Practice Management Alert

This investment system might offer the key to expanding your operations.

Private equity (PE) refers to the process of a firm collecting funds from individual investors and institutions to purchase other companies, helping those companies grow and increase profits, and then exiting the deal by selling them to a larger corporation or letting the public purchase stock in it. At a 2017 annual meeting of the American Health Lawyers Association, attorney Peter A. Pavarini from Squire Patton Boggs global law firm reminded attendees that private equity (or private capital) “is not like venture capital, which is for startups. It’s for more mature businesses that have grown to a certain point and have reached an obstacle.” For example, if you want to add a retail component to your medical practice, such as eyeglasses or a line of supplements and vitamins, private equity is one way to fund the inventory, point of sale software, and extra staff you may need.

If you get a bad taste in your mouth when you hear the words “private equity” (PE), that’s understandable. The term “vulture capitalism” has been used to describe the way some unscrupulous private investors got rich by laying off workers for no reason. Controversy aside, Pavarini reminds people that private equity “is a good, viable option in many cases.”

Private Equity Enters the Healthcare Arena

“Surprisingly, half of PE is now going into healthcare delivery,” he says. Bain & Co. reported that in 2014, private equity firms invested more than $29 billion in healthcare, a dramatic increase from the $16 billion that was invested by PE in 2013. Shifts in the market like value-based reimbursement and shared payment models make healthcare delivery more attractive than ever. According to a recent article in Modern Medicine, “Investors see an opportunity in being early participants in value-based care, even as the business case is still unclear given mixed results in Medicare’s payment and delivery reform demonstrations so far.” Todd Spaanstra of the accounting and consulting firm Crowe Horwath was quoted in the article, saying, “The niche is well-suited for private-equity firms, which feed on uncertainty.” Essentially, private investors are assuming that healthcare is heading towards an emphasis on shared payment models, and they want to get in on the ground floor.

Also, “healthcare is 20 percent of the GDP, so there is no way Wall Street is going to ignore that,” adds Pavarini. And since PE provides capital not available anywhere else, as banks aren’t typically interested in lending and it’s hard for hospitals or other health systems to compete with a PE deal, it can be a great source of funding for physician practices.

The rise of PE deals in the healthcare space is the result of a perfect storm of multiple factors, including:

• EHRs and analytics are on the rise. Practices have access to high-level data about how their financials is doing and where things need to improve, and investors can use that data to make decisions about where to invest. Also, health IT is a hot field, and investors want to partner with practices that take cybersecurity seriously.
• Physicians are becoming less and less willing to invest in their practice, creating an opportunity for outside funding to support the growth of practices instead.
• PE firms are much more involved in the businesses in which they invest than they were in the 1990s, when the buy-and-flip model was popular. Today, PE firms want to make businesses more profitable, so many use a buy-and-hold philosophy.

Learn What PE Firms Are Looking For

If you’re still wary of PE firms, Pavarini understands. “It’s certainly easy to be skeptical of PE because it doesn’t seem to pass the smell test,” he says. Here are some insights into the goals of private equity investors, and what they look for in partnerships with healthcare practices:

• PE is short-term funding. Investors provide funding for around five years on average and definitely no more than ten years. After that, the PE firm typically considers selling the practice to a larger institution, such as an insurance company or health system.
• Investors look for a high rate of return—typically 30%. “Their exit is probably the most important thing they think about,” says Pavarini. They want to get in, get out, and move on to the public market or to another strategic purchaser.
• Physicians will have majority interest or financial control. Investors want to keep physician owners fully invested in their business; they want them to have skin in the game, so they use minority shareholder rights.
• When funding practices, investors will not dictate how to pay physicians, but they will expect physicians to retain and reinvest their earnings into the practice.
• When considering their options, PE firms typically go for primary care practices rather than specialty ones, as the specialties are becoming more and more expensive. PE firms also want to work with owners who are ahead of the curve on value-based care and are implementing value-based and patient engagement solutions and processes (analytics, self-pay systems, patient portals, telemedicine), as that’s the way the market is heading (and that’s what PE investors are betting on).

Is Private Equity Right For Your Practice?

The European Private Equity & Venture Capital Association (EVCA) issued a special paper on private equity, which features a list of questions that business owners can ask themselves when considering whether private equity funding is right for them. These questions have been adapted for the issues that physicians and practice managers need to consider:

1. Are you prepared to take on or to continue to take on the responsibility of being an entrepreneur, i.e., to run your healthcare practice with a method and structures, to delegate responsibilities to your staff, motivate your staff, develop your knowledge outside of the business and bring that knowledge into your practice, and take on the legal responsibilities?

2. Are you prepared to give up part of your practice’s capital to a private investor?

3. Does your practice have a certain technological or competitive advantage that can be developed or exploited, e.g. telemedicine offerings, flexible office hours, patient portal, patient self-pay options, etc.?

4. Are you prepared to share and make strategic decisions with shareholders outside of your “inner circle”?

Private equity is probably not for you if you want to …

• Exploit the creativity and innovation of your team/internal staff.
• Sell part or all of your company.
• Change the size of your practice and take over one of your competitors.
• Start a practice.
• Liquidize some of your assets.

If you’re finding that private equity isn’t the best option for your practice, EVCA recommends that you consider self-financing or obtaining a loan from a creditor.

Ready to start the PE process? Follow the steps below!

The EVCA whitepaper outlines the general process that practices need to follow in order to get private equity funding. 

1. Write a business plan. This will be sent to various private equity firms that target healthcare practices. Investors will use this document to learn about your practice’s history and determine whether they can help you achieve your growth goals and make a profit. Since the business plan is a PE firm’s first point of contact with your business, you need to demonstrate how your practice is different from your competition. Main components of the business plan should include: history of your practice, management team, products and services, market analysis of your competitors, your market potential, cash flow projections, capital required, and exit possibilities that tell investors when and how they can exit from the investment.

2. Research private equity firms. Only send your business plan to firms that focus on healthcare (and even your medical specialty), and match your geographical focus, practice size, and investment stage. Visit the websites of your potential PE firms, speak to colleagues who know of them, and visit any open forums or websites of private equity firm associations. Once you narrow your list to 3-5 firms, EVCA recommends sending them “a summary of your business plan, keeping a more detailed plan for your first interviews.”

3. Interview, select, and negotiate with a PE firm. After receiving your business plan, some PE firms will want to set up a meeting or interview with you. In this stage, you will present your business plan in more detail and provide additional information that the investors request. This is the time in which you and the PE firm will decide whether a partnership will work and what the conditions of the deal will be.

4. Create a valuation of your practice. This stage involves you and the PE firm determining what your practice is worth.

5. Investor will send offer letter. After the practice valuation, your investor will send you a formal offer letter, which details the “aims of the operation, its structure, and the general conditions attached to the investor’s proposal subject to the outcome of the due diligence process,” says the EPVA whitepaper.

6. Perform due diligence. The investor typically calls in external consultants, such as lawyers, tax advisors, insurance experts, IT experts, and more, to determine what needs to change in the practice before making a final decision as to whether they will invest in your practice.

7. Final negotiations. During this stage, the transaction will be secured legally. Lawyers will draw up the legal documents, and you and the investors will sign.

To read the full EPVA whitepaper, go to: https://investeurope.eu/media/78722/guide-on-private-equity-and-venture-capital-2007.pdf.