What to Know Before Agreeing to a Private Equity Deal

An increasing number of physician practices are turning to private equity as a way to monetize. A global private equity report by Bain & Company published in 2019 found that the number of healthcare deals involving private equity increased by 48% from 2010 to 2017. During this period, the value of private equity deals (largely involving the acquisition of physician practices and hospitals) increased by 187% and reached $42.6 billion in 2017.

In the United States, 102 physician practices were acquired by private equity in 2017. According to Casalino and colleagues, many of these deals have been in specialties such as dermatology that are particularly attractive to private equity for their potential for additional revenues from elective procedures and ancillary services. But other specialty practices are increasingly joining with private equity (Ann Intern Med. 2019;170:114-115).

As private equity makes further inroads, those familiar with such deals advise physician practices to become familiar with and get counsel from experts on the many issues that could change their practice environment. Physician practices need a clear understanding of why private equity may be a good option and the issues to consider when weighing that decision.

How Private Equity Works

Private equity firms use capital from an array of funds, such as pension funds and university endowments, to invest in industries such as healthcare, according to Casalino and colleagues (Ann Intern Med. 2019;170:114-115). These firms anticipate an average return on investment of 20% or more. To achieve this, they typically buy large, well-managed (“platform”) practices with the aim of selling a practice within three to seven years of acquisition. Within that time period, they augment the value of the practice by acquiring and merging smaller practices within the platform practice, recruiting more physicians, increasing revenue, and decreasing costs. Revenue that private equity infuses into a practice allows for important business expansion, including expansion of ancillary revenues, spread of fixed costs, and increased negotiating leverage with insurers (Ann Intern Med. 2019;170:114-115).

When acquiring a practice, private equity firms base the price on EBITDA (earnings before interest, taxes, depreciation, and amortization) as a measure of the operating performance of the practice. Typically, they pay eight to 12 times EBITDA for a platform practice and two to four times EBITDA or less for a smaller practice. Upfront compensation for practice owners at the time of acquisition varies but can be as high as $2 million per physician, but afterward their compensation typically is based on market rate salaries. Although contracts are negotiable, 60% to 80% of the ownership of acquired practices typically transfer to the private equity firm (Ann Intern Med. 2019;170:114-115).

Why Choose Private Equity?

Physician practices may look to private equity for a number of reasons. Independent private practices may have a tough time recruiting physicians in an era of hospital consolidation and physician employment, said Gavin Setzen, MD. Or, Dr. Setzen said, large independent practices may have limited capital for continued development in growth and infrastructure, while smaller practices may be strapped because of increased regulatory burdens and reimbursement models that favor value-based payment. Other practice owners may be interested in private equity because they feel uncertainty about the future direction of healthcare policy and reimbursement, said Dr. Setzen, who is past president of the American Academy of Otolaryngology-Head and Neck Surgeons (AAO-HNS) and associate clinical professor of otolaryngology-head & neck surgery at Albany Medical Center. He also sees a shift to private equity due to the fact that fewer hospitals are acquiring physician practices and the reluctance of physician practices to partner with hospitals.

Private equity could put some money in their pocket that they could not otherwise get if they went with an internal buy out. —John Fanburg, Esq.

“In an era of reimbursement reform, with recent legislation that eliminates so-called site of service payment differential, the incentive for hospital systems to continue to acquire private practices will decline,” he said. “Personally, I believe that independent groups are increasingly pursuing private equity options over being acquired by hospital systems in order to maintain greater independence and autonomy while securing greater financial security in the private equity arena.”

Craig Kilgore, CMPE, president-elect of ASCENT, an association that provides resources for otolaryngology practices, said practice owners are expressing more interest in private equity as an investment option. The main reason he hears for this interest is the desire to monetize practices for retiring physician partners.

John Fanburg, Esq., an attorney with extensive experience in health and hospital law, said practices with senior physicians who plan on remaining in practice for only three to five more years are particularly interested in private equity deals. “Private equity could put some money in their pocket that they could not otherwise get if they went with an internal buy out,” he said. Practices that are trying to grow and are having trouble expanding may also benefit from private equity investment.

Fanburg emphasized that focusing on a good business reason for investing with private equity is the crucial first step. “When clients come to me and tell me they’ve been approached by a private equity firm to monetize their practice, they often come in with not very good reasons for considering private equity,” he said.

Once practice owners formulate a good business reason, they should work with experts to ensure that negotiations with the private equity firm deliver the kind of contract they want, he said. Along with a lawyer familiar with mergers and acquisitions (M&A), he advised working with an accountant who understands the business of healthcare as well as the many tax implications of these transactions. He also advised partnering with an investment banker to represent the group when pitching to a private equity firm, to ensure that the practice gets the best price. He emphasized, however, not to consult with an investment banker until owners are absolutely sure they want to sell. “Investment bankers only get paid when they close the deal,” he said. “They do add value, but if you’re on the fence, don’t hire the investment banker yet, because they’ll convince you to sell whether you are ready or not.”

Maximize Value While Prioritizing Patient Care

According to Dr. Setzen, a favorable private equity partnership should provide for physician leadership and maximum value to physicians and shareholders. How do otolaryngology practices ensure they receive maximum value to their practices while remaining focused on patients?

Embedded in this simple question is a complex web of issues that physician practices need to consider when looking at private equity as an investment strategy. Physicians need to weigh various factors that govern a practice: revenue and costs, management, and operations, including who gets to decide key issues such as hiring employees and buying new equipment.

“When considering a private equity deal, favorable terms include significant cash at close, no claw-back provisions, no contingency clause, and no benchmarks, with physicians maintaining control of daily clinical decisions,” Dr. Setzen said.

To remain focused on patients, physicians need to ensure that services prioritize patients and not a financial bottom line.

“The otolaryngologist must consider, above all, whether there will be any potential negative impacts on patient care and professional behavior that cannot be tolerated,” said G. Richard Holt, MD, MSE, MPH, MABE, DBE, professor emeritus and clinical professor of otolaryngology-head and neck surgery and a faculty member of the Center for Medical Humanities and Ethics at the University of Texas Health Science Center. “Once patient care and physician autonomy are compromised, even a little, the slope becomes steeper and more slippery.”

Dr. Holt listed three main ethical concerns physician practices should consider when selling to private equity:

• Ensure that patient care is not compromised by continuing to provide excellent medical and surgical care in a caring and compassionate environment.
• Ensure that physicians do not subjugate their practice model to that of private equity business by practices that may jeopardize the patient-physician relationship.
• Ensure that physicians adhere to the ethical responsibility to their patients, which is a greater sacred obligation than a business has to its clients.

Of these, he said that patient care ethics is the foremost consideration.

Recent reports show that the advances private equity has made into dermatology have resulted in practices placing profitability over patient care. A 2019 study by Tan and colleagues reported on the steady increase in private equity acquisition of dermatology practices since 2012, from five acquisitions in 2012 to 59 in 2017 and another 34 during the first half of 2018 (JAMA Dermatol. 2019;155:1013-1021). The report highlights the need to assess how private equity is influencing the practice of dermatology, from clinical decision-making to patient outcomes. In 2018, Resneck (JAMA Dermatol. 2018;154:13-14) reported on concerns expressed by dermatologists under private equity ownership. Specific issues reported included feeling pressure to sell skin products, referring patients to affiliated specialists, upcharging in billing offices, and reliance on unsupervised physician assistants that could potentially compromise patient safety.

The otolaryngologist must consider, above all, whether there will be any potential negative impacts on patient care and professional behavior that cannot be tolerated. —G. Richard Holt, MD

“The buyers will say patient care is the return on investment, but I’m not so sure private equity in medicine is a good thing,” Fanburg said. “I think the jury is still out, and this needs to be analyzed and scrutinized as private equity proliferates in the healthcare field.”

Given the complexity of these arrangements, Dr. Holt emphasized that, along with the advisors mentioned above by Fanburg, otolaryngologists should seek counsel from someone with knowledge about the potential threats to patient care and professional ethics.

Dr. Setzen agreed. “I think it is important that the practice also performs a thorough evaluation of the private equity firm with whom they are considering partnering in order to make sure that the culture, history, and business practices of the firm are sound and ethical,” he said.

For otolaryngology practices, whether or not private equity investment will be a good model to follow is unknown. “This is pretty new to the ENT space, and I don’t know if we have enough experience with private equity in ENT to really know how it will work,” said Kilgore. “Time will tell what kind of success it will have in ENT practices.”

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Mary Beth Nierengarten is a freelance medical writer based in Minnesota.