The behavioral health industry is evolving rapidly, with demand for mental health and substance use disorder (SUD) services at an all-time high. As a result, providers are increasingly exploring new market opportunities, seeking to expand their footprint to meet the growing need for accessible care. However, entering new markets can be challenging, with competition, regulatory hurdles, and logistical considerations posing significant obstacles. For many providers, a de novo (brand new) expansion strategy, while often more complex, can be a highly effective way to establish a presence in a new location.
De novo expansion refers to the process of building and operating a new facility or program from scratch, rather than acquiring an existing one through mergers and acquisitions (M&A). Although M&A is considered the fastest way to scale, it is not always the most economical. De novo, on the other hand, can offer better long-term returns, especially if executed thoughtfully and strategically.
In this post, we will explore why de novo expansion is a smart strategy for behavioral health providers and delve into the key factors that influence successful market entry.
The Case for De Novo Expansion
For many behavioral health providers, de novo expansion is a compelling strategy due to the long-term benefits it offers. According to Dan Davidson, managing director at Brentwood Capital Advisors, de novo expansion often yields better return on investment (ROI) compared to mergers and acquisitions, which can come with significant upfront costs and integration complexities.
Davidson, who has advised over 40 behavioral health companies, has seen firsthand how de novo expansion can be a highly effective growth strategy. “Mergers and acquisitions are the fastest way to grow, but the most economical, the most return on investment is definitely de novo,” Davidson said during his presentation at the Behavioral Health Business INVEST event in October.
The appeal of de novo expansion lies in its flexibility and control. When starting a new facility or program, providers have the ability to design operations from the ground up. This means they can tailor services to the specific needs of the target market, build a strong organizational culture, and avoid the challenges that come with integrating a new company. For providers who have a clear vision and a strong understanding of the market they are entering, de novo expansion can offer a path to sustainable growth.
Tani Weiner, co-chair of the Behavioral Health Group at Polsinelli law firm, also supports the de novo approach, particularly in light of a slower M&A economy over the past two years. “De novo has been a steady channel of growth, particularly as we’ve had a slower M&A economy,” Weiner noted at the same event. As M&A activity has slowed due to various macroeconomic factors, including market uncertainty, de novo expansion provides an opportunity for providers to continue growing their operations.
Factors to Consider When Expanding De Novo
While de novo expansion offers a wealth of opportunities, it is not without its challenges. Providers must carefully evaluate several key factors when entering a new market to ensure their expansion efforts are successful. These considerations include market fit, local competition, clinician availability, reimbursement dynamics, legal compliance, and zoning laws.
1. Market Fit
One of the first and most crucial factors when expanding de novo is ensuring that the new market is a good fit for the provider’s services. Not all regions are created equal, and it’s essential to consider how the community’s needs align with the type of care the provider offers.
Chris Dooney, vice president of finance and development at BrentCare Behavioral Health, emphasized the importance of market fit in his discussion at the INVEST event. “Our programs are really experiential,” Dooney explained, referring to the adolescent mental health and substance use disorder (SUD) clinics BrentCare operates in Dallas and Miami. “Here in Dallas, we have a really ranch feel. And so we would not want to move to New York City.”
This example highlights how understanding the local community’s preferences, demographics, and cultural nuances is key to successfully expanding de novo. Behavioral health providers must consider whether their model and services will resonate with the new market’s population. They also need to assess the availability of potential patients and how well their programs will integrate into the existing health care ecosystem.
2. Competition and Payer Dynamics
Understanding the competitive landscape in a new market is essential for de novo expansion. Providers need to assess how many other behavioral health providers are operating in the area and whether there is unmet demand for services. Conducting market research and speaking directly with local payers and insurers can help determine whether there is sufficient opportunity for success.
Davidson advises his clients to look closely at several factors when evaluating a new market, including the level of competition, payer dynamics, and the availability of qualified clinicians. “One thing that I found helpful is to actually call the payers and ask for their availability to sign contracts,” Davidson said.
By engaging with insurers and Medicaid programs early in the process, providers can gauge the level of support for behavioral health services in the region, including reimbursement rates and contract negotiations. These insights are invaluable in assessing whether the new market offers sustainable revenue opportunities.
3. Legal Compliance and Zoning Laws
Legal compliance is another critical factor in any de novo expansion. Every state has its own licensing requirements for operating a behavioral health facility, which can vary significantly from one jurisdiction to another. Providers must ensure they understand the specific regulations in the new market, including those related to accreditation, clinical staffing, and patient privacy laws.
Additionally, zoning laws can pose a significant challenge when opening a new facility. As Weiner pointed out, some locations may require zoning variances to operate a behavioral health treatment center. “The gold standard is to find someplace where you can operate by right,” Weiner explained. This means finding a location where the zoning laws allow for a treatment facility without requiring special permits or approval.
In areas where zoning laws are restrictive or residents are opposed to the presence of behavioral health facilities, providers may face resistance in the form of NIMBYism (Not In My Backyard). Davidson advises providers to be prepared to navigate these challenges by attending town hall meetings and engaging with local stakeholders to secure support for their facility. “With NIMBY, you have to go to town hall meetings and make sure that the location that you found, which is not always easy to find, is in the right neighborhood and that the neighbors will allow you to run a facility,” Davidson said.
In some cases, providers may need to resort to legal action if a local government outright denies a facility. Courts have often ruled in favor of treatment centers, especially when denying a facility is seen as discrimination against people with disabilities under the Americans with Disabilities Act.
4. Speed and Cost of Expansion
For providers pursuing de novo expansion, speed is often critical. In a competitive market, being able to quickly establish a new facility can give a provider a significant edge over competitors. Converting an existing facility, such as a nursing home or office building, may allow for faster deployment and potentially lower start-up costs.
Dooney notes that converting existing properties can offer a cost-effective solution for new behavioral health centers. “It can be jumping into existing leases at below-market prices,” Dooney said. This approach allows providers to expedite the process and open their doors more quickly, which can be crucial for meeting demand and gaining market share.
The timeline for achieving financial viability will vary depending on the type of services offered. According to Dooney, a well-run partial hospitalization program (PHP) or intensive outpatient program (IOP) can become a break-even operation within a year. However, for residential treatment centers, it may take longer to achieve profitability, given the higher operational costs associated with these types of programs.
Conclusion: The Strategic Advantage of De Novo Expansion
Entering a new market through de novo expansion is undoubtedly a complex and challenging undertaking for behavioral health providers. However, for those who can navigate the complexities of market research, legal compliance, and local dynamics, the rewards can be substantial. De novo expansion offers flexibility, control, and a clear path to growth—allowing providers to design tailored services that meet the needs of a new community and avoid the complications that come with mergers and acquisitions.
By focusing on key factors such as market fit, competition, clinician availability, payer dynamics, legal compliance, and the speed of expansion, providers can increase their chances of success in a new market. For many behavioral health providers, the de novo strategy is not just a growth option—it’s a savvy and sustainable way to build a long-term presence and serve communities in need of high-quality mental health and substance use disorder care.
