There has been a noticeable increase in private equity (PE) investment in healthcare over the last 3 to 5 years. The main reason for PE investment is belief that these firms can provide substantial financial growth to physician organizations.
Healthcare organizations could benefit from PE investment for some of the following reasons:
- Improved EHR;
- Data analysis;
- Group purchasing options;
- Centralized Billing Office;
- Potential leverage with payers for improved managed care rates;
- Care coordination teams to assist with value-based contracts; and Expansion of Facilities.
The approach that most PE firms use to acquire an organization requires a financial analysis to determine the Earnings before Taxes, Depreciation and Amortization (EBITDA). This measure is considered by investment bankers to be the excess cash flow for an organization. The payment to acquire the firm is a multiple of EBITDA (i.e. today typically 8 to 12 times).
The owners of the organization typically receive 70% to 80% of the multiple as an upfront payment of which the majority could be considered for favorable treatment as a capital investment. The balance of the upfront payment 20% to 30% is retained as equity in the organization. This retained equity is paid out when the PE firm sells the practice in a three to seven-year period with a multiple that increases its value.
The annual compensation of the physicians after the purchase is typically adjusted down to a percentage of their productivity. The differential of compensation before and after the deal needs to be analyzed, however, it could be material. This reduction of compensation allows the PE firm to start monetizing its investment immediately before any sale in the next three to seven years.
The culture of the practice will change after the acquisition by a PE firm. There will be a primary focus on a return on investment (ROI) by the PE firm. This can have disconcerting effect on the physicians and staff as they provide services to patients. The decision to allow a PE firm to purchase a practice is not for all physicians but could be a source of capital that is needed to survive and prosper in a complex environment.