Ketamine Clinic Acquisitions: Get the Law Right BEFORE the LOI

We often receive calls from potential ketamine clinic clients that just signed a letter of intent (“LOI”) or term sheet to acquire entire medical practices that are undertaking ketamine treatments. In the psychedelics space, many companies are starting off with off-label ketamine treatments while building towards a bigger suite of psychedelic services as the laws change at the federal and state levels (ketamine is a hallucinogen in the classical dissociative category of drugs). We’ve written many times about how hot ketamine clinics have become. See here, for example.

When potential clients sign these LOIs, they don’t even question whether or not there might be some kind of issue directly venturing with a licensed physician in the U.S. Unfortunately, in most instances, we have to break the news to the client that the proposed form of their transaction will not work under a given state’s health care laws. Among other things, the corporate practice of medicine doctrine (“CPOM”), which varies from state to state (see here, for example, in California) prohibits a layperson or lay entity from directly owning a medical practice or even employing a physician. The brain damage then ensues of what business model will work that the client can shoehorn into a deal that remotely brushes the expectations set out in the defunct LOI.

Such structuring is not a cakewalk, but not all hope is lost. In a state that has a CPOM doctrine, there are several transactional models a lay entity or lay individual can pursue–whether or not they actually make any business sense is up to the parties and their performance (like any other contract under the sun).

The Friendly PC Model

Under this model, a management services organization (“MSO”) enters into a long-term management services agreement (“MSA”) with the physician’s professional entity (“PE”). Typically, the MSO buys most of the assets (goodwill, IP, personal property, etc.) of the PE, and it also takes over the clinic lease. The MSO then helps to run the non-clinical aspects of the PE.

One bright-line rule is that the MSO cannot have any involvement in any clinical and/or medical decisions, and there can likewise be fee-splitting issues in many states (which typically arises when the PE pays excessive fees to the MSO). In most states, there are no bright-line rules for fee-splitting, but we recommend an appraisal of any fees to insulate the PE and MSO from potential fee-splitting liability.

The advantage of this model is that it is compliant with CPOM (if done correctly) and provides a constant revenue stream to the MSO. The downside for this model is that it could be hard to recapture the MSO’s investment and the MSO will not have any control over the PE outside of the MSA (which can sometimes be mitigated by non-competes, stock restrictions, and a pledge agreement with a proxy physician in place – all of which depends upon each state’s laws). We typically see MSOs paying millions (in cash and stock) for such assets (including for the goodwill and IP). In the end, unless the MSO is doing high volume work with multiple practices, it could take a while for the MSO to see any kind of return on its investment.

Minority Equity Purchase of Stock in the PE

Under this model, the MSO buys a minority interest in the PE (but, whether an MSO can buy a minority interest is completely dependent upon state law and the CPOM doctrine for each state). The advantage of this model is that the MSO can recapture its investment more quickly, and the MSO has more involvement in the management of the practice (although in jurisdictions where an MSO can acquire a minority interest in the PE, often times a majority of the managers/directors must be physicians, so the MSO will not control the day-to-day affairs of the PE).

The downside for the MSO is that it is making a substantial investment in the practice, but the MSO has no ultimate control over the entity. On the flip side, the MSO does get minority shareholder or member rights, which are potentially stronger than anything an MSA can provide.

While there may be some creative ways to give the MSO more control (e.g., mandating that certain decisions will require the unanimous consent of the owners and/or directors/managers), there is simply no way for an MSO to essentially control all decisions for the practice. Moreover, as a minority owner, the MSO has more exposure to medical malpractice claims. While the MSO would not necessarily have primary liability (since it is not practicing medicine), the practice would, and that would directly impact the MSO’s investment (if, for example, an award exceeded the malpractice insurance coverage amounts). We rarely see our ketamine clinic clients directly venture with physicians in this way.

Hybrid Model

If an MSO combines the Minority Equity Purchase Model with the Friendly PC Model, you get closer to the best of all worlds with less exposure on the liability side. The MSO can recapture its investment much faster and the MSO would have as much control as possible since it would be running the MSO independently from the practice.

Joint Ventures

One way to entice a physician to pursue one of these models (when he or she cannot sell their practice outright) is to incorporate a joint venture agreement (“JV”). JVs in healthcare can get very tricky if there is federal or state reimbursement involved. There have been several fraud warnings issued by the main US regulator for healthcare fraud and abuse issues. For more details on ketamine clinics and JVs, see here.

If, however, the practice is all cash pay (or no federal or state money – and possibly no commercial insurance as well), then a JV gets easier. Under this model, the physician could enjoy some of the profits from the JV without having to invest in the JV (but that is obviously a business decision for the MSO to make). One of our clients (an MSO) is currently pursuing a JV and it is fronting 100% of the costs of each new clinic but giving a 50% ownership interest to the practice (for their time and effort in setting up these new clinics).

However, before a JV can be finalized, state law must also be reviewed to make sure there is nothing that would prevent the JV. For example, if a state has a referral prohibition for physicians (which is akin to the Stark law at the federal level), then the MSO would need to make sure the structure is feasible.

Side Note for Insurance

Third-party reimbursement (insurance) is a tricky thing. The upside for taking insurance is that it drives volume for a clinic. The downside is that commercial and government insurers typically try to squeeze physicians on reimbursement, they can be difficult to deal with (and get claims paid), and there are some federal fraud and abuse laws that apply to commercial insurance. We believe that the typical intravenous ketamine treatment is probably not reimbursable by Medicare and Medicaid, but we have seen clients VA cover some services, like intravenous ketamine (additionally, Esketamine may have some coverage since it’s being used for “on label” claims – or at least some of the time).

If an MSO intends to pursue other psychedelics if and when they are approved by the Food and Drug Administration, it is possible that there will be more insurance coverage available. Since several psychedelics are going through clinical trials, they could be used for “on label” claims which have a higher probability of third-party reimbursement. Formularies and coverage decisions for insurers are complex issues that are usually dealt with on an insurer-by-insurer basis.

At the end of the day, health care is full of traps and landmines for the uninitiated (both for clients and your run-of-the-mill corporate and transactional attorneys). We highly recommend that clients vet deals with health care attorneys before signing LOIs and term sheets. Not only does it set realistic expectations for both parties when a deal is coming together, but it also saves the client time and money overall.