Arguments in favor of private equity investment in healthcare make sense. Advocates contend that private equity groups have the necessary business expertise and the capital to eliminate waste and fragmentation, fuel innovation, improve quality, and generate substantial returns for providers and investors in a relatively short time frame.
Then there are others who claim that private investment is usurping healthcare, and that private investors’ dogged pursuit of profits can relegate patients to second place and push competitors out of the marketplace.
Kaiser Health News, for example, reports that private acquisitions in healthcare often fly under the radar of federal regulators and that this lack of scrutiny and private equity’s inherent focus on returns raise questions about quality shortcuts and rising costs.
A study by health economists from Johns Hopkins University and others in the Sept. 2, 2022, issue of JAMA found that within a large, commercially insured population, private equity acquisitions of physician practices were associated with increased spending and utilization.
Another study of private equity hospital acquisitions between 2005 and 2014 that appeared in the April 2022 issue of Health Affairs showed a reduction in costs per adjusted discharge but an increase in operating margins.
So, which is it then?
Experts say the reality lies somewhere in between. Indeed, there are bad actors in private equity.
But there are also plenty of private equity firms that appreciate the unique complexities of healthcare, believe in value-based care and population health management, and hold values squarely aligned with healthcare’s Quadruple Aim. Through deals such as these, they say private equity in healthcare can drive progress and benefit all players.
What to Look for in a Partner
That’s why healthcare organizations considering entering into an agreement with a private equity firm must first do the careful work of analyzing the firm’s goals beyond the acquisition and the infusion of capital, according to Scott Ransom, DO, FACHE, partner, Health & Life Sciences Advisory, Oliver Wyman.
“What is their character, culture and value proposition? Is there something about their unique experience and expertise that’s going to make your business better or align better with other healthcare ecosystem stakeholders?” he says. “If they’re all about quality and efficiency and your incentives are aligned, that can be a very good thing. If they’re all about the money without regard for value, that can be a problem.”
Physician entrepreneur, consultant and gastroenterologist Rajiv Sharma, MD, believes the issue is less about how the healthcare organization is owned than it is about the quality and nature of the partnership. Sharma was the sole proprietor of his corporation, Digestive Health Associates, Terra Haute, Ind., for five years before selling it to private equity in late 2021.
“Any health entity that preserves the value and trust of the doctor-patient relationship has my respect, whether it’s corporate, nonprofit or private equity owned,” he says. “The difference is that if an independent medical group wants to open 10 clinics and scale for their personal success, only private equity can make that happen.” This is why Sharma argues that a wisely structured private equity deal can be “rocket fuel” for a practice.
Healthcare private equity’s outlook remains promising even in the aftermath of the pandemic and recent economic downturn, so it behooves healthcare professionals to learn the pros and cons of a force that will influence the sector for a long time.
The Present Situation
Private investment has entered virtually every area of healthcare, from hospitals and health systems, ambulatory surgery centers, imaging centers, medical practices and specialty groups to medical devices, pharmaceuticals and biotechnology, healthcare technology systems, billing, coding, staffing and, more recently, consulting and value-based care.
“There will always be a drive for private equity because healthcare is a $4 trillion per year pie,” says Alan S. Kaplan, MD, FACHE, CEO of UW Health, the nonprofit, integrated health system of the University of Wisconsin-Madison. “It’s 20% of the GDP. As long as there is that much money in healthcare, there will be people interested in investing.”
In 2021, $151 billion of private equity capital entered the healthcare sector globally—more than double the amount in 2020—representing 515 deals, according to a report by Bain & Company.
A more recent Oliver Wyman analysis reports a “shifting landscape” in healthcare private equity in 2022, with the number of deals in the first half of the year declining 23% from 2021. Invested capital in 2022 exceeded 2021 levels for the first and second quarters of the year, but that was due to a single deal, a $17 billion buyout of a health services company. Still, even with the potentially chilling effect of inflation, fears of a recession and other economic factors, the firm says opportunities remain for investors who approach their partnerships strategically.
The opportunities to tackle healthcare inefficiencies and improve quality; boost provider negotiating power with payers, suppliers and pharmaceutical companies through consolidation while enhancing value; and improve consumer satisfaction with healthcare delivery are private equity’s “sweet spot,” says Ransom. Though investors moved more cautiously in 2022, healthcare remains the fastest-growing sector for private investment, he says.
Long-term trends, including the increase in chronic disease prevalence with the aging baby boomer population and the many healthcare subsectors that are ripe for consolidation, have created a perfect storm of opportunity for private equity investors.
“Though activity cooled slightly in 2022, investors still see healthcare as a recession-proof growth industry,” notes Todd A. Zigrang, FACHE, president of Health Capital Consultants, St. Louis, a firm that guides both healthcare providers and private equity firms through the due diligence and valuation processes of private equity transactions. “Demand for healthcare services didn’t decrease during the pandemic; it increased. That’s attractive to investors.”
The numbers show that healthcare private equity partnerships tend to be fruitful. An analysis of data from 2010 through 2021 by Bain & Company revealed a median internal rate of return for healthcare private equity deals of 27.5% compared with an internal rate of return of 21.1% for deals in all other sectors.
But not everything is rosy.
Balancing the Capital With the Clinical
Healthcare’s inherent “market frictions” may put consumer needs and investor goals at odds in ways unique to the sector, a study by the National Bureau of Economic Research indicates.
Among other things, the study, which focused on the impact of private equity on nursing home care, found 10% increases in 90-day mortality for short-stay Medicare patients in private equity-owned facilities and 90-day spending increases of 11%.
Features unique to the healthcare sector, including the fact that patients often do not pay directly for services and that a web of government agencies acts as both payer and regulator, “could mean that high-powered incentives to maximize profits have detrimental implications” for patients, according to the report.
In a similar vein, Ransom adds that “private equity has done a good job of reducing some areas of fragmentation in healthcare, and that consolidation can improve providers’ competitive position. The problem is when that greater scale enables a physician group to negotiate higher rates with payers and then those costs are passed on to consumers and employers, adding to the cost of healthcare services.”
The upswing in healthcare private investment activity in recent years has also drawn the attention of federal regulators, who voice anticompetitive concerns.
Private equity-backed organizations are likely to undergo heightened scrutiny in coming years, particularly as it relates to the Stark Law and other fraud and abuse laws, notes Zigrang. After a period of quietly sitting back, federal regulators appear poised to act, he observes, with anti-trust concerns raised by traditional hospitals and health systems—the entities that have long been under the government’s watchful eye—helping to pique their interest.
“At their best, [private equity] companies can add value and help,” said Andrew Forman, U.S. Deputy Assistant Attorney General for the Antitrust Division, in a 2022 speech to the American Bar Association. “But at their worst, they can extract value or try to thwart rivals—adding cost, delay and burden, while reducing quality and impeding innovation, which competition brings. That is why competition enforcement is so very important in this industry, and why the Antitrust Division feels a unique duty to safeguard the competitive process in healthcare.”
On the plus side, private equity funds innovation and can enable providers to serve patients better by helping them add or strengthen key capabilities. “Who else is going to take that risk with startup medical device or biotech companies?” says UW Health’s Kaplan.
He cites his institution’s partnership with private equity-owned rehabilitation services provider LifePoint Health as an example. “If we didn’t have access to their capital and market expertise, we might not have as great a rehab hospital as we do today,” he says.
Done well, private equity also creates competition that can be healthy for the market and beneficial to consumers. “As a hospital provider, do I want that competition across the street? No, but it forces all of us to get better,” says Kaplan.
On the other hand, since private equity exists to make money for investors, an investment that isn’t generating returns could create pressure on expenses that might not be in the best interests of patients, he adds.
But Kaplan’s leading criticism of private equity is its potential to thwart the integration healthcare has been working so hard to develop for the past 20 years. “At one end of the spectrum, you’ve got healthcare saying, ‘let’s integrate to become more efficient.’ At the other end, you’ve got private equity saying, ‘let’s disintegrate by owning ophthalmology or ambulatory surgery, lower the unit cost of care and become more efficient at a narrow slice of the healthcare system at the expense of integration,’” he says.
Private equity also has the potential to perpetuate rather than reduce waste, Kaplan argues. A solution designed to streamline prior authorization, for example, doesn’t address the complexity that caused the inefficiencies in the first place, which means “a private equity group is profiting from addressing a problem, but the underlying causes of the problem persist,” he says.
Still, he concedes that “private equity has so many entry points and products that you can’t put a label on it.” More recently, those entry points have included the introduction of products designed specifically for integration, population health management and value-based care.
Advice From the Experts
The experts interviewed for this article have several pieces of advice for healthcare organizations and medical practices exploring the possibility of entering into a private equity agreement.
Know who you are. Understand what your organization delivers to the market that others don’t, advises Kaplan. Don’t get distracted by novel products that distract from that core. Stick to what you and only you do best and only purchase things that enhance your services. How can you leverage private equity capital and expertise to create a symbiotic relationship that strengthens your offerings to the community?
Consider all the “what ifs.” Protect yourself from the potential hazards of a private equity partnership. If the investment fails, your partner may disappear and your nonprofit organization will still be standing and liable, Kaplan says.
Understand why you are interested in working with a given private equity firm, Ransom recommends. Are your practice or organizational aspirations long term or short term? What expertise beyond the capital infusion will the private equity firm provide? Do your due diligence on the private equity group’s culture and track record to know whether its goals and values are likely to align with yours. Always work with experienced advisers who specialize in guiding healthcare organizations through the intricacies of private equity deals.
Consult early and often with your attorneys and investment bankers. Always involve a knowledgeable, experienced third party—your investment banker, for example—as an intermediary in your dealings with the private equity firm, urges Sharma.
Involve the medical staff. A private equity deal that involves only nonclinical executive leadership and doesn’t include the participation of physicians could be detrimental to patient care and physician retention, stresses Zigrang, who has seen instances in which physicians have been asked to see twice as many patients a day to generate profits. Cost-cutting can be accomplished without jeopardizing the quality of care if changes are based on physician input and current best practices, he says.
“Private equity can offer the capital and the tools to re-engineer how healthcare is delivered by reducing inefficiency and fragmentation, but, as healthcare leaders know, that re-engineering isn’t something that happens overnight,” Zigrang notes. “The patience required to achieve those efficiencies could be diametrically opposed to the goals of a private equity group that is primarily interested in generating large profits quickly and selling. For this reason, I urge providers to work only with a private equity firm that demonstrates a true commitment to value-based care.”
Susan Birk is a Chicago-based freelance writer specializing in healthcare.