In late December, the California Office of Health Care Affordability (OHCA) issued final regulations for the new material change transactions filing process, which goes into effect this year. (22 Cal. Code of Regs. §§ 97431-97442.) Section 97435(c) identifies eight types of material change transactions that will require filing, discussed in more detail below.  

Health care entities contemplating mergers, acquisitions, and other transactions in California have been anxiously waiting for OHCA to issue final regulations on this new regulatory approval process. SB 184 was passed by the California legislature in June of 2022, and requires health care entities to provide a 90-day pre-closing notice to OHCA of any proposed merger, acquisition, corporate affiliation, or other transaction that will result in a material change to the ownership, operations, or governance structure of a health care entity. We previously summarized the Health Care Quality and Affordability Act (HCQAA) here and the initial draft of OHCA regulations here. OHCA issued further proposed regulations in November, and these final regulations were published at the end of December.

What Changed in the Final Regulations?

The final regulations include several updates that will assist health care entities working through the new OHCA regulatory process. 

Management Services Organizations. One key change in the final regulations was the removal of a reference to “management service organizations” from the definition of a “health care entity” that is subject to the statute. The HCQAA a health care entity subject to the pre-closing filing requirement as a payer, provider, or a fully integrated health system. The implementing expand the definition of a health care entity to include  pharmacy benefit managers and certain parents, affiliates or subsidiaries of a payer. Prior drafts of the regulations also included management services organizations in the definition of a “payer,” but this concept was removed from the final regulations. While health care management service organizations are not directly subject to the regulatory review process, health care entities that enter into a management arrangement may still be required to file an OHCA notice if the arrangement with a management services organization is considered a “material change transaction.”

Material Change Transactions Defined. The final regulations also removed two types of arrangements from the types of “material change transactions” that trigger a filing obligation.  Health care entities that are subject to the statute are required to file a pre-closing notice if they are engaging in a “material change transaction.” A “material change transaction” is defined in the , and was expanded upon in the regulation to include a host of transactions or arrangements that would trigger a filing. Prior drafts of the regulations required a filing if health care entities were to join, merge, or affiliate with another health care entity, affiliation, partnership, joint venture, or parent corporation related to the provision of health care services where any health care entity had at least $10 million in annual California-derived revenue. Prior drafts of the regulations also required notice of transactions which would change the form of ownership of a health care entity that is a party to the transaction, including a change from a physician-owned to “private equity-owned” entity or a publicly held to a “privately held” form of ownership. The regulations deleted these two circumstances from the list of transactions that require a filing. Note, however, that the formation of a new health care entity, affiliation, partnership, joint venture, or parent corporation for the provision of health care services that is projected to have at least $25 million in California-derived annual revenue or the transfer of control of $25 million in assets will require a filing. This means that health care entities have more flexibility to continue to explore joint venture arrangements of less than $10 million, or private equity investment opportunities, so long as the transaction doesn’t trigger another concept in the definition of a material change transaction. 

Health Care Entities Required to File. The final regulations also revised references to the type of health care entity that is required to submit a filing, which narrows the potential circumstances that will require a filing. Prior drafts of the regulations suggested that a filing would need to occur if a transaction involved a health care entity and required a notice of transactions involving the sale or disposition of 25% or more of the total California assets of any health care entity in the transaction.  The regulations changed this obligation to the sale or disposition of 25% or more of the assets of the submitter. This could include either the health care entity that is the buyer or the seller in the transaction.

Key Concepts Remain

The final regulations provide further clarification to California health care entities entering into material transactions, but the key concepts of the enabling statute remain unchanged. Health care entities that are entering into material change transactions closing on or after April 1, 2024, are required to file a pre-closing notice with OHCA, and the transactions may be subject to a cost and market impact review process. Whether a particular transaction will require pre-closing review will depend on the type of health care entity involved, and whether the structure of the transaction is considered a material change that requires a filing.  

Want To Learn More?

• California: Health Care M&A Market Heats up as New Regulator Takes a Closer Look
• California: Proposed Regulations Impacting the M&A Market in California
• Health Care Joint Ventures: What’s the Big Deal?

�鶹��ý is here to help you address the short and long-term impacts in the wake of regulatory changes. We have the resources to help you navigate these and other important legal considerations related to business operations and industry-specific issues. Please reach out to the authors, your �鶹��ý relationship partner, or to our Health Care Practice Group with any questions.

On December 7, 2023, the Senate Budget Committee (the “Committee”) launched a into the reality of private equity ownership of hospitals in the United States. This investigation stems from concerns around negative patient outcomes associated with hospitals under private equity ownership, and key committee members have sent letters to the CEOs of major private equity firms outlining the Committee’s concerns about how these entities own and operate hospitals.  

The Committee’s investigation is the latest signpost of the government’s growing scrutiny of private equity in health care. As highlighted in our earlier blog post, the Biden Administration has raised concerns about private equity investments in health care, and a series of False Claims Act enforcement actions have targeted private equity firms in the health care sector. Moreover, the Centers for Medicare & Medicaid Services (CMS), with its current focus on private equity in the long-term care sector, has publicly criticized private equity owned and operated entities, and increased provider enrollment requirements to require full disclosure of private equity ownership (and control). CMS has also indicated that concerns with private equity operations were part of the reason for its revised requirements for increased scrutiny for Medicare participation approvals for nursing facilities. 

The State of Private Equity in Health Care  

The health care industry has experienced a surge in private equity investment in recent years, culminating in a record-breaking 515 deals valued at in 2021. At least are owned by private equity firms in the United States. Notably, these hospitals are largely owned by a handful of private equity firms with a keen focus on rural populations, accounting for over a third of for-profit hospitals. 

The Senate Budget Committee’s Concerns

The Senate Budget Committee’s associates private equity ownership of hospitals with:

• Significant staffing reductions
• Substandard health care
• A stripping of valuable assets (including real estate)
• Unmanageable leveraged debt
• Facility closures
• The prioritization of profits over patients

Senate Budget Committee Chairman Sheldon Whitehouse elaborated on what he said was a common practice observed in hospitals under private equity ownership. In this routine, private equity firms acquire a hospital, amplify its debt while implementing substantial cost-cutting measures, and subsequently divest the hospital. The Committee’s concern is that this practice frequently leaves the hospital in a precarious state, devoid of essential operating resources, and functioning with minimal staff. Significantly, nearly 90% of health care companies classified as financially distressed by a are under the ownership of private equity firms. 

Scope of the Senate Budget Committee Investigation

Hospitals that are or were formerly owned or operated by private equity companies will be investigated. Currently, the scope of this investigation includes hospitals in California, Pennsylvania, and Rhode Island. However, the scope and reach of these investigations will likely expand beyond the named states, and even beyond hospitals into other health care entities, given the Committee’s interest and the growing government scrutiny of private equity in health care.

In the letters by the Committee to the CEOs of these private equity firms, the Committee requested documents and detailed answers to color concerns about the impact these firms have on the delivery of health care.

Implications for Private Equity and Health Care Entities

As the investigation unfolds, it serves as a critical warning to private equity firms to reassess their strategies in health care investments, both as acquisitions and as ongoing operations. All investors and operators, especially private equity which is currently under especially strict scrutiny, must pay close attention to the myriad of regulatory risks and requirements, many of which are unique to health care. The Committee’s investigation emphasizes the need for heightened compliance efforts to mitigate deemed potential adverse impacts on patient care and the broader health care landscape. In an environment of constantly changing regulations, a heightened focus on compliance with both state and federal law is crucial to navigate potential health care regulatory pitfalls and (perhaps) avoid unwanted scrutiny.  

Additionally, private equity owned health care entities must be vigilant in addressing concerns related to patient outcomes, staffing levels, and the overall quality of care, as these factors could become focal points under increased scrutiny. These concerns may be especially acute if distressed facilities are acquired by private equity.

�鶹��ý is here to help you address the short- and long-term impacts in the wake of regulatory changes. We have the resources to help you navigate these and other important legal considerations related to business operations and industry-specific issues. Please reach out to the authors, your �鶹��ý relationship partner, or to our Health Care Practice Group with any questions.

A panel discussion moderated by Sofia Guerra of Bessemer Venture Partners aptly titled “The Great Leveling Out” provided some clear insights into how investors view the current state of play in digital health markets. Laura Veroneau, Managing Director of Optum Ventures, Andrew Adams, Managing Director of Oak HC/FT and Nick Richtt, Managing Director of JPMorgan, covered the topic from early stage to mature private equity (PE) financed to public strategic buyers.

Capital Efficiency

Not surprisingly with valuations and funding down sharply in 2023, investors are looking for companies with a speed to profitability as compared to the TAM (Total Addressable Market) driven growth models of the prior early years of 2020 and 2021. Overall tolerance for funding losses over an extended period has sharply dropped for both new investments and existing portfolio companies.

New Barriers and Valuation Drops

The panel uniformly felt that reduced valuations happen routinely in the bulge and bust environment of early-stage tech and health care investing. This time is no different. A reduced valuation is not a reflection of a poor management team or a poor platform. In fact, the presence of an experienced team that can navigate funding lulls is key, as is the judgment needed to survive another day to achieve long term goals despite reduced valuations. A team with significant experience in managing health care platforms, especially through choppy waters, was identified as a key marker by investors.

How To Escape the “Leveling” Process

Both the Optum and Oak speakers identified the Medicaid space, an area routinely associated with poor management, possible inefficiency and expanding demand with a challenging population cohort, as an area for focus given the size of the market and the challenges of population health management for low income groups. Uber’s new collaboration with United Health’s Medicare Advantage plans to bridge the appointment access hurdle was cited as a creative development in value-based care.¹

Another area for opportunity is the expanding series of partnerships between payers and providers, such as the virtual care collaboration between Spring Health and HighMark Health.²

Niche areas (e.g. eating disorders) that are curated and focused to address the health care needs of a very specific population have received the attention of investors as well.

While artificial intelligence (AI) has captured headline valuations, most of the panel felt the investment decision for AI was still too early. Tangible success stories are needed showing cost savings, labor savings, and/or revenue to justify the persistent high valuations. Early billing and clinical documentation success stories are needed to build on larger gains and investment confidence.

Building a “multilingual” team with clinical, operational, development, legal/compliance and financial acumen was recognized by all as probably the single largest factor in investment decision making for investors.

Five Key Criteria

While not anything new, the new investment paradigm will look to the following:

1. Does the service or product solve a persistent long-term issue?
2. Does the company have hard predictable and scalable, clinically verified data to show a return on investment (ROI) that supports the valuation?
3. Does the team have a focus on a large and growing market?
4. Does the company have favorable unit economics (i.e., margins)?
5. Does the company have a strong multilingual (as discussed above) team?

What does the balance of 2023 and 2024 show?

The panel felt long term a “leveling out” isn’t bad as it promotes the winning survivors and allows those firms to scale and access capital.

The investor panelists focused on 1) definitive consolidation in some markets where operating model overlap amongst 3-5 competitors is clear; 2) bold initiatives such as the one by General Catalyst to buy a health system outright to serve as a product and service innovation lab for new entities born inside the health system ecosystem itself;³ and 3) new ideas/teams that have yet to surface in the rapidly changing area of value based care.

All panelists held firm that the future of digital health investing is on solid ground. The bridge period we are in is sometime slow and painful but needed. A new cycle of investing and deal making is gathering momentum…it simply takes a meeting of the minds.

We have the resources to help you navigate the important legal considerations related to business operations and industry-specific issues. Please reach out to the authors, your �鶹��ý relationship partner, or our Health Care Practice Group with any questions.

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