As behavioral health organizations continue to be attractive targets for private equity investment and strategic acquisitions, legal readiness is essential. This article outlines the legal considerations that behavioral health providers should address to attract buyers and investors while minimizing risk, with a focus on practical steps these organizations can take to prepare for a successful transaction.
Corporate structure compliance in behavioral health M&A
Establishing a legally compliant corporate structure is a critical first step for behavioral health organizations preparing for investment or sale. Depending on the types of services provided, a behavioral health entity is most likely licensed as a facility within its state or is owned directly by clinicians. Many states enforce the corporate practice of medicine doctrine, which prohibits non-clinicians from owning or controlling entities that deliver clinical services. This corporate practice prohibition applies not only to physicians but can also apply to psychologists, social workers, therapists, and nurse practitioners.
To navigate the corporate practice prohibition, many organizations adopt a PC-MSO model, where a clinician-owned professional entity (PC) contracts with a management services organization (MSO) to provide non-clinical administrative support. This structure allows for operational efficiency and investment flexibility, but it must be carefully documented. Agreements between the PC and MSO should reflect fair market value, include appropriate transfer restrictions that do not run afoul of state law, and clearly delineate clinical versus administrative responsibilities to ensure regulatory compliance.
Due diligence: Be organized, be ready
Buyers and investors seek a well-organized target. We strongly recommend maintaining an organized document depository with copies of fully executed contracts, corporate records, payor agreements, and compliance documentation. Missing signatures, outdated forms, or incomplete exhibits can raise unnecessary flags and delay the completion of due diligence or further derail a deal.
Due diligence also includes an asset review, ensuring that both clinical and non-clinical assets are properly identified, and fully assessing any operational or legal risks. Proactive financial and billing audits and cleanup efforts signal maturity and preparedness.
Regulatory risk: What buyers and investors will examine
Healthcare transactions are subject to significant regulatory scrutiny, and behavioral health transactions receive even more due to additional state and federal laws that uniquely apply to behavioral health operations. Buyers and investors will examine compliance with HIPAA, 42 CFR Part 2 (for substance use disorder treatment), and state-specific privacy laws. They’ll look for evidence of a robust compliance program that not only addresses the privacy and security of patient health information but also ensures appropriate billing procedures, controlled substance prescribing practices, and fraud and abuse controls. Organizations should develop or refine their written compliance program policies, code of conduct, and audit procedures. They should also be able to show compliance “in action” by clearly having compliance training logs and periodic internal and perhaps external audit documentation.
Billing and coding practices are another high-risk area. Behavioral health billing is complex and payor-specific. Improper coding can lead to overpayments and enforcement risk. Conducting a proactive billing audit before negotiations begin demonstrates operational integrity and reduces surprises on both sides of the deal table.
Quality of earnings for healthcare transactions
Buyers and investors are focused on financial performance. A quality of earnings (QofE) report, prepared by an independent accountant, provides a detailed analysis of revenue and profitability. While buyers/investors generally prepare a QofE, sellers can arrange their own independent one, which helps them present a vetted financial picture and supports valuation discussions.
We often see sellers benefit from coordinating with financial advisors to ensure the QofE aligns with operational realities and that any discrepancies, such as revenue tied to questionable billing practices, are addressed early.
Employment agreements and restrictive covenants
Buyers and investors will closely examine employment relationships. Misclassifying employees as independent contractors or incorrectly designating exempt status can lead to wage and hour claims. It’s important to review employment and independent contractor agreements, ensure proper classification, and confirm that restrictive covenants, such as non-disclosure and non-solicitation clauses, are enforceable under applicable state law.
Non-competes remain a contentious issue, with enforceability varying by jurisdiction. These provisions should be tailored carefully and implemented before transaction discussions begin.
Patient-facing forms and policies
Patient-facing forms should not be generic templates. They should reflect current legal requirements and the organization’s specific operations.
Patient intake forms and marketing materials should clearly identify the organization delivering behavioral healthcare. Errors here suggest broader operational disorganization and invite scrutiny.
Common legal pitfalls in behavioral health M&A
We frequently encounter the following issues during transactions:
- Cap table confusion: Unclear ownership records or unissued equity promises can derail deals.
- State tax exposure: Operating across state lines may trigger unexpected tax obligations.
- Excluded provider risks: Unknowingly employing clinicians excluded from Medicaid, Medicare, or another federal government program can result in repayment obligations and reputational harm.
- Patient referral concerns: Arrangements involving patient referrals, travel payments, or third-party navigators must be vetted under necessary state and federal laws, including the federal Anti-Kickback Statute, states’ patient brokering acts, and the Eliminating Kickbacks in Recovery Act.
Legal strategy drives transaction success
Behavioral health organizations contemplating investment or sale must approach the process with legal precision and strategic foresight. Whether working with in-house counsel or external advisors, organizations benefit from early preparation, clear documentation, and a proactive approach to compliance.
By addressing legal vulnerabilities early and presenting clean, organized, and compliant operations, behavioral health providers can maximize valuation, minimize delays, and attract high-quality buyers and investors.
