In California, pending Assembly Bill 3129 (the Act) could severely limit the ability of digital health companies to grow and operate in the state by prohibiting arrangements between physician, psychiatric, and dental practices and any entity that furnishes business or management services to providers that accept investments from private equity groups and hedge funds. The legislation’s current definition of private equity is arguably broad enough to capture venture capital funds, angel investors, family offices and even the innovation or investment arms of academic and nonprofit medical centers. The Act is part of the recent wave of scrutiny from state and federal regulators and lawmakers toward private equity’s involvement in the healthcare space.

This pending legislation continues to evolve, but as currently drafted its effect could undermine the ability of digital health companies seeking venture capital or other investments to fund growth from operating in or expanding to California. As a result, California’s physician, psychiatry and dental practice community could be transformed back into a “cottage industry” without the ability to leverage modern management, administrative and financial practices. Additionally, Californians could lose the opportunity to use the services of most virtual care platforms or other digital health offerings.

IN DEPTH

The Act contains several restrictions on healthcare transactions involving private equity and hedge fund backers, including (1) prior attorney general approval for private equity or hedge fund acquisition of healthcare facilities and provider groups and (2) a range of restrictions on arrangements and agreements (e.g., management services agreements) between provider practices and entities owned directly or indirectly, in whole or in part, by private equity groups and hedge funds. Funding sources for management services organizations are diverse, including hospitals, venture capital, angel investors and nonprofit entities, and the broad definition of private equity use in the Act could potentially capture arrangements funded by these groups.

Most notably, Section 1190.40(c)(2) of the Act prohibits physician, psychiatric or dental practices from entering into any arrangement or agreement with a private equity group or hedge fund (or an entity controlled directly or indirectly, in whole or in part, by a private equity group or hedge fund) “for the furnishing of business or management services” for any fee passed through “directly or indirectly to a payor, purchaser of physician, psychiatric, or dental services, or patient.” The specific arrangements the Act prohibits is not clear since the Act does not define “business or management services.” However, on its face, this restriction could be interpreted to broadly prohibit providers from entering into standard management services agreements with any third party with private equity or hedge fund backing.

This restriction would also undermine the physician practice management (PPM) structure, which uses management services agreements to create non-clinical and administrative stability across practices and to provide clinicians with the necessary business support to continue to grow their practice. The PPM structure is relied on by thousands of healthcare organizations, including virtual care providers, private practices, hospitals, managed care organizations and others, to take advantage of efficiencies, create more integrated care delivery approaches and, often, simply to operate efficiently. For digital health companies, the Act would limit their ability to grow and operate in California by restricting access to any outside capital from investment groups.

The Act could hinder the ability of digital health companies to operate in California once they reach a certain size. Virtual care providers and other digital health companies often turn to venture capital or other investment groups to raise funds to launch the next stage of growth and expansion into new markets. Critically, the Act as drafted would seem to treat venture capital funds as a private equity group. For purposes of the Act, a private equity group is “an investor or group of investors who primarily engage in the raising or returning of capital and who invests, develops, or disposes of specified assets.” This broad definition could presumably capture venture capital funds and other sources of investments, including innovation centers of academic medical centers, which often provide capital to startups to fund their expansion or commercialization of a product with the goal of making a return on that investment (typically when the startup is sold or goes public).

As a result, early-stage digital health companies seeking funding to grow (such as Series A funding) may find themselves captured by the Act and unable to serve California patients. This restriction could even limit expansion or new operations in California for large digital health companies that rely on PPM structures to integrate complex technologies developed by lay entities with quality clinical care.

Nathan Gray also contributed to this article.