Health care has historically been dominated by corporate and strategic M&A, but there has been tremendous growth in private equity and venture capital over the past few years. Chris Carnahan, Founder & CEO, Carnahan Group, speaks with Jim Daniel, Partner, Hancock Daniel & Johnson PC, about the current landscape of private equity and venture capital in health care and how they are advising their clients about the opportunities and challenges. Sponsored by Carnahan Group.
To learn more about AHLA and the educational resources available to the health law community, visit americanhealthlaw.org.
Health care has historically been dominated by corporate and strategic M&A, but there has been tremendous growth in private equity and venture capital over the past few years. Chris Carnahan, Founder & CEO, Carnahan Group, speaks with Jim Daniel, Partner, Hancock Daniel & Johnson PC, about the current landscape of private equity and venture capital in health care and how they are advising their clients about the opportunities and challenges. Sponsored by Carnahan Group.
To learn more about AHLA and the educational resources available to the health law community, visit americanhealthlaw.org.
Support for A H L A comes from Carnahan Group, which is focused on automating the routine and humanizing the extraordinary. Carnahan Group is an innovative healthcare advisory firm that leverages its expertise in technology to drive compliance, improvements, and cost reductions for some of the nation's largest healthcare organizations. For over two decades, Carnahan Group has performed complex physician compensation and business valuations, community health needs assessments, strategic consulting plans, and other services within the industry. The company offers specialized strategic solutions that are tailored to the goals of any healthcare organization. For more information, visit carnahan group.com.
Speaker 2:Welcome. This is Chris Carnahan with the Carnegie Group. We are a strategic healthcare consulting firm that, uh, operates in the space of valuation, strategy and compliance. I am here with, uh, Jim Daniel Hancock Daniel, and I'll let him introduce himself.
Speaker 3:Thank you, Chris. I'm Jim Daniel. I'm a partner with the firm of Hancock, Daniel and Johnson out of Richmond, Virginia. And we look forward to talking a little private equity with you today.
Speaker 2:Fantastic. Well, we wanna introduce the topic of private equity, venture capital in healthcare, because there has been tremendous growth over the last six, seven years in that area, which has been historically dominated by corporate and strategic m and a. But private equity in BC has come a long way. Um, if we go back to 2014, there was approximately a little over 150 billion of investment in healthcare. Uh, the majority of which about 97, uh, 0.8 billion of that was, uh, corporate and strategic and a, to a lesser degree, we had VC coming in at 21 million. And then we also had, um, the, uh, total capital raised by private equity at about 41 billion. Fast forward to 2021, private equities investment was over 46, uh, was was 90, excuse me, 97.66 billion in, um, investment. And then, uh, slowed down a little bit last year with 69.49 billion in private equity. And then to a lesser degree, we had, um, total about 36 billion in vc. So we can see that, you know, we've almost through private equity and, um, venture capital, we had almost exceeded in 21 the total investment of what was invested in 2014 in all deals. So there's been a huge growth and rise in private equity and vc. And one of the big challenges for providers and healthcare companies is, is VC or private equity the right structure for me and what are my alternatives? And that is where Jim is going to come in and kinda walk us through some of those alternatives to, um, selling or, um, recapitalizing with VC or private equity. Jim, you want to talk a little bit about some of the things that you're seeing, some of the things your firm is doing?
Speaker 3:Absolutely. So we're seeing, uh, you know, everyone is trying to look for their seat on the bus. So private equity is a significant and real player in the market. We're seeing aggregations of physicians who want to come together and do a physician only organization without any investment. We're seeing payers getting in the space. And then of course, health systems who I think, uh, you know, the literature ires reported that they became the majority employer of physicians, uh, a couple years back, uh, are are actively looking in the space they have. The growth of employment health systems has, has, has been continuing, but it's the point at which there are viable opportunities other than staying in private practice or being employed by, uh, a health system is really rampant right now, particularly with the emergency private equity. And there's, uh, everyone's kind of looking for where, where things settle. Uh, you know, health systems are trying to decide, um, the typical health system that employs physicians, partly due to, uh, the way health systems operate, practices mission-based criteria, partly because of overhead. Generally the literature suggests they have to support those practices through investment. Um, a typical private equity deal, physicians will create a, uh, EBITDA through a reduction in current income with the idea of a future payout over equity. So we see health systems trying to decide, are we better to, you know, allow these physicians to go join private equity and then have aligned relationships with them, but not employ them, take the, uh, investment off our books. Are we better to come up with a deal that's comp private equity, or do, is this something that's going to pass private equity? Seems to be, um, looking, uh, the wave seems to move through specialties and there seems to be a, a ramp up now in, in, in my practice around orthopedics and cardiology. So we're seeing specialties that were less dependent upon outside investment becoming more interesting in those areas. But everyone's kind of trying to find their, their position right now. Chris, I I, I'm sure you see, see things from a, a different lens. I'd love to hear your perspective.
Speaker 2:Absolutely. And, uh, you and I have been in this industry long enough to see these cycles and if you look at the, um, kind of the graphs of investments over time and how they wave, um, they do roll through specialties. They do, um, pandemic is a, is a great example, 2021. 2020. We saw lots of investments in telehealth in, um, other enabling technology companies that were not necessarily practice based. And we also saw, um, a number of transactions that were in the pipeline come to a halt due to the uncertainty around the pandemic. So you're absolutely right. And the same as what we're seeing in our practice is that this is an ever-changing landscape. What's going to happen in 20 23, 20 24, um, is, is really unknown. And, um, one of the things that a lot of, uh, folks look at is what the, in the VC world private equity world, they talk about Bri dry powder, how much, what are the funds that I have to invest? And we're seeing some of that, we're seeing some of the deals slow down a bit in 2023 because of the uncertainty in the market. But for strategic buyers, um, there is no, um, we don't have a reprieve in terms of what they have to do to accomplish, as you said, their mission. But with depressed margins, I mean, we're coming off of 2022, which was absolutely a horrific year for finance and certainly the acute care and, uh, some of the other very capital intensive, uh, parts of the industry. So they don't have the, the money to invest either. And these things go through cycles. So it's, it's one of those things that is this the right time to take on an investment and who is the right partner? And so when, you know, what we look at, and we are also involved in helping, um, groups come together, and the question is, what are you willing to leave in the larger practice? And in fact, um, one of those things are that, you know, we, we won't get into the specifics of, um, designated health services and how those play into an acquisition or a broader practice, but as you said, if you are going to do a transaction, understand that you will have to go at risk for something, you will probably have to give up the certainty of what historical comp or distributions have been in order to get this greater return. So, um, and how do you guide your, your clients through that? Because it's a, it's a delicate situation. It's a situation that strategic buyers may have a different, um, they may have a different recipe for that than vc, but how do you talk about, look, you're gonna have to leave something in the practice. You're not gonna be able to take it out and you're going to go at risk for those future distributions.
Speaker 3:And I think that's, I think that's where we need, you know, strong, good financial advisors. We look at the situation and that's often a, uh, a comparison. And you have to look at yourself and your practice largely where you are in your career, your willingness to change some of the things about the way you practice, maybe some of the autonomy that you had, and you're going to possibly have a significant upfront, uh, cash infusion. Um, when you, when you do a transaction with private equity, there are things that you have to think about in that, like, how much longer I'm gonna practice, what's my total return under both scenarios. If I stayed independent, if I went with a health system, if I went with private equity, how does my total return look, how much of this is on the second sale? What will the market look like in a second sale? What are gonna be my tax implications? What is gonna be my net net after I pay off my liabilities, my taxes, my professional advisors, and take some of my purchase price in deferred comp through rollover equity? Do I, you know, how does that scenario look? How does it line up with how much longer I wanna practice what my expectations are? And so it's a very, it's a very profile based, and it gets complicated because most groups have multiple partners in them and not everybody's in the same place in their career. And so, uh, there's a lot of, uh, you know, group discussion to kind of kind of get to where you are on this, but to me it's, you know, am I better in the long term into this scenario versus the alternatives that are available to me? And we always, you know, think that, uh, financial advisors, you know, test the waters, get the idea of what's available to you, and have good financial advice as to how the different scenarios work out for you.
Speaker 2:That's perfect, because that's also one of the, that that is a process that we work through with groups, uh, in particular because as you said, the individuals in the group are usually at a different place in their career. So we look at, you know, what is your mental state in terms of your willingness to change the practice? And then the other is what's your financial ability? So, um, you know, we kind of think, look, think about this as mental readiness and financial readiness. Well, someone who's been practicing for 25, 30 years is definitely in a, hopefully in a different financial situation than the associate who's been out three to five years. And the associate who, or partner who's been out short a period of time now has to live with this new structure for a longer period of time. And getting the group to come to agreement or get to a point where they have some range of agreement is, uh, is very important. And then there's also that mental readiness, as you alluded to, are you, are you willing to, and ready to give up the autonomy of a new owner and that that takes place, even if it's a strategic buyer or a, um, or financial buyer like DC or private equity. And, um, really understanding why you want to get into this transaction. And I think you and I have had conversations in the past where some of this is as much about therapy as it is about the actual deal terms. And, and I think that's where good counsel really can because of the relationship that counsel has with the, and and can develop with the both their client and the other party. Kind of getting into that, what is it that you're really trying to achieve? Just because someone said, I'm willing to buy you, you need to understand what you're giving up. And I think about it in three, three terms. You're giving up governance, you're giving up income, and you're giving up equity. And in some respect, you're going to get back either income or more, more returns on your equity. Um, but certainly any buyer is going to ask you to give up some governance, um, unless you know you're Zuckerberg, and then you can still say all the, all the governance relay, uh, it remains with me, but, uh, most of us aren't in that position. So what, how do you counsel, how do you counsel groups, Jim, when, when they come in and you've got this spectrum of, of partners that have to live with this?
Speaker 3:I mean, that's the hardest part, right? First you gotta spend some time getting to know them. I think that everybody feels better once they've been had an opportunity to be heard. So early on, we typically get a group together. We let everyone voice some concerns. We take notes, we try to identify those issues. We ask people to rank what's most important to them. And so when you have that ranking, you kind of use that as your true north. Okay, does this, you know, are these still, are these still our imperatives in a transaction? Is this still our goals are long term this, you know, are we, have we changed our outlook now that we're a month into this? Or is this where we are? And if so, how does the, how does what we have on support the support the goals? There's typically some, uh, two deals that have to be done, you know, a deal among the partners because the groups are generally structured years ago without private equity in mind and group may not be structured the way that it would be to ideally participate in one of these transactions. And then there's always the, you know, really the difference largely in my experience, runs around seniority, sometimes around specialty, sometimes around marquee name value. But people feel they contribute differently to the value of the practice. And now they look at this as a sales transaction, they should be compensated differently because of the value of practice. So there's a significant group dynamic, you know, easy, everybody same. But you know, I, I often, often think you double the people, you square the app square the number of opinions. So if you have a lot of folks in the room, uh, group therapy, I, I hope no one hears that term pejorative. But there's a lot of need to have people be heard, address their concerns, realize that, you know, the solution is probably somewhere in the middle. And try to just commit the process of how you get to the consensus recommendation or position of the group with respect to the imperatives of the transaction
Speaker 2:Creed. That, um, I think that willingness to sit down and listen to what the individuals want and or what they believe they want is, is crucial to getting the deal at least far enough down the path that you can really start talking about, um, what does this look like? Because, um, everybody is enticed by a big pool of money. Um, there's a reason when the lottery, uh, jackpot goes up, ticket sales go, go up, people get enticed by. And if someone, uh, private equity or someone else comes in and says, we can do this deal and DC and private equity don't have, and, and some strategic buyers, the insurance companies don't have the same constraints that a healthcare system or a entity that is going to receive referrals from practitioners has. And we saw this, you know, back in the nineties with the, uh, you know, practice management organizations. They were able to offer stock, they were able to offer deals that were, uh, far greater than what, um, the other strategic buyers like hospital companies at that time could, could offer. But we also saw the implosion of that whole market. And, and I think the exit, as you indicated, is important to talk about in, and the risk of not exiting at the multiple that you hope for is important. Somewhere in those, in those discussions, and you had said that, uh, you know, what is that second bite of the apple? And, um, for us, it's one of those things that the future holds no certainty, but it's all probabilistic. So it is about what's the probability of getting there? And, and I think that when, when you're in the early discussions, it's really difficult because, you know, BC they're they and private equity, they need to get out within three to five years. Um, you know, seven, you know, talk about, we'll, we'll get into the J curve and things like that in, in equity investment, but they need to, they need to liquidate because that's part of their portfolio. Do you have those discussions with the, your clients?
Speaker 3:We do. And, and usually our experience, and sometimes physicians, you know, aren't familiar with these type transactions and they're surprised about how upfront the second transaction is. But the, you know, I think the idea is, you know, if this transaction's good, wow, the next one's gonna be better. I feel the deals are marching on. I feel there's been a lot of uncertainty driven to transaction this nature with, with the issues around clawbacks, with the labor force expense, being able to keep the, the margin where it, where it needs to be the, you know, pressure on reimbursement with the, with the a aspects of clawbacks in these deals. And also the FTC recently put out, uh, uh, an announcement that it's thinking about limiting the enforceability of noncompetes, and that's out for public comment at this point. But all that to me, um, makes it a little cloudier further out. And so, you know, my view is protect them as best we can in the first transaction and, you know, apply a, uh, probability to your point of what's gonna happen in the second transaction. Cuz I don't know, you know, so much it would be hard to go back three years or five years and even imagine what's happened in the last three to five years. And the clouds may part, uh, or the, or the, or we may have more stormy conditions around these type of transactions, but I think the real issue is protect them as best you can, uh, in the, in transaction one and understanding that there's a lot left to develop. Uh, it's like Yogi Bear said, it's hard making promises when you're talking about the future, uh, that, that there's only so much we can buffer them against future events.
Speaker 2:And I think one of the things that, um, needs to be considered outside of the cash or the, the, in not only the investment, but as you said, it's really what you get to keep at the end of the transaction and really taking into consideration what am I getting, what do I get to keep? And one of the things that I think, um, strategic buyers sometimes have that they don't really factor in or, um, put into the transaction in a manner that can really be quantified and it can't, is the fact that they are an entity already in the community. And then juxtaposing that with what is it you're getting from your private equity investor versus, um, uh, uh, say a health system. And I know you've worked on some, probably some, um, interesting and novel, um, investments with health systems into groups and other, um, other entities. How do you, how do you bring that into the conversation?
Speaker 3:Well, I think that's important. I, uh, you know, everyone has their point of view. I work with some large physician groups who think the ideal situation for private practice physicians is aligned PSA with the health system because it allows them freedom to have their governance allows them to have independent investments, ASCs, imaging, other type of arrangements. And it also allows them to have kind of a, a lifeline possibly through the psa. Now, the thing that the downside on PSAs is they're stark regulated. They typically have a finite period of time at which they have to be revalued and reconsidered and making sure they're, they're reasonable and necessary and fair market value. So there's uncertainty even in the PSA world. I have other, other, uh, health system clients who've decided they need to create offerings more comparable to private equity. So they're considering allowing, uh, investment alternative, you know, medical office buildings, uh, some instances, uh, ASCs even with employed docs, which at one point was not very prevalent, uh, seems to be picking up. We're certainly getting a lot of questions by employed physicians. Why can't they invest in ASCs? Uh, some of that is, is financial, some of it's regulatory. And then we've seen actually health systems who have gone new and novel ways to try to play in the value-based space where they actually are joint venturing practices with physicians operating the Moffitt bottom line model, much like, uh, much like, uh, private equity would bring in, uh, an enhanced third party to stand them up for value-based care and letting them contract for their best reimbursement, even though it may cannibalize some of the, this news to the health system. So that's why I sit started this call by saying, uh, everybody's kinda looking for their spot. Um, nothing operates in a vacuum. Um, there, there's a growing, uh, awareness of health systems that private equity is, is, is looking at disrupting the independent physicians as well as some employed physician relationships, aggregate them into bigger organizations. Um, and, and it's uncertainty as to what that means for them, which is leads you in a situation whether to embrace this or, or, or try to, you know, try to try to mote around your organization. Um, I see, I don't think anyone has the perfect solution, but the joint ventured physician group with an enhanced MSO feature is something that, that we think, um, you know, has real interest. If you're in a market where there's a good value-based opportunity, um, we actually see health systems looking to partner with private equity in order to, uh, to have aligned relationships. And they see this as an opportunity to go on offense. So groups that were not aligned with their health system can be, you know, if you get a platform group in the market, maybe the health system contributes its employed physicians to create the platform group. And then you have the tuck-in mergers along the way of the ancillary of the outline groups that may not have essentially been someone you had relationships with. So it's, it's a daily conversation. I don't know, someone will figure this out as the best I think, think, I think I think if it's not built around quality and if it's not cost, and if it's not built around the patient, it probably has limited duration, limited durability. But, uh, everyone needs to have the economics, uh, you know, everyone's attracted to good economics. Um, and sometimes we, we sometimes we see these things as oppos oppositional forces, but quality and the patient, uh, need to, need to be in the model in order to, uh, to make these durable cost is, is a rising imperative in, in every market we work in.
Speaker 2:That's a great comment. And again, you and I have been around long enough to see these things that they have gone in and out of fad. They were, uh, the hottest thing. Um, I remember reading, you know, three, three and a half inch, um, investment reports from Goldman Sachs and a lot of other investment companies that no longer exist. That said the physician management industry was the, the way of the future and then only to have that industry collapse. But there again, um, having not only sound economics, but patient value, um, those at the center of, of any model is going to be important. And I think you bring up a great point, Jim, in that there is one, there will be no one right model, and each market is going to have to, um, think about and respond or proactively act in a manner that is going to keep providers patients value in their, um, proposition, whether they be an acute care, uh, entity or an a s c company, company or whatever it may be, that at, at the forefront. And that is going to be coming up with new and different models. And I think that, so in my mind, I don't see private equity as, as being a bad thing in the market because it's going to force us to think more creatively. And again, if we keep those fundamental tenets of, of what it is to be in healthcare in a healthcare provider or, um, the, the triple aim and, you know, all these other things, we're probably getting onto ary aim or something else at some point. But, um, if we keep the patient at the center and what's in in their best interest in value, I think you're absolutely right in that you're going to have to work with and think about what you're willing to do in this new paradigm because it's not going away. And we're not even really addressing the whole other issue of payers and what they're doing to, uh, maybe that's, uh, a different podcast about how payers are influencing because that would take up an enormous amount of time. But all of these, all of these variables are impacting markets in different ways, and I think that, um, counselors and firms like yours are in a, um, in a great position to provide guidance in an area that, you know, is, is uncertain and it is novel because a lot of this stuff we haven't done before, and you need, you, you need advisors who can think about these issues and, uh, as you said, put'em in the context of not only sound economics, but sound, um, principles related to the tenets of healthcare. And, um, you know, I think that that that type of, uh, advisory services will continue to go into the, will also be fruitful for whatever happens in 23, 24 and beyond. Um, there's a lot of uncertainty in the market right now, financial world, global supply chain, you name it. And, um, I think private equity is gonna be looking to cash in on some of these returns. So it's gonna be an interesting next couple years. Any other things you'd like to discuss in closing?
Speaker 3:I think the, um, I think the real aspect of this is there's such a fear of being, fear of missing out, uh, that I'm seeing in the market at all. It's creating almost a heightened sense of urgency. And I think, I think you need to go back and, and I, I think, I think the disruption in healthcare created by the increased private equity is both an opportunity and a threat. It's an opportunity to innovate, it's an opportunity to revalue costs, it's an opportunity for physicians to earn returns in ways they haven't previously. So I think it's an opportunity and a threat and I think it's just something that, um, that should be approached with, with reasonable rational expectations. You know, there's somebody, somebody famous said, there's no such thing as a free lunch. There's always, uh, there's always pluses and minus to these type and healthcare is a, is a national service, but it's is delivered locally and each market is specific to its own dynamics and to its own players. So my view is it's everybody's worried this bubble may go, may burst tomorrow, but it's been to your, I thought you did a great deal review. It's actually been on the, on the incline, uh, on the increase, and it, I think it's, looks like it has legs for the immediate foreseeable future.
Speaker 2:Agreed. It's, it's here to stay and, um, we'll see what, uh, 2023. But as you said, we've been at this a long time. Healthcare's not going anywhere and, um, we can't deny that all of this will, um, be predicated on providers and patients and how those two interact and what's the value with inside that, uh, engagement. Well, I greatly appreciate you, uh, being on this podcast, Jim, as always, it's terrific speaking with you. With that, I think we have wrapped this up.
Speaker 3:Thank you, Chris. Thank you for the opportunity. Always enjoy our discussions.
Speaker 2:Likewise. Have a great day.
Speaker 1:Thank you for listening. If you enjoy this episode, be sure to subscribe to a H L A speaking of health law wherever you get your podcasts. To learn more about a H L A and the educational resources available to the health law community, visit American health law.org.