CEO SUMMARY: Physician Solutions becomes the second pathology-based physician practice management company to receive venture capital funding. The company is poised to acquire a number of pathology practices in cities throughout the United States. It is another sign that traditional pathology business models are about to undergo fundamental change.
FRESH ON THE HEELS of an $18 million funding commitment, Physician Solutions is ready to commence acquiring pathology practices in various cities throughout the United States.
“News of our funding has triggered acquisition discussions with a number of pathology practices,” stated Harold Roe, Chief Executive Officer of the Nashville-based company. “It is reasonable to predict that we will complete four to five acquisitions by the end of January.”
Physician Solutions is a pathology-based physician practice management company (PPM). The company’s objective is to acquire an equity interest in pathology practices, then help them increase revenue and operating profits.
Philosophy Is The Key
“Our philosophy is the key to understanding our business plan,” said Roe. “We see ourselves as partners with the pathologist in a long-term relationship. The common objective of both partners should be to provide superior anatomic pathology services.
“As partners, it is the pathologist who possesses the essential clinical skills. From a financial standpoint, they hold the majority interest in the partnership’s cash flow. We play a supporting role. Our minority interest in the partnership allows us to share in the growth of the business.
“We provide incremental skills and capabilities which add value to the pathologist’s effort,” he continued, “Our role in the relationship is to improve the business operations of the practice, provide strategic direction, and market the practice in such a way as to generate profitable growth.”
Not every pathology practice is a good prospect for partnering with Physician Solutions. Roe explained why. “We look for pathology practices which meet three criteria.
“First, we would prefer that the pathology practice does not own its histology laboratory. It is our intent to acquire that histology laboratory and use it as a foundation to expand both net revenue and pathology services.
“Second, we seek out pathology practices with a traditional focus on hospital inpatient business. Since they’re not doing outreach business, we can increase and diversify the flow of anatomic specimens by marketing to the outreach community.
“Third, we prefer to partner with pathology practices which are in geographical areas where pathology consolidation has yet to take place. The ability to combine two or more pathology practices is one way to lower over-head and increase operating profits.”
This prospect profile is not like the type of pathology practices acquired by AmeriPath, Inc., the first pathology PPM. “The business objectives of both companies are different,” explained Roe. “AmeriPath acquired high-volume dermatopathology practices. They’ve also pursued the larger pathology practices which serve multiple hospitals. These practices handle a considerable volume of specimens. Within their market area, they hold a large share of business and can be considered mature.
“In contrast, we are looking for growth opportunities,” he continued. “We want to partner with pathology practices that can be considered at an early stage in market share development. Over five years, it is much easier to double the volume of a two-man practice than it is to double the volume of a 25-man practice.”
Employment Versus Equity
Another relevant difference between Physician Solutions and AmeriPath is the relationship between the company and the pathologists. AmeriPath is organized around the employment model. Physician Solutions uses the equity model.
AmeriPath’s employee model calls for the company to acquire 100% ownership and control of a pathology practice. The selling pathologists are typically paid five to seven times revenues for their ownership interest. They sign an employment agreement and receive a salary from AmeriPath.
Physician Solutions’ equity model leaves the pathologists with majority ownership. Physician Solutions invests in pathology practices to acquire a minority interest. Roe explains: “Typically our investment would take the form of purchasing the assets of a pathology practice. We will establish a Physician Solutions subsidiary in that city. Assets would be transferred to that subsidiary. The pathologists retain their professional corporation or partnership arrangement.
“All non-pathologist employees of the practice would also be transferred to the subsidiary,” said Roe, “and the subsidiary conducts all business operations. The acquisition agreement specifies a percentage of profit which goes to Physician Solutions for a management fee. The balance of the profits are distributed to the pathologists.”
Under this arrangement, the pathologists continue to practice autonomously as before. Physician Solutions assumes responsibilities for management, administration and marketing. As the partnership increases specimen volume and operating margins, then all partners share the increased profits.
Funding Sources Lend Credibility
PHYSICIAN SOLUTIONS’ $18 MILLION funding commitment immediately makes the company a serious player in the pathology practice management arena. Further credibility comes from the two venture capital firms which invested in Physician Solutions.
The Sprout Group is a venture capital affiliate of Donaldson, Lufkin, Jenrette, the Wall Street brokerage house. 21st Century Health Ventures is an affiliate of HEALTHSOUTH Corporation. The participation of The Sprout Group is particularly relevant, as it means that Donald, Lufkin, Jenrette (DLJ) has been involved in both pathology-based physician practice management companies which obtained venture capital financing.
AmeriPath, Inc., of Riviera Beach, Florida, was funded by venture capitalists in 1995 and 1996. In October of this year AmeriPath took its stock public in an initial public offering (IPO). Donaldson, Lufkin, Jenrette was the lead underwriter in AmeriPath’s IPO.
21st Century Health Ventures may represent an interesting twist to the Physician Solutions story. Its affiliate, HEALTHSOUTH, owns the largest number of surgicenters in the United States. Surgicenters are a fast-growing source of anatomic pathology specimens. Since these specimens originate outside of the hospital, competition for this AP business will be intense.
Could it be that HEALTHSOUTH is investing in Physician Solutions with the motive that Physician Solutions could eventually become the exclusive provider of anatomic pathology services to HEALTHSOUTH’s surgicenters? Were this to prove true, then Physician Solutions could be entering the marketplace with a competitive edge that is unnoticed by others.
Execution Is The Challenge
Now that Physician Solutions has access to $18 million to fund pathology practice acquisitions, the challenge comes in execution. Rapid changes to healthcare and reimbursement will require skillful responses. Another challenge common to Physician Solutions and all PPMs is the ability to strike a balance between acquisitions and operations.
As the second pathology-based physician practice management firm to receive substantial funding from venture capitalists, Physician Solutions is proof to pathologists that a market evolution is under way. Investors are betting huge sums of money that the business models represented by Physician Solutions and AmeriPath will capture business from traditional pathology practices.
Stated bluntly, every dollar invested in a pathology-based PPM is a bet by an investor that these PPM companies can capture significant business from existing pathology relationships. THE DARK REPORT predicts these companies will definitely influence and shape the next generation of pathology business models to emerge from the managed care battleground.
Commercial laboratories were the first to undergo radical restructuring by the marketplace. Widespread consolidation of hospital laboratories is transforming that segment of the industry. Now market forces are concentrating on pathology. These are the earliest stages to a period of change which THE DARK REPORT predicts will be revolutionary, not evolutionary.
During this period of marketplace restructuring, pathologists will need to complement their clinical skills with improved business knowledge. It will become increasingly difficult for pathology practices to sustain profitability if they don’t acquire expertise and resources in sophisticated techniques of business management and administration.
Growth of the entire physician management company industry is built upon the recognition by an increasing number of physicians that survival in the managed healthcare world requires a marriage of clinical skills with business acumen. The arrival of pathology-based PPMs comes after PPMS were developed for other medical specialties.
As the next year unfolds, at least two additional pathology PPM models will emerge. Collectively, these business initiatives will influence and reshape how pathology services are organized and delivered.