How joint projects are fraught with unexpected risks
Money is the driving force behind many concerns and decisions in healthcare.
Physician practices, hospitals and others need money to invest in capital needs or to simply to keep the doors open. Digital health companies see a market ripe for disruption and ready to acquire new products. Private equity firms see the opportunity to acquire and consolidate multiple practices by getting into an area where there seems to be no shortage of money spent.
Regardless of the reason or need for money, it is an ever-present concern and topic of discussion within healthcare.
Looking at private equity and healthcare specifically, the pace of transactions is not slowing down, and the number of targets is increasing. As suggested, private equity firms are interested in investing money into healthcare entities of almost any type with the hope of entering an industry often cited as taking a growing chunk of overall spending in the entire economy.
At the same time, healthcare entities already in the industry are facing pressures of reduced access to reimbursement or other funds despite all of the overall spending, which impacts the ability to put money into capital needs. The confluence of factors and interests creates a seemingly natural fit between the two sides.
Despite the clear potential for synergies, both private equity investors and healthcare entities should not rush into a transaction because either or both sides’ eyes have been blinded by opportunity. To avoid getting into a bad relationship, appropriate due diligence and review of proposals should occur.
While it is not possible to address or protect against every outcome, at least setting the stage by considering a number of likely outcomes can enable all parties to a potential transaction to set more reasonable expectations.
The private equity view of healthcare can be summarized as looking for the chance to get into a market where usage is fairly guaranteed while, at the same time, there is a lot of chance to disrupt or otherwise create dominant market players. From this perspective, private equity firms have been focusing on particular segments of the healthcare industry, such as acquiring and accumulating physician practices in specialties known for the ability to drive higher margins—dermatology being a prime example.
Jumping into healthcare is not without risks, though. As one of the more famous statements about healthcare goes, it’s more complicated than anyone thought. From the perspective of running or owning a business, the regulatory environment can be particularly fraught.
When a private equity firm first gets into healthcare, a somewhat stronger, though not necessarily fully accurate, argument can be made that the private equity firm has no connection and may not face the same fraud and abuse constraints that a buyer that is another healthcare entity may. While that could hold weight on a first transaction, each subsequent transaction makes it more difficult for that to remain true, which means the same potentially lucrative offers may not be feasible.
The impact of regulations on day-to-day operations is also an aspect that those inexperienced with healthcare may find difficult to work with. Fraud and abuse regulations can twist sound business ideas around because such ideas may be premised on driving revenues or patient referrals, which is a good way to lead to scrutiny in healthcare. Data are also restricted in different ways, though the impact of HIPAA could become less significant as broader, more stringent privacy regimes come to bear in other markets.
The complexity of Medicare billing and program requirements is another matter that can be unexpected. One misstep could trigger an audit that potentially exposes an organization to significant monetary penalties. Pressure to generate a return on the private equity investment could unintentionally trigger less attention to billing compliance to create more margin. The sophistication of data mining may make such changes easier to detect, which raises the risk.
The list of issues can become quite numerous, but the underlying issue is that a quick exit with a high return may not be possible. Accordingly, private equity should take the time to fully understand how a target entity operates and take the time to learn its business before buying or changing it.
While private equity is looking to create a return, healthcare entities are often looking for a quick infusion of cash and a means of exiting the industry or ownership concerns. Both may not be the actual outcome from a private equity transaction.
A common transaction structure for private equity is to keep the seller hooked into the organization through a combination of extended employment and retained equity. To entice a seller to remain, suggestions of big returns in the future can be made. While those returns are possible, a healthcare entity selling should question the premise for generating the returns and get a better understanding of what assumptions will need to occur. Since the future cannot be predicted, it may be a safer course to assume that any future return is a “bonus” and that the only guarantee is the present upfront cash.
Another issue to consider is what changes could be made to the entity if the seller will need to remain in place. Fundamental changes to operations that have been in place for a long time are not bad, but habits are hard to break. Additionally, while change can be good, it can also be detrimental. Are the proposed concepts not aligned with how the type of selling entity can operate or could the changes be expected to cause issues quickly? The potential inexperience of private equity discussed from the private equity perspective, can be flipped around to the healthcare entity, which means the healthcare entity should think about what would be needed to “educate” the new partner.
Running behind many of these considerations are taking the time to explore the culture behind the potential buyer. Since a longer term relationship may result, the selling healthcare entity is entitled to vet the buyer to look for alignment in views or at least receptivity to open dialogue. Creating an oil and water working relationship is not conducive to happiness.
Ultimately, no transaction will run exactly as expected nor will outcomes be the same as anticipated upfront. However, some unknowns can be addressed by taking time and no rushing to get to closing. Both sides should appreciate the benefit to be earned and will hopefully be happier in the end from having taken a measured approach.