The Rise of Private Equity in Healthcare: Challenges, Opportunities, and Regulations

This episode discusses the significant increase in private equity acquisitions of physician practices, analyzing the challenges and opportunities these investments create in the healthcare sector.

1. Private equity investments in healthcare have surged, significantly changing the landscape of ownership and operation of physician practices.
2. The transition period of the pandemic saw an intense flurry of activity, with a focus on growth at all costs facilitated by cheap money.
3. Current economic conditions and higher interest rates are causing a more cautious approach to investments and valuations in the healthcare sector.
4. Regulatory scrutiny has increased, with states and federal bodies paying closer attention to the impacts of these investments on competition and healthcare access.
5. Despite challenges, private equity can provide substantial operational and financial expertise to healthcare entities, enhancing their growth and service delivery.

1: Introduction to Private Equity in Healthcare

Recio outlines the growth of private equity investments in healthcare and the operational focus of VMG Health. Key topics include financial due diligence and regulatory compliance. Lucas Recio: "VMG Health aims to serve clients across all their needs regarding transactions and financial regulatory compliance."

2: Transaction Trends and Economic Impact

Discussion on the historical trends in healthcare transactions and their acceleration during the COVID-19 pandemic. Lucas Recio: "We've seen a frenetic pace of deals during the pandemic, influenced by low interest rates and a growth-focused strategy."

3: Regulatory Challenges and Opportunities

Recio addresses the challenges of increased regulatory scrutiny and the opportunities it presents for healthcare practices to align with competent private equity partners. Lucas Recio: "Regulatory reviews are becoming more stringent, impacting the timing and execution of transactions."

1. Evaluate Partners Carefully: Healthcare entities should thoroughly assess potential private equity partners to ensure alignment of values and objectives.
2. Understand the Terms: Be clear on the terms of the investment, including the implications of equity rolls and secondary sales.
3. Prepare for Regulation: Stay informed about changes in regulatory landscapes and prepare for potential delays or adjustments in transaction processes.
4. Focus on Operational Excellence: Leverage the expertise provided by private equity to enhance operational efficiency and service quality.
5. Plan for the Long Term: Consider the long-term impacts of private equity investment on practice operations and ownership structure.

This podcast explores the surge of private equity acquisitions in physician practices. We discuss the current transaction environment, key trends, and the impact on healthcare professionals. We’ll also delve into recent regulatory developments and their potential effect on private equity activity in the future.

People

Lucas Recio, Scott Becker

Companies

VMG Health

Books

None

Guest Name(s):

Lucas Recio

Content Warnings:

None

Scott Becker

This is Scott Becker with the Becker private equity podcast, thrilled today to be joined by Lucas Recio. Lucas is the leader of the financial due diligence team at VMG Health. VMG Health is one of the great consulting firms in the country. We've had a chance to work with VMG health on different projects, different situations for nearly two decades, really, almost since their founding by a number of what were big eight and big six accountants that drove the founding of VMG Health? A great, great firm.

Lucas, we're going to talk today about practice acquisitions driven by private equity and the landscape and a lot more. Can you take a moment, Lucas, to introduce yourself and tell us a little bit about yourself and about VMG health? Yes, absolutely. So first off, thanks so much for having us here today on the podcast. Great things and collaborations have always occurred between VMG health and your firm here.

Lucas Recio

So like you mentioned, my name is Lucas Recio. I'm a financial due diligence director working on both buy side and sell side transactions in the m and a role as far as accounting and finance is concerned. And like you mentioned, VMG Health is a firm now with 30 years under our belt, just about, I think, 29 and a half, if you want to be exact, coming out of formerly the big eight. And now many of the folks on our team in the financial due diligence role are ex big four employees. So a lot of accountants, CFAs and other finance professionals here.

VMG Health, as our name indicates, is a boutique advisory firm focusing solely in healthcare. And we're really aiming to be in a space to serve our clients across all their needs with regards to transactions and financial regulatory compliance. So that means valuations, compensation arrangements with physicians, coding and compliance work operational excellence, whether it be consulting or HR or other financial functions itself, as well as my team in particular, financial due diligence or more actively known as quality of earnings analyses. That's probably about 95% of what my team does. Thank you very, very much.

Scott Becker

I date myself when I say big eight, big six, and don't throw in the big four, which it came down to the big four now. So funny. And I feel so embarrassed not to immediately say that in the introduction as well. Lucas, talk a little bit about this. The number of physician practices that were acquired by private equity firms increased by more than 600% in 2012 to 2021 or 22.

Can you talk a little bit about the current transaction environment and what key shifts are you seeing in the transaction environment currently? Yeah. So first of all, the interest in the healthcare services and healthcare more broadly sector of investment by private equity has really flourished over the last 15 years. Like the statistic there outlines, it's very much reflected the growth of healthcare spend as a percentage of GDP. And so over time, I've been with our firm five years now, and in those five years, we've really seen the dollars allocated specifically to investment in the healthcare space really take off alongside those investment figures that you've noted.

Lucas Recio

So those players who have specialized in investing in healthcare have continued to raise additional funds and make additional investments. And those who are not traditionally in healthcare have been asked by their limited partners to become active in healthcare. So when we think about those changes and trends, and really this is going to fit with most of the world, everything kind of changed in 2020 with the pandemic, right? 20, 2021 and 22, we really saw deals happening at a frenetic pace. Money was cheap.

If you wanted to roll out an inorganic growth strategy, you had the ability to do so. And there was very much this attitude of grow at all costs, right? We would. In our world, normally on the financial due diligence side, we get engaged after a letter of intent has been signed. But in 21 and 22 in particular, we were getting engaged before the letter of intent was signed simply because sellers were able to say, look, we have eleven people at the table that are very interested, and we want your offer to have its financial due diligence completed, at least in all material respects, as we sign this letter, so there's no retrade later.

That's a significant amount of leverage that shifted to the sellers during that really hot and heavy time period. And what we've seen is that it comes up to that art and science blend of making a deal, right. We've seen a dislocation between buyers and sellers, as buyers now have to be more conscious about how they're deploying their capital because of the higher interest rates that we see here today. So just thinking through the simple math of it all, valuation should come down as interest rates come up. And that's what your buyers are stating to these potential assets.

The sellers, though, saw their colleagues and their competitors draw these high multiples, right? We saw some physician practices trade in the high teens, even up above 20 in one case that we worked on, because it was an attractive asset. So if you are thinking about selling your practice or ASC, and you're getting a significant haircut on valuation versus your competitor or colleague, I'm not sure which one you would find more harmful, but or more painful to your pride. But you are seeing your business that you think is on par or better trade at evaluation, lower than what was trading in 21 and 22. And so there's that psychology component for the sellers and the buyers to make the math work.

But my practice is just as good as those practices, maybe better. 2023, you really saw that play out where there was this back and forth, and we saw it in two ways. Deal volumes, number one, were down significantly from 2022 and 2021. But when you look at it from a wider lens, we're really back to even with 2019. So we're back to pre pandemic levels there.

And that's the first component is just the raw numbers. The other side is then the amount of time it took to close a deal. A lot of deals were closing in 60 to 90 days during the fervor of 21 and 22. And now we're seeing those timelines stretch out further and further.

Scott Becker

Thank you very, very much, Lucas, and talk to us about this. If you're a healthcare professional, either someone who owns a practice, works in a practice, what challenges and opportunities come to mind for healthcare professionals and any examples that you think of when you think about this? Absolutely. So if you own a healthcare entity and you're going through a deal process, I touched on it there. It's a longer closing period.

Lucas Recio

Everyone is kicking the tires and making sure that the numbers can work and that the culture is a correct fit, that deal fatigue really sets in and is a material consideration for folks who, who are working through the process of a transaction. It's a very time consuming process. Most of the time, these entities are going to be in positive positions, meaning that they're not distressed or needing to offload certain parts of their business or their enterprise. And so they have their day job and they have high volumes and they have staff that they need to hire with the labor markets the way that they are. So some of the challenges that are present when thinking about these trends are just really related to the overall macroeconomic factors that are out there and balancing those while also trying to close a deal.

And so one of the things that is an additional challenge to especially those people who are owners would be that with interest rates at their, let's call it elevated levels, when we think about the recent trend, right. There's an impact on secondaries. And when I say secondaries for all the viewers out there, or listeners, rather, we're talking about the ability for the overall private equity platform to then trade or sell to another private equity firm. So if you are a seller of your founder owned practice or with your group, there and you are rolling part of your purchase price into the go forward entity. Well, that value only becomes monetized when the asset trades again.

And so with interest rates where they are, we've seen a slowdown on secondaries that has brought to the forefront the idea of, well, how much can my rolled equity actually be worth, and when will that actually come to materialize? The other component of this is that private equity gets kind of a wrap for coming in and slashing costs, and that means labor. A lot of times what we've seen, and I was reading a research paper probably earlier in this year, around what the actual impact to jobs are from private equity. And it's pretty level with those who do not have private equity investment. So if you are working in a healthcare setting and you hear that your company is going through a transaction or considering a transaction, there are a lot of positives that also come along with it.

And that fear of job insecurity is pretty much level with what we see across the broader marketplace, not just thinking about private equity. So those are some of the challenges there. And I can touch on some opportunities in a moment as well. No, thank you. And part of what happens with private equity, everything is pretty much the same in terms of employment and jobs and so forth, because they want to grow a successful firm as well.

Scott Becker

Where you get a little sideways is when margins squeeze. If they get squeezed, just because of normal events like you've seen over the last couple of years, reimbursement doesn't go up as much and inflation hits margins, then if you have added on a lot of debt, it can then add to more stress for the practices and so forth than they might have otherwise had, if not having that debt on it. But all things being equal, private equity firms versus non private equity run practices are not generally trying to cut people unless they really have to take a moment on both opportunities and increased regulatory questions about private equity, invest in healthcare about maybe those two subjects and what you're seeing there. Absolutely. So as far as opportunities go, you do as a practice or a healthcare entity.

Lucas Recio

I keep referring to practices because we've seen so many move in the last five years, but they do get access to additional financial expertise and operational expertise. And some of these private equity firms have their playbook really locked and loaded, ready to go, and they are able to buy and build is the way that they refer to their strategy. That's one that's been very successful in the healthcare space so far. And getting access to that additional thought leadership and that additional advisory group really can help elevate a healthcare entity, practice, ase, whatever it may be, by tapping into that institutional knowledge that exists there. And so when we think about deals in themselves, 2023 was definitely a down year as far as total volumes.

But what we found was that quality assets in attractive markets were still experiencing healthy multiples. And attractive markets don't just mean your Dallas and New York and Los Angeles, but also your kind of second rung of cities that are just as attractive in terms of growth in their population, who lives there, access to quality of life and cost of living, and all the things that everyone considers when they're thinking about, if I were to move to a different city, where might I go? Your Birminghams and the like. Those assets still traded with healthy experiences at healthy multiples and overall really provided a way for these physicians who are getting deeper into their career, to monetize what they built over 2030 years or even beyond. And that succession planning becomes a little more professionalized.

You have a piece of the pie that you're able to monetize when you have this vehicle through an investment with private equity or others, even that really is a lot harder to obtain. If you were to go from being an associate physician to then becoming a partner in that practice, how do you monetize that, rather beyond just the EBITDA that you generate on a monthly, annual, quarter basis, whatever it may be? So all of these things, the pressures, the challenges, the headwinds, the opportunities, the considerations, it's grown like we touched on kind of at the top of the episode here to such a level that now government regulatory agencies are taking a deeper look at what's occurring here and what the downstream impacts may be. So when we think about that increased scrutiny and attention, there's really two areas, and I'm sure that you all could educate me on many more that come to mind when I think about the investment of private equity in the healthcare space. And that's number one, when these investments are made traditionally, non competes are also signed.

So there's that idea floating around that non competes may not hold any water and maybe they'll all be struck and down. When we talk to a lot of firms, it's something that not a lot of folks believe will actually come to fruition, but it's something that remains in the conversation now, 18 months later, or however many it is after it was originally recommended here. So what happens around non competes is really important, but more importantly would even be how the individual states are starting to say the way that we view antitrust and the way that we view healthcare and access to care, they don't marry up right now. So we know that this is important is what the states are saying, and we need to review these transactions. And so with those regulatory reviews, comes time.

So a transaction is signed, it goes into regulatory review, it may be unwound, it may be challenged. The process, there is one that I'm not so close to. But you can easily imagine a world where it becomes more difficult to execute an investment in these states that are imposing these regulatory reviews, because in some cases, they could take months to review the information before they let you know whether or not it's been greenlit. And so when we think about all of the factors that we've talked about so far, if you add in this possibility that either an investment won't be made or an exit cannot occur, you really start to see some additional psychological hurdles. And regulatory hurdles are very real.

I don't mean to diminish that, but it's another item for both buyer and seller to consider. And so I think you're going to see activity in those states become a little bit slower and a little bit more methodical, a little bit more intentional, just as they start to understand, okay, my time horizon has always been four to seven years, but now I need to think about seven years from now. Do I have an exit pattern that will exist through the legal framework that's set out today?

Scott Becker

Lucas, thank you very, very much. And it's fascinating how there's a lot of discussion at the federal level periodically, and once in a while something happens, like there's this big situation, of course, with steward healthcare that has ended up with some financial trouble and private equity finance, and we don't need to dig into that today. But it also helps lead to more attention. There's also big practice in Texas ended with some antitrust challenges. And so you see some of these things, both from a federal level, a state level.

Then there's a number of states that have sort of developed many review requirements for private equity transactions or practice transactions or other types of rules and restrictions. And there's others, some states that don't allow non compete covenants. And that's always been an issue in some states, like California and others. It's evolved over the years, like Texas has a specific prohibition and so forth. Talk to us a little bit about Lucas, and you also mentioned the potential of the private equity transaction where you're getting some capital off the table and potentially a second bite of the apple and what that looks like and whether timing has slowed down on some of those.

We just a lot of different things going on. Talk for a moment, Lucas, about any other things that listeners should keep top of mind or people should think about in this space. Absolutely. I think that one of the items that happens, particularly with sellers of founder owned businesses, is they believe, and where the idea comes from is interesting, but that private equity may be some type of silver bullet. Right?

Lucas Recio

The idea being that let the physician go back to practicing medicine and let an individual who is solely focused on running a business run the business side of it all, the administrative side, the financial statements, etcetera. Let's take that off their plate and let the physicians be physicians. Let them focus on patient care. It's a wonderful component of what does occur in these transaction environments, whether you're joining with private equity or a larger system, those things do occur, but it's not the silver bullet that it sometimes is built up to be in the mind of individuals. There's still a component of this is the practice that you are in charge of running, that you are responsible for.

So the thing that is really important to know is that private equity can be a really great partner. But there are also things that you need to consider that are going to have their challenges, as with any other relationship that you're going to be in, whether it's personal or professional, that you need to be thinking about. If you are a seller or if you are currently employed in one of these platforms, there are all of those situations that are going to impact you on a different level now that there's another voice in the room. So private equity investment has been really profound and meaningful in the last five years, 15 years, really. If we take it back to 2010.

And the big takeaway, I think, is that you just need to be selective whether you are the private equity firm or the selling entity, in terms of what you are building your platform to become. If you're intentional and you move as a good partner, there are a lot of good things that can come out of private equity investment. But if you maybe find yourself just trying to pay the highest dollar or squeeze out the last penny of margin, or just get the largest valuation, do your five year non compete and then move on, I think a sour taste may be left in your mouth there. But overall, I think that we've seen, in terms of volumes and practice and transaction volumes with private equity that there has been a sophistication and a leveling off in 2023 and a bit of a rebound in 2024, even through Q one here in terms of what it looks like to do a good deal and to roll out a good strategy in the healthcare space.

Scott Becker

Lucas, I want to thank you for joining us today on the Becker Private Equity podcast and also sharing so many insights on what's going on in the private equity practice transaction world and what we should expect. Again, Lucas Recio from VMG Health, brilliant leader there of their financial due diligence team. Just fantastic to visit with you today. Lucas, thank you very much for joining us. Yeah, thank you so much for the time.

Lucas Recio

Yeah, thank you so much for the time.