Conclusions Regarding Private Equity Deals

CRITICAL CHARACTERISTICS OF PE-BACKED FIRMS AND HEALTHCARE ENTITY AFFILIATION

The three significant areas of consideration with all affiliation deals are structure, economics, and governance. No matter the parties involved, these three areas must be considered for a healthcare entity transaction. As to PE-backed firms, the specificities of structure, economics, and governance differ from when healthcare providers such as medical practices align with healthcare systems to include hospitals and related entities. Nevertheless, similarities abound.

Still, some fundamental differences exist between PE-firm-backed transactions and healthcare providers. We have presented and discussed these differences in earlier chapters but delineate the vital aspects as we summarize this book.

Key Similarities

As we consider the similarities between PE and other healthcare entity affiliations, there are some notable points of common ground. These include:

1. Mutual emphasis on continuing to maintain quality care.

2. Motivation for realizing a profit margin and return on investment (ROI).

3. Desire for ancillary services development and/or growth and resultant ROI.

4. Accurate and compliant valuation and/or quality of earnings (QofE) economic foundations.

5. Desire for cost and volume efficiency.

6. Emphasis on growth and expansion after transaction.

7. Necessity of retaining providers and probability of recruiting additional providers.

8. Compensation of providers, both competitive and realistic.

Key Differences

Along with the similarities, there are several key differences between typical PE transactions and other forms of affiliation among healthcare providers. These include:

1. Valuation derived accurately via a market approach as opposed to cost or income approaches. Additionally, the derivation is usually through a QofE analysis, not a valuation or appraisal, per se.

2. Post-transaction compensation that entails the income scrape used to derive EBITDA.

3. Shorter-term affiliation, meaning inevitably, the PE firm will undergo a recapitalization in approximately five years.

4. Future affiliation that is short, not inherently long-term, nor is it intended as such.

5. Physicians as investors, including investing in rollover equity.

6. Varied benefits post-transaction, including those for the providers.

7. Support via a management services organization (MSO) entity.

8. Recruitment and retention applied with a shorter-term goal.

9. All assets of affiliation aimed at a short-term relationship.

10. Not especially concerned about a continuum of care outside its services.

Next, let us review some of the key components of the three major areas of getting a PE-backed firm deal completed with a healthcare entity.

ECONOMICS

The economics of PE deals entail several key concepts and terms. Several buzzwords are:

• Income scrape. This is a reduction of physician compensation to create earnings on which a multiple is applied to derive the upfront dollars paid by a PE-backed deal.

• Income repair. This includes efforts to offset the income reductions through increased cost efficiencies, managed care contracting, reimbursement improvements, etc.

• EBITDA. The earnings on which the healthcare entity’s value is based are largely attributable to that valuation or QofE process.

• Rollover equity. Unlike other healthcare provider transactions, PE almost always requires reinvestment in a new company called Newco. The Newco is part of what would otherwise be the proceeds from the sale of the practice/healthcare entity.

• Second bite of the apple. This process is the recapitalization that inevitably occurs when the PE firm chooses to sell its interest. That second bite is a result of the recapitalization and hopefully a second closing of some value to the physicians or other healthcare entity investors.

• Multiples. These equivocate to market rates to derive the total value when multiplied by EBITDA. The multiples can vary based on the QofE analysis and market conditions, even the specialty and type of healthcare entity under consideration. For example, an ASC may call for a higher multiple than the practice alone.

• Platform. The platform is the practice formed by the PE transaction that entails the basis upon which the private entity will complete additional merger and acquisition (M&A) work to build around that foundational practice entity.

• IOI and LOI. In addition, the indication of interest (IOI) and letter of intent (LOI) are tools used to expound upon the PE entity’s initial offers to acquire the healthcare entity. While not legally binding, they are expected to be the basis on which a deal is finalized.

Excerpted from Private Equity and Healthcare: Leadership, Economics, and Trends for the Future (American Association for Physician Leadership, 2024).