If you’re a physician practicing in the United States, chances are you’ve heard something about private equity. This may be during your job search, because a private equity group has approached your group about the potential for a buyout, or because private equity groups are changing the landscape of the field of medicine that you practice.
Over the past few decades, the role of private equity in healthcare has dramatically expanded. While many practicing physicians are not a fan of this trend (and have good reason for concern both for their patients and their careers), it’s necessary to understand the overall concepts so that you can put these discussions in context. This series within our blog is going to explore private equity, practice valuations, terminology to know, and how to evaluate offers to be bought out or partially owned by a private equity group. We'll start with a primer giving a high level overview on private equity involvement in the ownership of physician medical practices.
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What is Private Equity (PE)?
Private equity firms are first and foremost investment companies that are focused on returns for their investors. While they may focus in the healthcare space, they are not healthcare companies. This is not intended to make a blanket statement about whether private equity companies care about patient care, but rather to note that it is important to keep this in mind when understanding what their goals are going to be, and whether you are comfortable with private equity involvement in the healthcare space. In general, private equity firms don’t invest in ideas, but in mature companies that they feel they can optimize and expand revenue from, with the ultimate goal of then re-selling the asset with terms that are favorable to their investors in a short period of time (usually 3-5 years, but can vary).
How Is This the Same or Different Than Venture Capital (VC)?
Both private equity and venture capital companies are interested in either buying or investing in physician practices, and in many ways are similar in concept. They are each looking to infuse capital into private practices, optimize and expand operations and/or increase the scalability of a profitable practice model, and ultimately sell the asset for a return on investment for their investors. However, there are key differences. PE firms tend to want a quicker turnaround time and are going to be much more focused on the existing financials, and in general will take less risk. VC firms tend to play the long game and ‘go for the moon,’ taking the approach of investing in many companies with hopes that a few of them will be very profitable. They may invest in novel ideas that have not yet achieved proof of concept, whereas PE will not generally invest in practices unless they see a tried and true pathway to profit.
What Is the Value Proposition of Private Equity to Private Practices? Why Do Physicians Agree To Sell Their Practices To Private Equity?
Based on the experiences of members of our physician communities who have sold to private equity, the major selling points that attract physician practices towards private equity tend to be one of three things.
The first is the ability to scale a practice quickly and on someone else’s dime/risk.
PE groups will often see a practice which is already doing well, and recognize that there are either opportunities to optimize operations or actually build upon a practice’s existing success. Private equity can take an existing group and infuse a large amount of capital towards investing in the infrastructure of the practice, renovating the practices to make them more modern or buying new technology, opening new locations or acquiring other practices to operate under the same model, or hire lots of new practitioners (usually physicians as well as other healthcare professionals) at a rate that would be far too risky for a private practice operating as a small business to be comfortable with. Other ways they may do this are by trying to improve the patient experience or improve the efficiency of workflow within a practice by implementing new technology that patients enjoy or that eliminates the need for some work that practices typically do by hand. They may also increase the number of ancillary income streams the practice has by doing things such as adding additional revenue lines that are tangential but tie in well with the practice’s referral patterns or building more ambulatory surgery centers (ASCs). These are all things that can be done well by private practices by themselves, but that they may not have the capital or risk tolerance to do all at once, and therefore, many private practices become attracted to this proposition.
The second reason physicians may find this attractive is because they are frustrated with navigating the challenges of running a private practice in today’s healthcare environment.
This may be related to increasing overhead, increasing administrative burden, decreasing reimbursements, or a desire to simply practice medicine without having to stay abreast of all the challenges of staying profitable as a small business. PE groups will propose that practices will benefit from the power of sharing resources with other similar groups and decreasing overhead costs. They will also offer to take over the administrative tasks of the groups, such as payer contracting and credentialing, accounting, compliance with regulatory guidelines, chart management, and revenue cycle management.
The third, quite honestly, is the amount of money that is offered to the private practices for selling a portion of or their entire practice.
These deals can be quite lucrative for physicians who are looking to take some chips off the table and get some ROI for their years of work building the practice. This is particularly true for physicians at later stages of their careers who are thinking about ways to sell their practices and have a larger buyout than they may compared to traditional practice sales, which are usually based on hard assets and don’t usually offer a large goodwill component, but can also be true for burnt out physicians who are skeptical about future earnings in medicine based on the never ending threats to physician compensation in our healthcare system as a whole.
Why Should Physicians be Wary of Selling Their Practices to Private Equity?
Before getting into the ideological and long term concerns (of which there are several), let’s focus on the immediate downsides for a practice that decides to sell to private equity.
First, you will likely give up some or all autonomy and control of your practice, which may interfere with your day to day happiness and professional goals, or which may cause internal conflict about your mission as a physician focused on offering the best possible quality of care for your patients.
While the degree to which you give up control will vary based on the terms of the sale, which we discuss separately in another article, regardless of whether you sell a minority stake in the company, a majority stake, or sell the practice outright, you now have another entity that has a say in how you do things. Some PE companies will want to take over control of operations altogether, whereas others will simply offer you access to resources they have already achieved some scale with or help guide you with the future direction of the company in regards to both daily operations and growth. It will all depend on your exact agreement, but know that you now have an obligation to the PE shareholders to get a return on investment.
Per several of our physician members, this means that they may have to implement practice policies that prioritize profits, even if these practices are not ones that the physician leadership would’ve normally wanted to implement. Some examples may be the use of non-physician practitioners to handle cases the physicians would prefer to manage or worry that the non-physician practitioner may not be the best person to handle, stricter billing practices, or the addition of revenue streams that not all physicians in the practice agree are scientifically based. As we know, while physicians do need to be profitable in order to stay afloat, physicians often make decisions that aren’t the most financially savvy because they believe it’s in the best interest of their patients or quality patient care, and many of us become very uncomfortable with efforts that are in conflict with our inherent mission and altruism as physicians.
Second, based on the experience of our members, while you will get an upfront infusion of capital in the form of a partial or complete buyout of your ownership stake in the practice, you will almost definitely take a cut in your guaranteed compensation as a physician going forward in terms of salary.
The PE company will want your future payoffs as a shareholder to be driven by growth of the company, so they will structure your incentives accordingly either in the form of shares for the new company where you as a shareholder benefit from the increase in valuation of the company based on expansion of the practice or growth in overall company revenue.
This is generally why this is a great deal for older physicians in later stages of their career (the “golden parachute,” where they get a large upfront payment and don’t need to worry as much about the opportunity cost of lower future earnings as a physician). This is also why physicians with several decades left in their career should pause, because they will have many years of decreased earnings as a physician, which may not be offset by the upfront balloon payment and which may not be worth it if their future ownership stake in the company doesn’t turn out to be as profitable as they were led to believe. For example, their shares in the company may not have as much worth later if the practice doesn’t increase significantly in valuation or if they are not able to find a buyer to purchase the practice at the desired valuation at the time the PE company decides they want to sell.
Third (and this is a big one) is the consideration of what private equity owned healthcare does to the quality of healthcare on a societal level, as well as the overall implications on our profession.
As alluded to in the first reason in this section, the private equity groups are going to make decisions that benefit their shareholders. Whether we as physicians agree with it or not, that is their job. This obligation to the shareholders often comes into conflict with our role as physicians who are ethically and personally programmed to place patient care above all else, even if it means that we make less money. While cost cutting measures increase profits, they can come at the expense of the quality of care delivered and the humanity involved in practicing medicine. Most physicians are not willing to make these sacrifices, and feel very uncomfortable with the constant reminder that their job is also to make money. We are one of the few professions that has in the past been fortunate to make a great living while also staying true to our moral obligations and enjoying the practice of and science behind medicine.
Additionally, in order to increase profits, these companies are highly incentivized to target their largest expense - labor. Physicians are expensive to hire, and they will push to decrease salaries and replace physician labor wherever they can. The net result of this in specialties where private equity has already taken over a large share of the market is that physician salaries have been driven down significantly and the value of physician expertise downplayed, often to the detriment of the patient experience and quality of care. Because of this, there are many physicians that understandably believe private equity has no place in healthcare, and that we have a moral obligation to not accept these deals, no matter how lucrative they may be in the short term.
How Do Private Equity Companies Buy Practices?
We have a much more detailed article on this, but essentially what will happen for most practices at the beginning is that you will be sought out by a private equity company that has set their sights on you as a potentially profitable or strategic investment. In some cases, private practices will actively seek out private equity buyers because they know their current model isn’t working for them or because they are looking to exit their practices.
At this point, the two parties will have some preliminary discussions about the goals and vision each party has. If felt to be mutually beneficial, the PE company will then determine a market-based valuation of the practice, which will take into consideration factors such as how much revenue the practice generates and how much potential growth/optimization of revenue they see in their desired timeframe before reselling the practice in the future.
They will then usually make an offer based on this. Often, this offer is based on a multiple of the practice’s existing revenue, referred to as EBITDA (Earnings Before Interest, Taxes, Debt, and Amortization). When people ask what multiple that other practices got, they are usually referring to this number. This can be structured as a one time payment or be spread out based on the achievement of specific benchmarks or increases in valuation. There is often a component where the physicians receive shares in the new entity, in order to provide them with the incentive to stick around and ensure a smooth transition as well as encourage them to continue to work hard, as they now have a carrot to increase the valuation of the shares since they will also benefit from the future resale of the practice.
Conclusion
While there is much more to learn about private equity as it pertains to physician practices, this article is intended to introduce you to the concept of private equity and the pros and cons that physicians approached by private equity groups often consider before entertaining the idea of the sale. Our other articles in this series get into the nitty gritty of how practices are valued, evaluating an offer to be purchased by private equity, and contractual terms that you should be aware of.