Private Equity: Who’s the Doctor Here?
One of the hottest tickets in town for private equity investors? Your medical practice. Private equity firms are making offers that physicians find hard to refuse. A huge influx of capital, along with regulatory management and relief from administrative tasks.
That’s the pitch from private equity firms to doctors – you take care of patients, we do the rest.
If that sounds too good to be true, ask yourself why.
It’s extremely rare – as in never – for private equity investors to be passive partners. Private equity firms invest in companies with potential. When they come into your practice, their goal is to increase the ROI.
They take charge of day to day operations – supposedly the back office they say. Then you find yourself needing to meet quotas. They measure how long it takes to answer the phone. They look at the percentage of salary to revenue.
If you could slip in one more consultation a day. Couldn’t we schedule a few more tests? There’s money left on the table, the finance guys say. Do more, bill more.
Who’s the doctor here?
What is Private Equity?
Private equity is the investment of capital in a business that isn’t publicly traded. These investments come from wealthy individuals or private equity firms. They buy equity (i.e. ownership) in private companies.
The goal is return on investment (ROI.) The investors gain sufficient ownership to manage day to day operations. They push for operational efficiencies and increased revenue generation. Venture capitalists are private equity investors.
Private equity firms focus on shareholder value. They are experts in finance, not healthcare. But trends show that medical practices are an emerging market for private equity firms. The other piece of
The Fine Print
When a firm invests in your practice, they own some percentage of your company. The structure of the deal defines the parameters of the relationship. The first step is a valuation of your practice.
Medical Practice Valuation
Investors want to know what your practice is worth. There are different ways to assess it. The variables include:
- Business structure: LLC or S-Corp
- Specialty: Cardiology vs Primary Care
- Equipment: Medical devices
- Profitability: Annual revenue
A simple way to determine value is to multiply annual revenue by 1.5%. This is easy but probably not as accurate as you need. A comparison of similar sale prices for practices in the same location will give you an estimate, but not the detail and investor would want to see.
The specialty of the practice carries quite a bit of weight. A gynecologist has a higher income potential than family medicine. Medical devices are high priced assets outside of standard business equipment. Use this calculator to estimate market value for used equipment by specialty.
Most physicians aren’t MBAs – this is a big financial decision. If you’re not sure how to proceed, hire a professional to do the valuation. Choose a firm that has experience in medical practice valuations.
There are two options for private equity investments.
Equity investing is the investor provides capital (equity) to your practice. In return, they own a percentage of the company based on the valuation of the business. If your practice is valued at $3 million and the investor puts in $300,000 – they own 10% of the company. They get 10% of the profits but also take the hit for 10% of any losses. The bigger their investment, the more of the company they own.
Debt investment when a private equity investor provides your practice with a loan. The investor makes money from interest and expects full repayment of the principle. Sometimes the loan is funded with bonds. This investor has no ownership in the company, so no profit or loss apply. Debt investment is less risky in the event of a business failure. If the practice goes bankrupt, debt investors go to the front of the line.
Profit & Pitfalls
Both provide capital to your practice. Both have some pitfalls to avoid.
Equity investors tend to be looking for businesses to build up and sell-off. If that’s not your plan, pay attention to the percentages. Note –a leveraged buyout can be a good thing if you’re looking to retire or leave your practice.
One of the ways a debt investor can protect their interest is by putting a mortgage lien on your business property or assets. If you’re delinquent on your loan payments, they can foreclose on your property. Not a good look for a medical group.
How you engage with investors is up to you and your partners – no one size fits all. Due diligence is essential. The AMA has a contractual guide that walks through key legal points.
What to Expect if You Accept
For some smaller practices, private equity investments can seem like a godsend. They want to grow their business and need capital to make that happen. There is nothing wrong with considering those offers. But you need to understand what you’re getting into.
Too many physicians put themselves at risk. As an MD with an MBA, it’s why this site was started. The private equity firms will spin their pitch – you need to hear both sides.
When you accept private equity, you’ve got new partners. Those partners are now in control of your practice – they create a new corporate entity. Though someone in your practice may get a seat on the board, understand you’re no longer a decision-maker. At best you’re a minority owner. At worst, an employee.
Private equity firms are in business to make money for their shareholders. They aren’t investing in your practice per se – they’re preparing to put it up for sale. There will be directives on achieving operating efficiencies and increasing revenue. They expect the employees (that’s you) to get on board.
When the private equity firm sells your practice, you have no say in the matter. The most likely buyers will be hospitals or corporate healthcare systems. If you hoped investment meant support for a stand-alone practice – prepare yourself.
Owning the Market
A strategy private equity firms like is to control the market. They identify a geographic area and target investments to a specific practice type – primary care, internal medicine. Primary care practices are becoming increasingly more attractive. They hold risk-based contracts with third-party payers.
When investors gain ownership in 10 or more primary care practices in one market, they control the patient population. This gives them leverage to negotiate rates with the third-party payers.
Another method is investing in a “platform” practice. These are successful physicians who are highly successful. They own the market for their specialty, with multiple locations and significant revenue. Investment firms go to medical conferences and talk to attendees to develop leads. Once they invest new services are added. Or they combine the practice with another investment property.
You should also expect a change in your income. Private equity investors compare regional salaries to what the practice has been paying. It’s common for physicians to receive a salary cut of up to 30%. The justification is that managing the business is no longer part of the job description.
On average, private equity firms want fully-loaded salaries to be less than 56% of annual revenue. Fully-loaded includes your benefit package. It affects doctors, nurse practitioners, RNs, LPNs, and administrative staff. The salary issue can have a negative effect on recruiting new physicians.
What types of changes should you expect when private equity investors become business managers? Every decision is data-driven. Financial experts like data – especially in terms of how it relates to increasing revenue. That becomes the primary focus.
Expect a strong look at DSO’s (Days Outstanding Sales) and a concerted effort to shorten that timeline. Patient collections may become more aggressive. The metric to meet is 90% – anything lower will be addressed by investors.
The Claim Denial Rate is another metric under inspection. According to the American Academy of Family Physicians, the average rate is 5 to 10%. Most practices work with multiple players. That increases the complexity of improving the acceptance of claims.
Expect an increased use of technology. EHR systems get updated or replaced with a new application. Digital scheduling is a must. Nurses may conduct intake sessions online prior to an office visit. This frees up time to schedule consultations and treatments.
None of these improvements are bad, but they can be disruptive to your staff and your patients.
Quality of Care
Concerns about the corporate overtake of the medical community are rising.
To be fair, investment can sometimes improve access to care. They enable smaller practices to hire doctors, add or update medical equipment and digitize their systems.
But there is little alignment between the priorities of patient care and private equity.
Doctors have raised concerns about some of the operational changes. They find themselves running ragged trying to meet goals. There are ethical concerns about pushing business to other investment owned entities. They want you to recommend certain products. They encourage the use of certain labs and specialists, even if it’s more costly for the patient.
There have been no studies on the convergence of private equity and quality of care. More research is needed.
Value based Purchasing as Catalyst
Healthcare finance reform is moving away from Fee for Service (FFS) to Value Based Purchasing (VBP.) VBP is much more than a change in pricing – it transforms the current service delivery model.
FFS is based on the number of services a physician provides. VBP charges on the quality of care, as measured by patient outcomes. It prioritizes teamwork, encourages interactions between healthcare professionals. It includes an entirely new billing structure.
VBP is an opportunity for private equity investors to engage with medical practices. They offer capital to support the changes in process, workflow, technology, and training. A practice that serves patients in a Medicare Advantage Plan needs to make the shift.
Remember the growing interest in primary care? It’s the first point of entry into the healthcare system for most patients. It’s also where Medicare Advantage patients receive the majority of their services.
The expectation is that VBP will reduce the cost of health care. The model helps to eliminate waste and low quality of care. But the transition from an FFS model can leave medical practices cash poor. That opens a door for private equity firms to make their pitch.
Pros & Cons
Good decisions are based on due diligence. The pros and cons are part of the homework.
- Large influx of capital
- Regulatory management
- Risk mitigation
- Upgrades in technology
- Increase in collections
- Handles business administration
- Minority owner
- No decision-making authority
- Salary cuts
- Ethical concerns on referrals
- Profit versus quality of care.
- Practice sold in 3 to 7 years
Is Private Equity Investment Right for Your Practice?
Much of that depends on what you’re willing to give up to get it.
For smaller medical groups with no other opportunities to grow, it may be a smart choice. Keep in mind they’re investing in your practice so they can sell it later. Make sure you read the fine print and negotiate to have some involvement in the resale.
For a large and successful practice, the rationale is less clear. It’s easy to see the benefit for the private equity firm but not as much from the medical side. When you’re doing well, there are other sources of capital to access. It’s not necessary to give up control of your business.
There are more profits to be made from accepting investor money. Private equity firms expect to make a 20% return on investment. Anyone looking to retire or get out can make some money before they go.
Here’s what we’ll tell you. If finance isn’t your thing, pitfalls abound. If you don’t know what you’re doing – don’t do it alone.
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