HomeLast Word → The Invasion of Private Equity into Healthcare- Are we experiencing a new era of efficiency or a 1990s disaster sequel?

The Invasion of Private Equity into Healthcare- Are we experiencing a new era of efficiency or a 1990s disaster sequel? Print E-mail
Written by David H. Fater   
Saturday, 05 October 2019 13:17

There is a marked invasion of private equity into healthcare (again) and a day does not go by without reading about another physician practice acquisition or some other combination of healthcare providers being ushered along with private equity dollars and financial backing. There were 181 private equity deals for all types of physician practices last year and this year there will be even more.  In dermatology alone, there have been 200 practices acquired by private equity groups over the past six years. Orthopedists, along with gastroenterologists and urologists are among the newest targets in the current gold rush. The attraction with these types of groups are the rich revenue that can be generated from ancillary services such as ambulatory surgery centers, lab, imaging and other such services. This rapid proliferation of private equity deals has raised alarms about whether investor ownership of physician practices will negatively affect healthcare costs and quality. The other $64,000 question is whether this rash of deals will implode, crash and burn much like they did in the late 1990s.

Three Card Monte or the Shell Game

The big potential payday for both the doctors and the private equity groups comes three to seven years down the road when the private equity group sells the “expanded” business to another private equity group, insurer, hospital system or another physician company. In some respects, it is like a large chain letter and hopefully you are not the one that is left holding the bag. Of course, the song the private equity groups sing is “We are simply focused on growing the business and consolidating the market in orthopedic surgery [dermatology or whatever the specialty is] in the best interests of our patients”. Sure, and the moon is made of green cheese if you think there is not a real profit motive here. And when there is a profit motive, someone has to come up with the short end of the stick.

Despite the experience of the 1990s and many of the deals of this decade, physicians are still running into the arms of private equity groups because they see this route as their only and best alternative to ownership by hospital systems or insurers and that they will be able to preserve their professional autonomy. Because of the prohibitions in many states against the corporate practice of medicine, the practice itself is not “acquired” but a Management Services Organization (“MSO”) is formed that takes over the administrative non-clinical functions freeing up the physicians to focus on medicine and patient care.

Typically, the shareholder physicians receive a large cash payment upfront (this is particularly attractive to the older physicians near retirement) with the golden carrot being the bonanza that will be realized when the private equity firm sells to another buyer. The initial payment is calculated with rocket science and differential calculus and is based on a multiple of the practice’s EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). The multiple can be as high as 12; HOWEVER, since the EBITDA of a typical practice is 0 because the physicians pay all that out to themselves, the physicians have to take as much as a 30% decrease in compensation. This plus any valuable practice assets turned over to the Private Equity Group “pays” for the physician ownership in the MSO. Naturally a year later, the physicians forget about that and just start grousing about how their personal income has gone down.This could lead to inevitable friction that will ultimately lead to a meltdown of the entity leaving everyone unhappy.

The Pot of Gold at the End of the Rainbow

Advocates contend that private equity groups can help physician groups grow and improve their efficiency and quality of care through investments in management and technology as well as facilitate the transition to value-based payment models which are being mandated by the Centers for Medicare and Medicaid Services (“CMS”). The transition to one-stop shops for all needed services helps speed the shift to lower-cost outpatient settings. Additionally, the improved quality, larger size and expanded services and locations enables the group to negotiate better deals with payers.  This fact is often kept quiet to avoid attracting the attention of the antitrust regulators.

Not all is rosy, however, and there are naysayers besides the unhappy physicians. Those that develop health policy are concerned that private equity firms are not focused on making healthcare better. The belief is that they are rather focused on hunting out narrow slivers of the healthcare system where they can make significant amounts of money by exploiting loopholes. Two examples, determined by a study at Yale University, found that two large hospital-based medical groups (Team Health and EmCare) owned by private equity groups aggressively used out-of-network billing tactics to boost revenue. In fact, insurers have pointed to private equity ownership as a factor in the current battle over legislation to end surprise out-of-network medical bills.

Is the Business Model Sustainable?

A looming question is whether the private equity business model is sustainable for medical practices, particularly after the first buyer cashes out. Who is going to be the ultimate buyer? If there is no ultimate buyer, then things don’t turn out so pretty. Today’s buyers and sellers say they are acutely aware of the disastrous experience with the wave of investor- owned physician management companies in the 1990s. (And I was one who lived through those wars from the beginning in 1992 through the meltdown in 1999). Several of those companies, along with the physician practices they acquired, went bankrupt and have been called Ponzi schemes.

Today’s buyers seem to have learned that putting physicians on salary is not productive or beneficial. Physicians are intelligent, self-select and are autonomous in nature. So smart private equity firms now structure deals to allow physicians to be “partners” with strong financial incentives to boost productivity and revenue.  Unfortunately, some investors continue to see this trend as a pure financial play spurred on to acquire, acquire and grow. The caveat is that if you don’t integrate what you buy, you have a mess on your hands.

So Who Really Benefits from Private Equity Buyouts?

One could argue that if the policymakers really want to expand value-based care, then someone needs to hit the pause button and take a closer look at this private equity buyout activity. The trend that may have started with dermatology, ophthalmology and dentistry (which is interesting because each of these have an element of retail plus healthcare) are spreading to the costliest areas of medicine-orthopedics, gastroenterology and urology. As stated above most of the balance billing surprises from being “out-of-network" arise from the large emergency departments who are staffed by physicians that work for private equity owned firms.

This business model in healthcare parallels other industries by using highly leveraged private capital to roll up small companies into a larger one with the private equity firm providing the management. They charge hefty fees for arranging the deal and a 20% annual return on its investment after paying the interest on the debt related to the transaction. After three to seven years, the private equity firm and the physicians earn a windfall with the first flip and by this time, the private equity firm has taken all its money off the table. If things don’t go as planned, there is always a bankruptcy which cuts the private equity firm loose with no loss. As to how to achieve the financial targets, there can either be sharp cost reductions or ways to increase revenue. Since those specialty physicians took a pay cut to play the game, they have a powerful incentive to ignore cost controls or value-based treatment.  While we give lip service to value-based payments, the majority of revenue (which pays those physician salaries) still comes from fee-for-service medicine. It’s hard to see how this cycle is going to help the United States achieve a less-costly and higher-quality healthcare system. And let’s not even go near “Medicare for All”. We need to make sure that physician practices are allowed/mandated to practice medicine and still achieve the Triple Aims of High Quality, Low Cost and Patient Satisfaction.


David Fater is CEO at ALDA and Associates International in Boca Raton.

Last Updated on Monday, 07 October 2019 13:20

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