How private equity can improve the health of healthcare

Improvements in tracking patient satisfaction, securing key talent and enhancing compliance are among the benefits. But complexities remain.

Strong and growing interest in the health sector by PE investors shows little sign of easing. In fact, the reality is quite the opposite. PE funding continues to flow into the sector from investors who are attracted by its resilience in the face of potential market volatility and the perceived opportunity for attractive returns.

The year 2018 was a stellar one for health sector PE, with US$32.9b invested in 647 transactions in the US — an amount double that of 2014. In addition, in 2018 alone, US$10.7b was invested in 279 deals outside the US. Moreover, one in seven PE firms made at least one health care investment in 2018.

The wasteful, siloed and fragmented nature of health delivery are a natural match for the traditional PE skills of enhancing value by eliminating inefficiencies, improving operating models and consolidating markets. And future opportunity will likely be strong. Health care is poised to continue not only as a significant economic force, but one subject to ongoing disruption.

However, PE and health care can make for an uncomfortable pairing. Concerns have been expressed about possible implications of PE investments, including the potential for conflicts of interest. PE is often viewed as a force that will, at best, have limited impact on clinician behaviors, clinical outcomes and patient satisfaction.

To gauge the market’s perceptions, we turned to a group of founders and executives who have lived through a PE investment in their business.

The outlook of those with direct experience of PE investment is largely favorable

We spoke with and surveyed more than 80 health care company founders and executives with direct experience of PE investment in their physician practice management companies. The good news: 90% of those we surveyed said PE involvement with their company has been positive overall, with over 80% of those surveyed highly likely to consider PE investments in the future.

Not only is PE perceived to have a beneficial overall impact on health care businesses, it is also considered to positively influence the focus on quality and clinical services.

As well as providing greater access to capital, PE investors are credited with introducing leading practices from companies in their investment portfolios, especially with respect to improved management, clinical metrics and compliance systems.

Some apprehension about PE persists, however. One home care company CEO sums it up well: “I think some in PE are spread pretty thin, and as such don’t grasp the nuances of clinical care. In health care, sometimes a subtle issue can lead to underperformance, but PE folks [make] changes before it can be properly addressed.”

Looking ahead

What may not be clear at the beginning of a PE deal is that a prime concern should be to figure out how to make the relationship work, by confronting and resolving any potential conflicts between investors and business owners on expectations. If handled well, it seems clear that partnerships between PE and health care companies can produce highly successful outcomes.

Executives and business owners and PE investors contemplating entering into a PE transaction will need not only to weigh the need for a ready source of capital, but also to consider the following:

What will unlock value for both parties?

Value creation brings the promise of transforming the company and creating long-term viability by making the business better. Pathways to value differ — through digital transformation, reconfiguration of assets or repositioning to enter new markets.

The litmus test is whether a potential investor partner will bring the right entrepreneurial and management talent to complement the owners’ domain expertise to reinvigorate the company to achieve its full potential. Alignment includes:

• Agreeing on validated business fundamentals that will release value
• Sustaining relationships and governance including an openness to collaborate on a journey of constant reinvention to remain relevant to the future
• Understanding that in health care, value creation will likely have a long-term investment horizon. Market segments and new technologies will grow at differing rates, so where should bets be placed that capture optimal alignment among market, product and timing?

Is risk a two-way street?

Both sides need to do due diligence, in commercial, operational, IT, human capital and cyber areas. In addition to the traditional financial, operational and tax diligence, environmental, social and governance diligence should be covered. Bringing partners along is vital, including:

• Aligning expectations and requirements for risk and reward
• Paying attention to the often-invisible cultural factors and organizational alignment that are vital for establishing a firm foundation for any business relationship
• Managing business continuity and risk and accurately assessing the complexity of scaling a business across multiple geographic areas or market segments

Does familiarity matter?

The complexity of investing in health care (e.g., the science, the regulatory factors or the intricacy of payment mechanisms) gives an edge to PE firms that specialize in the sector. Evidence from our research suggests that people who know the health industry best appear to navigate it more successfully. Mastering the health industry includes:

• Acquiring deep industry knowledge and a high degree of comfort operating in a highly regulated environment
• Understanding that health is a people business and, as achieving outcomes for the patient motivates practitioners within the industry, this should also be a key concern for investors
• Challenging and validating working assumptions about market trends, target company performance and new and expanded opportunities for both the company and its owners

Managing clinical processes can be complex, and health institutions can move slowly. Appreciating the constraints of the sector and a willingness to understand the complexities of each other’s businesses can lead to an enduring relationship with PE that positively affects the health of health care companies.