MSO Recapitalization: Leverage Underpayments and More to Appeal to Private Equity Investors 

Healthcare organizations are coming to accept that it takes an MSO and consolidation to participate in healthcare’s digital transformation. MSOs offer the technological expertise and economy of scale that help providers modernize their way into reduced costs, streamlined operations, and even better patient care. Adding these advantages to a macroeconomic environment of declining interest rates and easing regulations, it's no wonder healthcare leaders experts again forecast growth in healthcare M&A activity in 2025. 

Ann Elliott, founder of  M&A advisory Vertess, shares that private equity firms have accumulated substantial capital reserves and are eager to invest in healthcare. She expects a new wave of consolidation ahead, particularly in fragmented markets like home health, behavioral health, and outpatient services.

With entities rapidly changing hands, MSO recapitalization will pick up as well. MSOs consider recapitalization for many reasons in addition to scaling operations or restructuring in bankruptcy.  Review the smartest ways your MSO can undertake a recapitalization.

What is MSO recapitalization?

MSO recapitalization is the process of restructuring a management service organization’s financial structure. It typically involves changing the debt-to-equity ratio by either adding more debt or equity to its capital structure. Often, MSOs undertake recapitalization to potentially improve their financial flexibility and market perception, attract new investors, or prepare for expansion. MSO recapitalization can occur when private equity firms invest in healthcare practices. The recapitalization can provide MSOs with access to capital for growth, improved operational efficiency, and increased bargaining power in contract negotiations.

MSO recapitalization and private equity (PE) firms 

In the past 10 years, private equity firms woke up to the investment potential healthcare offers. They recognized that they could financially succeed by improving healthcare operational efficiencies, implementing advanced technologies, and leveraging economies of scale. Healthcare leaders admit they lag retail, manufacturing, travel, and more when it comes to modernizing and streamlining operations. 

However, because many states prohibit PE firms from directly owning medical practices, it takes an intermediary, the MSO, to create the bridge between healthcare organization needs and private equity capital, strategy, and expertise. As an entity tasked with managing the non-clinical aspects of healthcare practices, MSOs ensure private equity firms comply with government regulations.

Via the MSO, private equity can inject capital into healthcare practices, enabling growth through expansion, and new equipment purchases. It may choose to develop new service lines without requiring personal guarantees from physicians. MSOs push healthcare organizations to improve clinical quality and operations. 

The MSO consults with the private equity firm on major financial decisions such as recapitalization, as these decisions directly impact the investment strategy and potential returns for both entities. 

Types of recapitalization

The main types of recapitalization strategies are:

Leveraged recapitalization

• What - The company takes on additional debt to repurchase shares or pay dividends to shareholders. This consolidates ownership and can boost earnings per share. 
• When - An MSO opts for this approach when it wants to take on additional debt to buy out existing shareholders or pay dividends without diluting ownership. It’s also ideal when scaling operations, expanding into new markets, or acquiring competitors,  enhancing operational efficiency, or investing in new technology all of which offer ripe opportunities but require cash. Leveraged recapitalization is used most often by MSOs with strong, stable cash flows that can support increased debt levels.

Equity recapitalization

• What -  The company issues new shares of stock to raise capital, reducing its debt level.
• When - MSO that needs to raise capital for growth initiatives or to improve its financial position without taking on more debt go with equity recapitalization. These MSOs are often striving to bring in new investors or fund shareholders who want to partially cash out.

Debt-for-Equity (D/E) swap

• What - Creditors agree to cancel some or all of the debt in exchange for equity in the company. The swap lowers the company's total debt obligations, improving its financial health and decreasing the risk of default. With less debt, the company's interest payments decrease, potentially enhancing its profitability.
• When - Often used to improve financial stability, companies in financial distress resort to this strategy to avoid bankruptcy. 

Management buyout (MBO) 

• What - The company's current management team buys out the majority or all of the company's shares to take private ownership. 
• When -  The MBO is common in situations where private equity investors want to exit, or when founders want to transition ownership to the management team.

Dividend recapitalization

• What -  The company takes on new debt to pay a large dividend to shareholders. 
• When - Used when owners want to liquidate a portion of their investment without selling their stake. It enables owners to retain some control of the company

Reverse recapitalization

• What -  Creditors exchange debt for company equity. 
• When - Used during financial distress when debt is unsustainable. 

These strategies allow companies to adjust their capital structure to better fit current needs and future goals, optimizing financial stability and supporting strategic objectives. 

The goals that attract recapitalization investors

There are about as many reasons private equity wants to invest as there are private equity investors. 

MSOs range in size from relatively small, serving as few as 10,000 lives, while others manage over 1 million patients. Smaller MSOs may focus on a single physician group or a limited geographic area, while larger MSOs often manage multiple practices across many states, leveraging economies of scale and advanced administrative capabilities to support population health. 

When one or more of your acquisitions either stumble into tricky territory or face a growth opportunity, you may consider going outside your original PE backer to another source. In these cases, a well-structured MSO becomes more appealing to investors, particularly private equity firms, due to its scalability and potential for high returns. Recapitalization can showcase your strategic sophistication, demonstrating its ability to proactively manage financial resources, optimize operational efficiency, and create value for potential investors. By executing a well-planned recapitalization strategy, you signal financial acumen, forward-thinking leadership, and a commitment to continuous improvement in its business model. Even if your organization is smaller, with efficient structure, you can prove that it manages its acquisitions well and is on the lookout for good growth opportunities. 

Enhance your MSO’s appeal to external investors and lenders when you make it clear you aim to:

• strengthen market position and increase value.
• use that investor’s expertise to some text
  • professionalize operations
  • implement advanced technologies
  • improve overall efficiency
  • attract healthcare providers to their network.
• gain access to new resources, networks, and strategic opportunities that may not be available independently.
• improve clinical quality and strengthen practices through investment (particularly when a target investor has a proven track record in clinical quality improvement).

Reasons investors jump at MSO’s recapitalization opportunities

As healthcare consolidation surges forward, all players are looking for their best opportunities. Private equity firms looking to increase their healthcare footprint may be just the partner your MSO needs to build out your portfolio and grow individual practices. 

Keep in mind that in seeking investment opportunities, private equity firms typically aim to achieve: 

• participation in healthcare practices while complying with regulations that prohibit direct ownership by non-physicians
• consistent, non-cyclical cash flows
• larger economies of scale via specialty physician group acquisitions. 
• increase MSO value by implementing more efficient management practices and technologies
• entity growth that leads to their own acquisition or even their IPO

Fashion your appeals to meet these goals. Private equity firms are increasingly recognizing the value of MSOs as vehicles for growth, efficiency, and regulatory compliance. Ultimately, successful recapitalization can position your MSO for sustained growth and success in an increasingly competitive healthcare market.

Recapitalization and bankruptcy

Use recapitalization as a strategy to address financial distress and potentially avoid bankruptcy. When bankruptcy looms, the power of recapitalization can help: 

1. prevent bankruptcy - recapitalization can help you restructure their debt and equity mix, potentially improving their financial position and avoiding bankruptcy and the subsequent hit to reputation. By adjusting the capital structure, you can reduce debt burden, increase liquidity, and create a more sustainable financial foundation.
2. continue to function during bankruptcy - Chapter 11 bankruptcy, for instance, allows you to restructure their debts while continuing operation. 
3. consolidate liabilities - recapitalization can consolidate operations and related debts at your level, simplifying potential future bankruptcy proceedings. This consolidation can make it easier to address liabilities on a consolidated basis rather than dealing with individual practices.
4. increase leverage over creditors - a well-structured recapitalization can give you more negotiating power with creditors in the event of financial distress or bankruptcy. For example, securing management fee obligations with pledges of individual practices' assets can provide leverage against unsecured creditors. 
5. attract new investment - even for distressed MSOs, recapitalization can make an MSO more attractive to potential investors or buyers and subsequently avoid bankruptcy. 

Recapitalization affords multiple strategies to navigate or avoid bankruptcy. By restructuring debt, consolidating liabilities, and potentially attracting new investment, recapitalization can provide MSOs with the financial stability needed to weather financial storms.

Debt-to-Equity (D/E) recapitalization for MSOs in growth mode

New and growing MSOs are frequent users of D/E recapitalization. This group needs robust cash flow to finance new projects, expand into new markets, or invest in new medical services. 

Once an MSO starts bumping up against high costs of debt, D/E recapitalization can relieve some of this burden – although at the cost of giving away more of the company.  When debt is converted into equity, D/E ratios and debt load diminish, improving financial stability and credit profile. This adjustment can lead to improved financial flexibility and enhanced market perception, positioning the company for future growth and stability. 

5 key MSO recapitalization steps

1. Define objectives and set expectations

The first step in the recapitalization process for you is to clearly define objectives and set expectations among all stakeholders. This involves establishing a shared vision that aligns the management team, current shareholders, and potential investors on the goals of the recapitalization. First, financial stability is paramount; aim for improved cash flow and reduced debt burdens to create a more sustainable foundation. Second, operational efficiency should be targeted, with the goal of streamlining processes and optimizing resource allocation to enhance overall performance. Third, establishing strategic partnerships is essential for leveraging external expertise and capital, which can facilitate growth and expansion.

Additionally, prioritizing market positioning ensures your recapitalization strategy aligns with broader industry trends and competitive dynamics. This includes assessing opportunities for mergers or acquisitions that can enhance market share. 

Finally, it is crucial to set clear performance metrics to monitor progress post-recapitalization, allowing for adjustments based on real-time data and outcomes. By focusing on these objectives, you can effectively navigate the complexities of recapitalization and position yourself for long-term success in the evolving healthcare landscape.

By ensuring that everyone understands and agrees on these goals, you can focus its recapitalization efforts effectively, significantly increasing the likelihood of a successful outcome. 

2. Gather intelligence

Once objectives are defined, the next step is to gather critical intelligence that will inform the recapitalization strategy. This includes a thorough analysis of your current financial condition, including existing debt levels, equity structure, cash flow, and overall market conditions. Understanding the capital markets and how they may impact your ability to raise funds is also crucial. This intelligence helps you craft a recapitalization plan tailored to your unique circumstances. Base your decisions on accurate and comprehensive data.

3. Design the recapitalization strategy

With clear objectives and gathered intelligence, work with your team to design your recapitalization strategy. This strategy may involve various financial maneuvers such as issuing new equity shares, taking on additional debt, or executing a debt-for-equity swap. The goal is to restructure the capital in a way that maximizes efficiency and flexibility while aligning with long-term objectives. Detailed financial models and scenario analyses are often employed during this phase to forecast potential outcomes. Ensure your strategy supports your growth plans.

4. Execution

The execution phase involves implementing the recapitalization strategy as planned. This includes negotiating terms with creditors and investors, issuing new shares if applicable, and restructuring existing debt agreements. It is vital to maintain compliance with all regulatory requirements throughout this process while keeping stakeholders informed to manage expectations effectively. Clear communication is essential to build trust and ensure that all parties understand their roles in the recapitalization effort.

5.  Post-recapitalization adjustments

After executing the recapitalization strategy, ongoing adjustments may be necessary to refine the capital structure further. This phase involves monitoring market conditions and financial performance to identify areas for improvement or additional restructuring if needed. The primary aim is to establish a more resilient capital framework that enhances financial stability while providing operational flexibility for future growth opportunities. By continuously evaluating performance metrics and making necessary adjustments, you can ensure that they remain well-positioned for success in an evolving healthcare landscape.

Highlight underpayment recovery potential when shopping recapitalization

As you venture into the recapitalization, look for ways you can demonstrate maximum revenue potential. A key source of revenue MSOs can overlook is underpayments.  

Many management services organizations and MSOs have revenue locked up in underpayments. An RCM staffing shortage can make pursuing these shortfalls impossible for busy physician groups and MSOs. Should an interested party have the staff, technology, and experience to get to them, your MSO suddenly becomes more valuable, allowing you to negotiate more favorable rates and terms. 

Underpayments can represent significant working capital, an amount many providers now fight for. A study published in Becker’s Hospital Review found providers lose one to three percent of net revenue annually due to underpayments from commercial payers. Another study put the figure as high as 11 percent. Our clients have revealed that their underpayments reach five to seven percent of net revenue – if they even have a grasp on these figures.  

More providers are demanding the revenue they’ve earned

Healthcare organizations are becoming intolerant of this revenue hit. Recently, physician group TeamHealth won $10.8 million dollars in their underpayments case against UnitedHealthcare. In a similar underpayments case, an arbitration panel of three judges awarded nationwide medical group, Envision Health $92 million, from UnitedHealthcare Group.

When one large orthopedics group with 30 locations unleashed a contract management software solution that identified underpayments, it recouped $10 million dollars. 

In the south, a Louisiana civil court jury ordered Blue Cross to pay $421 million to the St. Charles Surgical Hospital and Center for Restorative Breast Surgery on appeal. In neighboring state Alabama, over 100 hospitals are now suing Blue Cross, claiming a $5 billion loss due to underpayments.  

Providers are done tolerating underpayments in the millions and billions. 

Use your EMR, third-party partners, or contract management software to entice investors to your recapitalization by finding and analyzing your underpayments. Many forward-thinking MSOs are turning to contract management software to find underpayments by analyzing actual payments against those listed in healthcare contracts and fee schedules. These specialized tools use automation to handle complex underpayment scenarios throughout all stages of healthcare contract lifecycle management. It helps employees address underpayments without manual review or cumbersome spreadsheet management.

Take a quick, self-guided tour through a powerful contract management solution that automatically identifies underpayments and lists them for easy access:

Strengthen your MSO’s recapitalization position with contract management software

As you prepare for recapitalization, positioning your organization as more valuable and efficient than competitors will attract higher valuations and more favorable terms.

One fast and affordable route to demonstrating your additional revenue potential is via underpayment identification. It takes contract management software like MD Clarity’s RevFind to find the payers, CPT codes, locations, and physicians behind both individual and aggregate underpayments. RevFind is an automated contract management system that meticulously analyzes payer payments against contracted terms, flagging discrepancies for staff review. This scrutiny enables providers to:

• identify and quantify underpayments by payers, CPT codes, locations, physicians, and combinations of the four
• spot payment trends and patterns
• track underpayment recovery against requests
• build a strong case for contract negotiations
• model the impact on revenue of proposed payer changes

By uncovering systemic issues, RevFind helps prevent future revenue leakage. The system centralizes contract management, generating detailed reports that compare reimbursements across CPT codes and locations. Incorporating Medicare benchmarks, RevFind also offers a comprehensive view of payer contract performance, enabling data-driven decision-making for healthcare providers.

Schedule a demo to see how RevFind can identify the underpayments and unfavorable contract rates and terms that impact your recapitalization. 

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