Private equity firms are not slowing down their investments in palliative care, as demographic tailwinds in a fragmented industry create an environment conducive to growth.
According to data from mergers and acquisitions consultancy The Braff Group, private equity deals took place in record numbers last year. Of the more than 60 estimated deals in 2021, at least 39, or 65%, were private equity-based, up from 56% in 2020.
Additionally, the proportion of palliative care and home health care deals involving private equity firms increased by 25% between 2011 and 2021, Braff reported. But as the presence of these investors increases in health care, more lawmakers and regulators are asking questions about their impact.
Hospice News spoke with Randal Schultz, CPA and health care attorney at Minneapolis-based Lathrop GPM, to discuss this regulatory landscape and the factors that may prompt a private equity firm to acquire a palliative care society. Schultz is also a former adjunct professor of corporate law at Rockhurst University and has spoken nationally on business and health care law.
What are some of the vendor characteristics that are most attractive to private equity firms today?
I’ll give you the straight answer: all equity funds are really looking for is cash flow.
If you were to sum up all the motivations of all equity funds across the entire healthcare spectrum, they are looking for cash flow. Their idea is this: they want to pay a multiple today, consolidate entities and increase cash flow. Once their cash flow reaches a certain level, they think they can resell that entity for an even higher multiple. It’s their game there.
There are two main types of equity funds. There’s the equity fund, it’s just pure money. This is a pure finance transaction where they pay a multiple, now hope to aggregate it, and then sell it for a larger multiple in two to three years. The spread is the margin they make, and that’s as far as their thought process goes. And then the due diligence looks at whether we’re acquiring something that will maintain or increase cash flow so that we can achieve that increased multiple objective.
Then you get the second type of equity fund, which believes they know more than any other about how to operate whatever sub-specialty of health care, whether it’s care palliative care, long-term care, orthopedics, etc.
They believe they have developed a business strategy and financial model that allows them to deliver the service more cost effectively and therefore hopefully at a higher level of quality than anyone else. .
I made an equity settlement with a urology group. There are all sorts of add-ons you can have to generate money for a urology practice, facility fees, certain types of imaging, and all sorts of things you can do. These are all separate sources of income.
The saliva equity fund is when they can find a urology group that has good young doctors, who have never developed any of these auxiliaries, and who are in a demographic area of a growing community growth.
What makes this kind of scenario so appealing?
Why does the equity fund like its situation? Because they can turn around, they can use whatever business you might have, get the doctors involved in all those auxiliaries, and dramatically increase cash flow over what was there before.
Now, where they may have paid a multiple of 9x for a cash flow of X, they can turn that cash flow into X plus Y plus Z overnight. They are instantly positioned to sell the shares to a larger fund at a higher multiple.
If there’s a very poorly run hospice, long-term care facility, whatever it is, and people who understand the business can walk in and figure out why it’s not running the way it should, then it’s It’s a target-rich environment for these businessmen. They then try to recreate the business model they have successfully worked on in the past and fix any issues with what they acquire.
The goal is to get the lowest production facility, producing at a higher more profitable rate, which again creates the position for even greater deployment. I’ve never been in a discussion where the equity fund hasn’t talked about the secondary roll-up as the ultimate icing on people selling. They say we will buy your installation for X dollars; 80% of this will be cash and 20% equity in our future deployment company.
Obviously, the buyer wants as little liquidity as possible and the highest working capital. They can make the case for investing with our new deployment company, and when we get to the top, you win.
Now the issue with all of these things is durability. For there to be a future sale of stocks in the years to come, there must be a continuous and growing profit margin that can be taken by the stock fund. That’s the math of the game. An equity fund will not want to buy a company whose capital contribution is so large that it cannot generate a profit on its multiple.
Now, if a company is doing something that’s obviously not as financially prudent as it could be – and the equity fund can see that instantly and make a change rather than having to invest a lot of capital – the equity fund will jump over that.
If it’s not too broken, let’s fix it and we’ll make a lot of money. But if it’s too broken, it will cost so much to fix it that it doesn’t make sense to buy it.
Where does regulatory compliance come into play during this process?
They are always looking at regulatory issues. Are you a company that has all sorts of regulatory issues that haven’t come to light yet? Or are you engaging in practices that are simply ripe for regulatory issues?
It’s the other side of the coin because no one wants to spend their money on litigation.
There has been more discussion among lawmakers and some regulators about private equity activity in healthcare. What are some of the legal risks that could potentially arise from investing in hospice?
I think from an ivory tower perspective, we would all like to think that health care providers are in the best position to deliver care, design care, and decide how care should be delivered. The last thing you want is for a banker to pull strings, telling people how to operate when that banker has no idea what they’re doing.
There’s a bit of Pollyanna in there, because who really understands how healthcare is delivered? One of the problems we have in health care right now is that we’re becoming so segmented and the organizations are so big.
Who are the best people to lead a healthcare organization? It’s the delivery of health care services, but it’s also the funding. And a lot of people who are really good at providing health care services don’t know anything about finance and can’t begin to use economies of scale, research new technologies and figure out where there are economies of scale. costs. These terms are simply totally foreign to many people who are educated from a scientific or health care perspective.
Similarly, many types of MBAs cannot spell “health care.” Most people can’t buy into a health care business from an informed perspective. There are not necessarily checks and balances on cost.
People automatically condemn equity funds because they don’t understand health care. They need to look at the larger scope of how health care is delivered in this country.
Technology allows us to do things more cheaply than we could do before, but it all takes a lot of money. If you’re a family-owned shop, you don’t have the capital investment, and you can’t get the technology, are you serving patients better?
Some of the lawmakers who ask about these companies say they have a negative impact on quality. What is your opinion on that?
I’m not here to defend equity funds, because I still believe doctors should be more balanced. There should be more of a sense of collective community with many of our healthcare providers. But that’s not what they’re taught in residency programs. They are taught to sub-specialize as much as they can.
So I don’t think it’s fair to automatically say that investment funds that own and acquire facilities diminish quality. Because some equity funds are technology driven. Can they provide more services with better results on a more cost effective basis? If they can, and if the refund is appropriate, they can make a better margin. This allows them to sell at their earlier multiple.
So it’s a complex issue, and it can’t be solved just by someone saying equity funds shouldn’t be in health care, or that we’re going to regulate equity funds more. Ultimately, equity funds are an economic engine. Most of my clients who participate in equity funds do so because they get money out of them, but also because they get the new technology they need.
By getting new technologies, they are able to provide a broader base of care and better, faster care for their patients. So there is also a positive attribute to the equity fund.
The delivery of health care is such a complex dynamic that we cannot roll up our sleeves and say equity funds are good or bad, or health care is good or bad.