A focus on the acquisition of physician practices by private equity investors

Global and National Private Equity Deals

Private equity in healthcare is a huge billion dollar market, both globally and in North America.  As financial and legal professionals providing services to health care providers and health care related companies, it is important for us to have an understanding of the scope of this market, the positive and negative aspects of private equity, how deals are made, and more.  As a valuation professional for twenty-four years with a focus in healthcare, I have been approached many times to consult on private equity offers and to assist in physicians’ decisions as to whether or not to accept these deals.

Globally, the private equity market was $63.1 billion in 2018, with 316 large deals made.  North America is the most active region, and deals were valued at $29.6 billion in North America with 149 large deals.  Deal activity was most active in the following sectors: behavioral health, retail health (clinics in a retail setting such as Walmart), physician practice management, home care and hospice, provider-focused healthcare IT (electronic medical records), biopharma and medical technology companies. 

There is significant competition for good healthcare companies, which has led to very high purchase prices for these companies.  Quite often to finance large deals, private equity will team up with corporate partners to have enough financing.

Private Equity Platform and Add On Practices

Private equity companies typically are looking first for a platform business, which is large enough to provide the base business in a certain market (like a very large medical practice in one specialty or multi-specialty).  After the purchase of the platform company, the private equity company will establish a management team, and then acquire add on businesses to obtain scale.  For example, private equity will acquire a large ophthalmology practice, possibly with a surgery center, and then they will add on small ophthalmology practices in order to gain market share and obtain more efficiencies.  Typically, private equity investors are only looking to be invested in a venture for five to seven years (sometimes longer) before they will sell the business they have created.  The expectation is to then obtain a premium purchase price from another private equity or corporate investor.  Thus, a private equity investor only has a limited time horizon in the investment before they are looking to sell. 

Private equity investments in healthcare are considered recession resistant as healthcare investments have historically performed better in a recession than non-healthcare investments. 

Many accountants, appraisers, and lawyers have physicians as clients.  Several medical specialties are very desirable right now for private equity investments.  These include the following specialties in medicine: ophthalmology, dermatology, radiology, ortho-spine, urology, and gastrointestinal medicine.  Dental practices are also highly desirable.  

Earnings Before Interest Taxes Depreciation and Amortization (EBITDA”)

Many private equity deals are based on a financial profit measure called EBITDA, which is an acronym for “Earnings Before Interest Taxes Depreciation and Amortization.”  EBITDA is considered a good proxy for a Company’s cash flow.  EBITDA is financial profit before a deduction for interest expense, before income taxes, and before deducting depreciation and amortization expense (the latter are expenses that are not actual outflows of cash).  All private equity investors are concerned with a company’s EBITDA and cash flow.

A private equity purchase will typically reflect a “multiple” of EBITDA, or a number times EBITDA (for example - five times EBITDA).  A private equity deal will typically reflect a higher multiple (higher number) of “EBITDA” than a purchase from another physician.  For a platform purchase of a large physician group, the multiple of EBITDA might be as high as eight to twelve times EBITDA.  For an add on purchase by private equity, the multiple of EBITDA might be four to six times EBITDA (using EBITDA after physician compensation is deducted).   If one physician is buying out another physician, the purchase price will be a lower multiple of EBITDA.  It should be noted that it is not only the multiple of EBITDA that matters in assessing a deal, but the compensation reduction required by the physician(s) going forward after the deal.  This is a critical component of the financial assessment of the deal.  I have seen proposed deals that offer a good purchase price, but the reduction in physician compensation going forward is too high and significantly reduces the value of the deal.

Regarding physician practices, the private equity company is looking to take some of the practice’s EBITDA as a return to the private equity investors (a profit for the private equity investors).  This in turn reduces the physicians’ compensation.  In almost all cases this means a reduction to a physician’s compensation when he or she enters into a private equity deal.  Thus, the buy-out price for the practice must offset the physicians’ compensation reduction.

Financial Considerations with Private Equity

It is essential that the physician(s) analyze the private equity package being offered to make sure it makes financial sense.  If a physician is looking to retire, within a few years, then a private equity buy-out could be the right decision.  However, if a physician still has a long work horizon ahead, then it may not be the right decision because of the compensation reduction.  I have personally seen offers of up to a 50% reduction in income which did not make financial sense, and the physician did not accept the offer, despite a purchase price for the practice that seemed reasonable.  This physician was also told that he could acquire stock in the new entity being formed, and that this stock could provide a significant pay out when the private equity group sells to another investor.  But there is always inherent risk as to whether the next buy-out will occur and at what price. 

The issue of young physicians versus older physicians has been a concern in private equity deal making, because the younger partner physicians do not want to accept lower compensation for a long time period, thus the younger physicians prevent the deal from going forward.

The Current Growth In Private Equity Deals

Right now is considered an optimal time to be a part of a private equity deal and possibly for the next one or two years, prior to a recession.  There are several factors that are fueling the growth for private equity deals.  First, there are many physician baby boomers who are in their late 50s and early 60s who are interested in monetizing their practices.  Private equity buyers pay a premium purchase price as compared to non-private equity buyers. (However, the physician must still consider the physician compensation reduction required by a private equity buyer versus a physician to physician purchase which may require no compensation or a minimal compensation reduction for the selling physician.)  Capital has also been readily available to private equity investors to invest in health care companies.  Additionally, there is a tax benefit of capital gains rates applicable to any gain on sale of a practice versus ordinary income tax rates applicable to physician income.

Some other benefits of a private equity investment are non-physicians in the practice, such as the CFO of the practice or head administrator can also receive equity in the new venture.  Private equity can assist with capital expenditures desired by the practice and can relieve physicians of having to use their own funds to finance capital expenditures for the practice.  Private equity investors are typically hands- off in terms of the daily management of the practice, but they can assist in helping to make difficult decisions that physicians may not want to make (such as staffing decisions, etc.).

Risks to Private Equity Investors

Private equity does have certain risks in these investments.  Physicians typically receive the purchase price of their practice at inception regardless of the success of the acquisition.  If the acquisition fails, physicians can possibly buy back the practice at a discount.  Physicians may lose motivation after a deal reducing productivity and profits (which happened in the 1990s when a similar consolidation of practices was occurring).  Potential disruptions to private equity are a recession which would reduce available capital for investment and a change to a single payer system, which would likely change the reimbursements to practices. 

Private equity investors have a limited time frame of investment, ranging from three to seven years typically, and in some rare cases, longer.  The goal of private equity investors is to create a successful company, and then resell the company to another private equity investor or public company.  If a physician becomes a stock owner in the private equity venture, he or she may see an increase in his value of stock when the second deal occurs.  Additionally, after the second deal, typically physician practice operations are not affected and it is usually a seamless transition.  Additionally, sometimes better C-suite executives are brought in to run the larger organization.

Important Considerations before Doing a Private Equity Deal

As an advisor to health care providers who are being approached by private equity investors, there are certain criteria that are important to consider:

  1. The private equity investor should have a history of treating acquired practices well, including physicians and staff.  Positive references from other physicians that have sold their practices is very important.
  2. The deal for younger physicians is a good deal for them in order to keep them working in the practice.
  3. The purchase price at the beginning is high enough that if the physician isn’t happy he or she can leave after the contract period and feel that his or her retirement is not in any jeopardy and they can comfortably live.
  4. The physician or group should meet with different private equity investors to compare different investors and offers, in order to get the best overall offer.

I have personally seen good offers and bad offers.  A careful financial analysis, as well as other considerations of non-financial issues, is very important before making the decision to join a private equity group.  Physicians have spent a long time developing their practices, reputations, and well-run offices.  It is imperative that the physicians receive a good purchase price and reasonable compensation offer that leaves only a minimal level of risk to the physician(s) should he or she accept the offer.