Healthcare Entity Formation: What Physicians and Investors Must Know

Most states permit healthcare providers to form professional corporations, professional limited liability companies, or limited liability partnerships, and the right choice depends on the type of practice, the mix of physician-owners, and the tax planning objectives. A professional corporation is required by some states and payers for credentialing purposes, while a professional LLC or PLLC offers more flexibility. In strict CPOM states, using a plain LLC can expose the practice to licensing violations and payer contract termination.

Corporate bylaws and articles and corporate advisory counsel can advise on the entity type most appropriate for the specific practice and develop the entity selection and formation strategy.

A professional corporation is governed by its articles of incorporation and corporate bylaws, which govern the board of directors, officer appointments, and procedures for transferring shares or admitting new physician-owners. Both professional corporations and professional LLCs typically require a shareholder or member agreement addressing the buy-in price, restrictions on transfers to non-physicians, and what happens to a physician's interest upon departure.

Corporate counsel and healthcare practice management counsel can advise on the provisions required in the articles of incorporation, bylaws, and operating agreement and develop the governance documentation strategy.

The CPOM doctrine prohibits lay persons from owning, operating, or controlling a business that practices medicine, and its strictness varies, with California, New York, and Texas enforcing it strictly. In strict CPOM states, a medical practice must be 100 percent owned by licensed physicians, and bringing in a non-physician investor as an equity owner will expose the practice to loss of licensure, civil penalties, and loss of all revenue received during the non-compliant period.

Healthcare laws and healthcare compliance and regulatory counsel can advise on the CPOM restrictions applicable where the practice will operate and develop the CPOM-compliant formation strategy.

A Management Services Organization is an LLC owned by non-physician investors that contracts with a separately owned physician practice entity to provide non-clinical management and administrative services in exchange for a management fee. The physician practice retains full clinical ownership and control as required by CPOM, while the MSO provides services such as billing, marketing, facilities, and staffing. The physician practice must retain genuine independent clinical control, because effective MSO control of clinical operations will likely violate the CPOM doctrine.

Healthcare and life sciences and deal structuring counsel can advise on the MSO structure appropriate for the practice and investor relationship, assess the management services agreement for CPOM compliance, and develop the MSO structure and documentation strategy.

Healthcare entity formation triggers compliance obligations under the Stark Law, which prohibits physician referrals for certain designated health services to an entity in which the physician has a financial relationship unless a specific exception applies, and under the Anti-Kickback Statute, which prohibits offering or paying anything of value to induce referrals. The initial governance documents and compensation arrangements should satisfy the applicable exceptions and safe harbors.

Healthcare fraud and corporate compliance and risk management counsel can advise on the Stark Law and Anti-Kickback Statute issues that arise at entity formation and develop the regulatory compliance strategy.

Equity in a physician group is typically structured as shares in a professional corporation or membership interests in a professional LLC, and the buy-in price and buyout terms are among the most frequently disputed issues in physician group transactions. State licensing laws restrict equity ownership to licensed physicians in the same or a related specialty, and the entity's governing documents should incorporate these restrictions.

Healthcare practice management and corporate advisory counsel can advise on the equity structure and ownership restrictions and develop the equity structuring and buy-in strategy.

A nonprofit healthcare entity qualifying for section 501(c)(3) must be organized and operated exclusively for charitable, educational, or other exempt purposes and must not allow any part of its net earnings to inure to the benefit of any private individual. The benefits include exemption from federal and state income tax on mission-related income and the ability to receive tax-deductible contributions.

Non-profits and healthcare compliance and regulatory counsel can advise on the formation requirements for a nonprofit healthcare entity and develop the 501(c)(3) application and compliance strategy.

Healthcare providers also use specialized structures including hospital-physician joint ventures for co-investment in ancillary service lines such as ambulatory surgery centers, independent practice associations that allow physicians to contract collectively with payers, and direct primary care practices operating on a subscription fee model. Each structure requires careful analysis of the applicable CPOM restrictions, the Stark Law and AKS exceptions, and the antitrust rules governing joint contracting.

Healthcare management solutions and business formation counsel can advise on the specialized entity structures available for specific healthcare contexts and develop the entity formation and compliance strategy.