment center owner essentially sells stock to the trust, and the trust can then borrow money—from a bank, for example—to pay for that stock. As the debt is repaid, an increasing amount of stock would be allocated to the employees who participate in the ESOP.
Employees are granted shares as a benefit, often with no required investment of their own money. Additionally, McGinley says employees are more likely to stay with a company when they share in its financial success.
“This is a way to financially reward employees, and it becomes a retention tool to help keep people employed because they get such significant financial benefits through their sweat equity that they’re putting into the company,” he says.
ESOPs are all about equity.
Profit accrues to value of the shares, and the value of the shares gets allocated to the employees over time. Then when each employee leaves or retires from the company, the ESOP buys back the shares, according to IRS rules. That’s when the “money on paper” becomes money in the pocket of employees.
“It’s an extremely powerful ownership structure where all of the value of the company flows to the employees,” McGinley says.
He recommends at least $1 million in annual cash flow as a minimum requirement to begin an ESOP structure. From there, setting up a trust and securing the loan would be the next steps.
There are specific tax advantages for ESOPs as well. In some cases, the owner doesn’t pay capital gains tax, and the business doesn’t pay income tax.
In one example, Cornerstone Treatment Facilities of New York, a 40-year-old addiction treatment program with two centers and about 300 beds, opted for an ESOP. The organization faced significant regulatory and licensing restrictions for the ownership of the business and didn’t see any viable buyers in the market. The ESOP allowed for an exit strategy while preserving the company’s mission.
ESOPs have a foothold in a number of industries including manufacturing, construction and other healthcare segments. McGinley says he could see ESOPs becoming a trend in the future for behavioral health.
3. Real estate investment trusts
There are a few real estate investment trusts (REITs) operating in the behavioral health segment today. Simply put, instead of directly owning buildings and the parcels they stand on, behavioral health organizations can opt to sell the real estate and then lease the space back. The provider becomes a tenant rather than an owner of the property it operates.
With a REIT, only the real estate is sold, while the organization continues to offer services just as it always has.
Among the benefits of selling to a REIT is that the deal offers the provider a source of capital, unlocking the equity that’s been built up in the real estate. In addition, the treatment center can still continue to treat patients and expand services as needed.
In one example, AAC Holdings sold two standalone outpatient facilities and two sober living facilities in Las Vegas and Arlington, Texas, to MedEquities Realty Trust in August 2017. Concurrently with the sale, the REIT began leasing the facilities back to AAC.
One common denominator in all of the business structures available is the need for solid leadership. An established management team is particularly attractive for PE firms, and most look to keep incumbent leaders in place to run the daily operations after the deal closes. Once MSOs gain traction, executives will be needed to drive big-picture strategies.
For Mintz, she remains concerned that the historical success stories of the treatment industry with be lost in the corporatizing of the businesses.
“It’s great that there’s an exit strategy for family-owned businesses—with a big payoff,” she says. “But it’s rare that you don’t see an eventual ‘sanitizing’ of these wonderful, concierge, boutique programs. There are so few left.”