Physician consolidation squeeze: Rising costs and tight cash flow are reshaping practice growth

Physician practices are being pushed toward consolidation as operating costs climb faster than reimbursements and acquisition pressure builds from hospitals, insurers and private equity, with the pandemic’s aftershocks still lingering.

That mix of rising expenses and constrained cash flow is reshaping how practices finance growth, according to John Pack, vice president of health care finance at Mitsubishi HC Capital America, who outlined what lenders look for and where midsize groups often hit a ceiling.

The following transcript has been edited for clarity and length.

Physicians Practice: What’s driving the surge in physician practice consolidation right now?

John Pack: That’s a loaded question, Keith. Right now, it’s a combination of elements that are driving the consolidation squeeze across practices.

Number one is rising operating costs and financial pressure. Practices are struggling to remain financially viable as the costs of staffing, supplies, compliance, technology with their electronic health records, malpractice insurance, those are all rising faster than reimbursements. It’s the stress of running a practice under these amplified financial pressures, and it’s becoming a chaotic part of physician practices in today’s world.

Number two is declining reimbursements and payment shifts. Medical practices are facing ongoing reductions or stagnation in reimbursement relative to inflation, especially with Medicare and commercial contracts.

And then there’s hospital, insurer, and private equity acquisition pressure. Consolidation has been accelerated over many years, probably the last decade and a half, with hospitals, insurers, and private equity firms aggressively acquiring practices. I read recently that up until last year, about 47%, almost 50%, of physicians were employed or affiliated with hospital systems, which is up from 10 years ago, when it was under 30%.

And let me finish by saying there are still aftershocks of the pandemic. We’re six years removed from the COVID pandemic, and it accelerated consolidation by hitting independent practices the hardest. Independent practices saw sharp drops in revenue and utilization that still spill over from that period, while operating costs increased. A lot of these groups have been sold to hospitals or private equity simply to survive.

Physicians Practice: Why do surviving midsize practices often hit a ceiling with traditional bank financing?

JP: I’d define midsize practices as somewhere between the $10 million or $15 million mark up to about $100 million or $120 million. They can get stuck in a lending no-man’s-land. Local and regional banks have facility limits that are too low, while large banks aren’t interested unless the practice is much larger or backed by private equity.

Banks still lend primarily against hard assets, buildings, real estate, equipment. And there’s what you’re going to hear me say a lot today, constrained cash flow. That’s been the hot button over the last 10-plus years with traditional bank financing for practices. Bank underwriting requires predictable cash flow, and health care cash flow is predictable over the long term, but banks view it as volatile because of payer-mix changes, reimbursement cuts, and delays in collections. That’s where I’d say midsize practices hit the ceiling with traditional bank financing.

Physicians Practice: What sort of numbers are lenders looking at when they size up a practice?

JP: First and foremost, they look at the bottom line, EBITDA, earnings before interest, taxes, depreciation, and the EBITDA margin. That shows true operating cash flow before debt service, and it determines how large a loan the practice can support. It also normalizes the quirks of physician compensation, owner perks, or one-time expenses.

Typically, lenders look for EBITDA margins from 10% to 20% for most outpatient specialties. It’ll be higher for surgical or ancillary-heavy groups and lower for primary care.

Another factor is days in accounts receivable, AR aging. Anything under 40 to 45 days is very strong. If you’re looking at 90-plus days in accounts receivable, that should be less than 15% of total AR. That’s a red flag.

And then payer mix. Lenders look at Medicare, Medicaid, commercial insurance, and self-pay/out-of-network. Those are the numbers they’re factoring in when they size up a practice.

Physicians Practice: What’s the cleanest way to fund growth without giving up control of your practice?

JP: The cleanest way is usually cash-flow-based debt, traditional or private credit. It’s best for profitable midsize practices with solid EBITDA. No equity is issued, no board seats are given up, and there aren’t covenants tied to clinical decision-making. You have a predictable repayment schedule.

Another option is asset-backed credit lines, using accounts receivable, equipment, or even real estate.

Physicians Practice: All right, so for acquisitions, what makes a deal financeable? What kills one of these deals?

JP: What makes it financeable is strong, very verifiable EBITDA. That’s number one. That’s a key component. The credit analysts, risk folks, credit in general, they go right to EBITDA and ask: How verifiable is it? How much is fluff, and how much is real?

They want to see a diversified provider base with no key-person dependency, and consistent revenue growth, trends that show a consistent “hockey stick” in revenue and volume. They want strong payer mix, Medicare, Medicaid, commercial, self-pay/out-of-network, nice consistency across the board, and not heavily weighted toward Medicare or Medicaid.

And, of course, a clean accounts receivable and revenue cycle operation. Keeping AR under 45 days would be very financeable. Anything that threatens what I just talked about, I’m not going to say it kills a deal, but it raises red flags for lenders.

Physicians Practice: What cash-flow fixes most often unlock financing or better terms?

JP: Number one is normalizing physician compensation, having a productivity-aligned model where physicians aren’t pulling everything out. A lot of practices are structured as S corporations, where they can take distributions.

And let me preface this by saying I’m not a credit underwriter. I just have experience facilitating deals and exchanging information between myself and our credit and risk teams. But lenders like to see physicians take fair compensation out of the practice, what they’re entitled to, while leaving some retained earnings and reinvesting back into the practice. That can unlock better financing terms.

Also, improving accounts receivable management. The fastest cash-flow win, and the most common lever lenders see, is cash flow. Positive cash flow is a win-win for most credit underwriters and most deals.

Physicians Practice: Speaking of cash flow, when reimbursements are unstable, and costs are unstable, how should practice owners stress-test their debt?

JP: That’s a tough question, and I don’t have a lot of experience in it, but it means asking whether the practice can still service debt if reimbursements drop. This can happen when labor costs rise, or a provider, one of your doctors, leaves the practice. To me, that’s a key component of stress-testing debt.

Conservative assumptions around coverage models and liquidity buffers help ensure the debt remains manageable even during short-term disruptions, like a provider leaving, hopefully that’s short-term, or a reimbursement issue, or that sort of thing. But quite honestly, owners, practice managers, physician owners should model downside scenarios, not just base cases.

Physicians Practice: What are the first three steps you tell an owner to take before trying to expand their practice?

JP: Before expansion, get a grip on where you are today. Get a clearer picture of your true cash flow, stripped of one-time expenses and any owner-specific add-backs.

Number two would be assessing operational readiness, including leadership depth and systems that can scale.

And number three would be engaging financial partners early and often, understanding realistic capital options before committing to any growth strategy. Talk to your banking partner, your financing partner, your investment partner, any trusted advisor within your practice. Honestly, that third one might belong at the top, now that I think about it, because they see this every day. Doctors aren’t financial gurus, I’m not saying that across the board. A lot have a high level of financial acumen. But most don’t. They care about patient care, that’s what they signed up for.

So first and foremost, engage your financial partner, whether it’s your banking partner or your investment partner. These are the folks who have a grip on where your practice stands and where it could be headed based on your objectives.

Physicians Practice: What’s one tip you’d give a leader that they can adopt today to improve their practice finances?

JP: Number one is patient care, that’s the objective in a medical practice, taking care of the patient. But next to that, start managing the practice like a business, not just a clinic. Monitor cash flow regularly. Look at your cash flow, talk to your accountant, talk to your financial advisors, not just about profit, but where money is getting delayed or where it’s leaking. Small operational fixes often have a bigger financial impact than just adding new volume into the practice.