Picture this: You're a tech founder with a brilliant idea. You've built a telehealth platform that connects patients with board-certified physicians for virtual consultations. Your app is sleek, your user experience is flawless, and you've just closed your seed round. You're ready to launch.
Then your attorney drops a bombshell: "You can't actually employ the doctors. We need to set up a separate professional corporation."
You blink. "What do you mean I can't employ doctors? I'm running a healthcare company."
"Welcome to the corporate practice of medicine," your lawyer says. "This is going to get complicated."
If this sounds familiar, you're not alone. Thousands of digital health founders have sat through this exact conversation over the past five years, many of them scratching their heads about why their tech company suddenly needs multiple legal entities and something called a "management services agreement" just to get off the ground.
Here's what's happening: the healthcare industry is experiencing a fundamental shift in how medical services are delivered and, consequently, how the business arrangements behind them are structured. The traditional management services agreement that worked perfectly fine for decades is now being stretched, twisted, and reinvented to accommodate a new generation of technology-enabled healthcare companies. And with that evolution comes a critical challenge that most founders don't see coming until it's too late—the valuation problem.
The Traditional Setup: How Things Used to Work
To understand where we're going, we need to understand where we've been. The management services agreement, or MSA, has been a staple of healthcare business arrangements since the 1990s. The concept was straightforward: a management services organization (MSO) would provide all the non-clinical "back office" functions to a medical practice or surgery center, allowing the physicians to focus on what they do best—practicing medicine.
Think of a traditional vascular access center or an ambulatory surgery center. These facilities needed help with things like:
- Billing and collections
- Revenue cycle management
- Accounting and bookkeeping
- Human resources and payroll
- Facility management and maintenance
- Equipment procurement
- Marketing and patient scheduling
- Regulatory compliance
The MSO would step in, provide all these services, and charge a fee. That fee was almost always structured in one of two ways:
- Percentage of revenue: The MSO would receive 10-20% of the medical practice's net revenue
- Hybrid model: A fixed base fee plus a smaller percentage (typically 3-5%) for specific services like billing and collections
This arrangement worked beautifully for everyone involved. The medical practice remained independent, owned by physicians as required by state corporate practice of medicine laws. The MSO was a separate business that could be owned by non-physicians. Both entities could be profitable. The MSO wasn't trying to siphon all the money away from the practice—it was genuinely a vendor providing services for a fair fee.
The valuation methodology was equally straightforward. When healthcare attorneys or regulators wanted to verify that the management fee was at fair market value and not some sort of disguised kickback scheme, consultants like us would use what's called a "cost-plus methodology." Here's how it worked:
- Identify every person at the MSO providing management services
- Determine their market-rate compensation (salary, benefits, payroll taxes)
- Add up all the direct and indirect costs
- Apply a reasonable profit margin (typically 10-30%)
- Voilà—you have a defensible fair market value management fee
This approach made sense because the MSO's value proposition was labor. It was providing human beings to do administrative work. More work required more people, which meant higher costs, which justified a higher fee. It was linear, predictable, and easy to defend in an audit.
Then COVID Changed Everything
In 2020, the world stopped. Patients couldn't visit doctors' offices. Elective procedures were cancelled. The healthcare system faced a crisis of access. And suddenly, telehealth went from a nice-to-have for rural patients to an absolute necessity for everyone.
The numbers tell the story: telehealth utilization skyrocketed from just 1-2% of ambulatory care visits before the pandemic to 30-40% of all visits at the peak. Even as things stabilized, virtual visits remained at 13-17% of all visits—roughly 38 times higher than pre-pandemic levels.
More importantly, the infrastructure needed to support this transformation required massive capital investment. Venture capital firms took notice. Digital health funding exploded from $14.3 billion in 2020 to a staggering $29.1 billion in 2021- nearly doubling in a single year.
This influx of capital didn't just fund existing telehealth companies. It encouraged an entirely new breed of founder to enter healthcare- the Silicon Valley entrepreneur. Software engineers, product managers, and startup veterans who had built companies in fintech, e-commerce, and SaaS suddenly pivoted to healthcare. They saw an industry ripe for disruption, powered by technology, artificial intelligence, and scalable platforms.
These founders brought with them a fundamentally different mindset. They weren't thinking about running a medical practice with some tech support. They were thinking about building massive, venture-backed technology platforms that happened to deliver healthcare. They expected rapid growth, multiple funding rounds, and eventually a lucrative exit through acquisition or IPO.
There was just one problem: they were operating in healthcare, one of the most heavily regulated industries in America. And they were about to run headfirst into a legal concept most of them had never heard of.
The Corporate Practice of Medicine Problem
Here's the issue: in most states, corporations cannot practice medicine. This doctrine, called the corporate practice of medicine (or CPOM), exists to ensure that medical decisions are made by licensed physicians based on patient welfare, not by business executives focused on profit margins.
The reasoning makes sense. We don't want shareholders of a publicly-traded company pressuring doctors to cut corners or ordering unnecessary procedures to boost quarterly earnings. Medical judgment should remain independent.
But for our tech founder with the telehealth platform, this creates a serious structural problem. They've incorporated as a Delaware C-corporation (the standard for venture-backed companies). They've raised millions in venture capital. They've built a proprietary technology platform. And now their attorney is telling them that this corporation—their company—cannot employ physicians or provide medical services.
The solution? The "friendly PC model."
Enter the Friendly PC Model
To comply with CPOM laws, digital health companies typically set up what's known as a friendly professional corporation (PC). Here's how the structure works:
The MSO (the founder's original Delaware corporation):
- Owns all the proprietary technology
- Employs all the non-clinical staff
- Holds the brand and intellectual property
- Receives the venture capital investment
- Handles all the business operations
The PC (a separate professional corporation):
- Is owned by one or more licensed physicians
- Employs or contracts with the physicians who provide medical services
- Maintains control over all clinical decisions
- Bills patients and insurance companies for medical services
- Legally receives all the clinical revenue
These two entities are connected through a series of agreements (typically a management services agreement or administrative services agreement, an intellectual property licensing agreement, and sometimes others). The PC pays the MSO fees for the services and technology it provides.
From a regulatory and legal perspective, this structure works. The PC is physician-owned and maintains clinical independence. The MSO is focused purely on business and administrative functions. Everyone is complying with CPOM.
But from the founder's perspective, this feels like a bureaucratic nightmare. In their mind, they're running one business—a unified telehealth platform. The division between MSO and PC is merely a legal formality, a compliance requirement, not a reflection of economic reality.
And this is where the challenge begins.
The Payment Flow Problem
Remember, for digital health companies to scale nationally, they need physicians licensed in multiple states. The most sought-after physicians in this model are what founders call "unicorns"—doctors licensed in all 50 states, allowing the company to provide care seamlessly across the country.
But here's the catch: all the clinical revenue must legally flow through the PC. Why? Because the PC is providing the medical services, and healthcare revenue follows the service provider.
This creates two possible payment models:
1. Single Payment Model (more legally conservative)
- 100% of clinical revenue flows to the PC first
- The PC pays the MSO a management fee
- The MSO's only revenue line item is this management fee
2. Bifurcated Payment Model
- The MSO collects "non-clinical" revenue (often called a technology or platform fee)
- The PC collects the clinical revenue
- The PC still pays the MSO a management fee
- The MSO has two revenue streams: tech fees and management fees
Most conservative healthcare attorneys prefer the single payment model because it more clearly maintains the separation between clinical and non-clinical activities.
But think about what this means for the founder. They've built a tech platform. They've raised venture capital. They need to grow the company and eventually exit at a significant valuation. Yet the majority of the revenue is flowing through an entity (the PC) that they don't even own.
The solution? The management fee becomes the mechanism to get money back to the MSO.
The New Management Services Agreement
This is where the traditional MSA morphs into something entirely different. In the older model, both the MSO and the medical practice were independent businesses that expected to maintain separate profit margins. The MSO charged a fair fee, the practice kept its profits, and everyone was happy.
In the friendly PC model, the economics are completely inverted. From the founder's perspective (if not from the legal documents), this is one business split across two entities purely for compliance reasons. The founder doesn't want profit "trapped" at the PC. The goal is to use the management fee to pull substantially all of the profit back to the MSO—the entity that will actually be sold when the company exits.
If you're a healthcare attorney, this is where you start to get nervous. A variable management fee that simply equals "whatever's left over" looks suspiciously like it's tied to the volume or value of referrals. That could trigger concerns about the Anti-Kickback Statute, Stark Law, or state fee-splitting prohibitions.
So the more conservative legal approach is to set a fixed annual management fee in advance—typically for a 12-month period. The fee is established based on projected financials (pro forma figures), locked in for the year, and then reassessed for the following year.
The problem with this approach becomes apparent quickly: digital health startups are high-growth, high-burn ventures. Expenses almost always precede revenue, especially in the early years. This typically leads to one of two outcomes after the 12-month period:
- Money is trapped at the PC (the PC has more profit than expected, but can't distribute it to the MSO without raising compliance issues)
- The PC can't pay the full management fee (the more common scenario—the PC doesn't generate enough profit to cover the pre-set management fee)
There's a legal mechanism involving a line of credit agreement that allows the MSO to essentially loan money to the PC, creating a note that the PC can repay over time. But this is a bandaid solution, not a sustainable model.
The real question becomes: How do we set a management fee that is defensible as fair market value, complies with all applicable regulations, AND allows the MSO to capture the economic value being created by the business?
Why Traditional Valuation Methods Break Down
This is where most founders—and frankly, many attorneys and even some healthcare consultants—hit a wall. They try to apply the traditional cost-plus methodology, and it simply doesn't work.
Let me give you an example. Imagine a founder (let's call him Jake) starts a company that provides emotional support animal certification. The service is simple: patients complete an online intake, have a brief asynchronous or synchronous consultation with a licensed mental health provider, and those who meet medical criteria receive documentation certifying their pet as an emotional support animal. This allows them to keep their pet in rental housing that otherwise wouldn't allow animals.
Year One:
- Jake develops and deploys the app himself
- He recruits a small network of licensed clinicians to the PC
- The platform processes a few thousand patients
- Total profit: Modest, maybe $200,000
- The MSO has just a few employees: Jake (the software engineer), maybe a customer support person and a part-time operations manager
Using a cost-plus methodology:
- Jake's market salary as a software engineer: $150,000 + benefits = ~$180,000 all-in
- Support staff: $100,000 all-in
- Other overhead: $50,000
- Total MSO costs: $330,000
- Add 20% profit margin: $66,000
- Fair market value management fee: ~$400,000
This covers the $200,000 in profit easily. Everything works. The founder, the attorneys, and the regulators are all happy.
Year Two:
- The app goes viral on TikTok
- Patient volume explodes to 500,000 encounters
- The platform is almost entirely automated with AI-driven intake and asynchronous consultations
- Jake hasn't hired anyone new—the platform scales beautifully
- Total profit: $15 million
Using the same cost-plus methodology:
- Jake's salary: Still $180,000 all-in
- Support staff: Maybe hire one more person, so $200,000 total
- Other overhead: $100,000
- Total MSO costs: $480,000
- Add 20% margin: $96,000
- Fair market value management fee: ~$580,000
Do you see the problem? There's $15 million in profit, but using traditional valuation methods, you can only justify a management fee of roughly half a million dollars. That leaves $14.4 million trapped at the PC, with no clear path to get it back to the MSO where the venture investors are expecting their returns.
You could try to inflate Jake's salary or the support staff costs, but there's only so far you can push that before it stops being defensible. No market data will support paying a single software engineer $10 million per year or claiming that customer support staff cost $5 million annually.
This is the core problem with applying traditional MSA valuation methodologies to modern digital health companies: there's no scalability built into a cost-plus model.
The Fundamental Difference
Traditional MSOs provided value through labor. More volume meant more work, which meant more people, which meant higher costs. The relationship between value provided and cost incurred was essentially linear.
Modern digital health MSOs provide value through three different things:
- Technology and Software: Proprietary platforms that can scale to serve millions of patients without proportionally increasing costs
- Brand and Market Position: A recognized name, patient trust, and marketing channels that would take years for a standalone practice to build
- Intellectual Property: Algorithms, clinical protocols, user experience design, and operational know-how embedded in the platform
None of these scale linearly with costs. In fact, that's the entire point—they're designed to create leverage, to deliver more value with the same or only marginally increasing costs.
This is where thinking needs to shift. The question shouldn't be "What does it cost the MSO to provide management services?" The question should be "What is the market value of the comprehensive solution the MSO provides?"
How Cabra Consulting Approaches Modern MSA Valuation
At Cabra Consulting, we've developed a methodology specifically designed for digital health companies operating under the friendly PC model. Rather than force-fitting a cost-plus approach where it doesn't belong, we break down the management fee into distinct components and apply the appropriate valuation methodology to each.
Here's our framework:
1. Labor-Based Services Component
For services that truly are labor-intensive (accounting, billing support, human resources, compliance), we still use a cost-plus methodology. This makes sense because these services scale somewhat linearly with volume.
2. Technology Licensing Component
For the proprietary software platform, we look to market benchmarks for SaaS licensing fees. What would a third-party medical practice pay to license similar technology? We consider:
- Comparable technology licensing agreements in healthcare
- SaaS pricing models in adjacent industries
- The cost savings or revenue enhancement the technology provides
3. Brand and Market Access Component
For the value of operating under an established brand with existing patient acquisition channels, we examine:
- Customer acquisition costs in the market
- Marketing spend that would be required for a standalone practice
- The value of reputation and trust
- Market data on what medical practices pay for patient referral networks (within legal bounds)
4. Intellectual Property and Operational Know-How
For the embedded expertise, protocols, and operational systems, we look at:
- Royalty rates for similar healthcare intellectual property
- Management consulting fees for operational support
- The cost to independently develop similar capabilities
By separating these components and applying the appropriate methodology to each, we can build a defensible fair market value conclusion that scales appropriately with the actual value being provided—not just the cost incurred.
This approach allows the management fee to grow as the business grows, capturing the economic reality that a mature, high-volume platform delivering excellent care to millions of patients is providing dramatically more value than an early-stage platform serving a few thousand patients—even if the cost structure hasn't changed proportionally.
Why This Matters
Getting this right isn't just about moving money around between entities. It has real consequences:
For Founders: If you can't defensibly get profit back to the MSO, your company valuation suffers dramatically. Investors are buying equity in the MSO, not the PC. If profits are trapped at the PC, your exit opportunities become limited or your valuation multiples get compressed.
For Attorneys: If you structure management fees that can't withstand regulatory scrutiny, you're exposing your client to significant legal risk. Fair market value isn't just a nice-to-have—it's a regulatory requirement under the Anti-Kickback Statute, Stark Law, and various state laws. Getting this wrong can result in civil and even criminal liability.
For Investors: Due diligence on digital health investments must include a hard look at the MSA structure and valuation support. A brilliant technology platform means nothing if the economics can't flow back to the entity you're investing in.
The Bottom Line
The management services agreement has evolved dramatically from its roots in traditional medical practice management. The friendly PC model, born out of necessity to comply with corporate practice of medicine laws, has created a unique valuation challenge that traditional methodologies simply can't address.
Digital health companies create value differently than traditional medical practices. They leverage technology, brand, and intellectual property to deliver scalable solutions. The valuation of their management fees must reflect this reality while remaining defensible under applicable healthcare regulations.
This isn't about finding loopholes or pushing boundaries. It's about applying rigorous, market-based valuation methodologies that accurately reflect the economic substance of modern healthcare delivery models. It's about ensuring that compliance with legal requirements doesn't inadvertently trap value or distort economic reality.
The future of healthcare delivery is digital, scalable, and technology-enabled. The valuation frameworks that support these models need to evolve accordingly. At Cabra Consulting, we're helping founders, attorneys, and investors navigate this evolution—ensuring that innovation in healthcare delivery is matched by sophistication in valuation and compliance.