Kim H. Looney, Partner, K&L Gates LLP, and John E. Kelly, Partner, Barnes & Thornburg LLP, discuss the current dynamics of private equity in health care. They cover why private equity is interested in health care and what segments they are most interested in, private equity deal trends, public scrutiny of private equity, federal and state oversight, compliance and regulatory considerations, and risk management. Kim and John spoke about this topic at AHLA’s 2024 Advising Providers: Legal Strategies for AMCs, Physicians, and Hospitals, in New Orleans, LA.
To learn more about AHLA and the educational resources available to the health law community, visit americanhealthlaw.org.
Kim H. Looney, Partner, K&L Gates LLP, and John E. Kelly, Partner, Barnes & Thornburg LLP, discuss the current dynamics of private equity in health care. They cover why private equity is interested in health care and what segments they are most interested in, private equity deal trends, public scrutiny of private equity, federal and state oversight, compliance and regulatory considerations, and risk management. Kim and John spoke about this topic at AHLA’s 2024 Advising Providers: Legal Strategies for AMCs, Physicians, and Hospitals, in New Orleans, LA.
To learn more about AHLA and the educational resources available to the health law community, visit americanhealthlaw.org.
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Speaker 2:This episode of A HLA speaking of health law is brought to you by a HLA members and donors like you. For more information, visit american health law.org.
Speaker 3:Good afternoon, everybody. My name is Kim Looney . I'm a partner at Canal Gates in Nashville here today. Speaking on private equity is a subject that , uh, I spoke on also at the Advisory and Providers Conference. And my CO today is John Kelly.
Speaker 4:Hi, Kim. Thanks so much. And, and welcome everyone. Uh , my name's John Kelly. I'm a partner at Barnes and Thornburg and chair of their national healthcare practice. I've had the pleasure of speaking with Kim on this topic about private equity and healthcare, and we're excited to, to share some time with you all today. So, Kim, let me, let me start right at the top. Uh, what is private equity? What does that mean to you?
Speaker 3:Well, I think it's something that it is important to kind of set out the framework, and that is, you know, everyone knows it's , it's money. I mean, you know, but it's a particular class of capital. So it's a class of capital that generally invest in mature companies. It's not early stage companies, but it is companies that the private equity firms feel are undervalued or underperforming, and that there's significant growth potential so that it's something that they can help this company get a little bit better and stronger. So, you know, I guess that's part of it too. What , why are they interested so much in private equity, John?
Speaker 4:Yeah. Well, I think , um, you know, I think folks in private equity, right? They're always looking for that next opportunity. They're looking for places where they can invest and , and grow money. And that's, that's exactly what we're talking about here in private equity. It's the money. Uh, I think what's happened is, is private equity firms, they see a particular value and the healthcare industry, they're willing to take on certain risk that maybe others might not be willing to take on. Um, and also if you take a step back and we think about where healthcare is today , uh, it , we've got an aging patient population that needs healthcare services. We have a rising prevalence of chronic disease. Uh, there continues to be development of, of, you know, new drugs, new devices. There's a lot of innovation in healthcare, just a lot happening here. So I think from the private equity perspective, they, they looked at this area and said, okay, this is a place where we can go in, we can invest and hopefully get really positive returns. And so, you know , that's sort of one side of it, right? The other side is, well, what are they actually bringing to the table that from a private equity perspective, Kim, and, and you know, that that's a little bit different, right? What they're bringing to the table is they're bringing that investment, they're bringing that money and that infusion of capital that, let's face it, a lot of providers and different healthcare services might need today. So instead of going, you know, sort of a traditional financial route in terms of trying to get access to funds, private equity has become a new place where they can look at that and, and, and seek that type of investment. Um, but they also don't just bring money, they also bring business expertise. Potentially they bring the ability to try to maybe increase efficiency. But I know we're gonna get into this. We're gonna get into the fact that, that there is a lot of different opinions, some good and some bad about private equity and healthcare. And, and so let's talk about sort of the time commitment when you're an investor.
Speaker 3:So, you know, private equity and investors have different time commitments. Basically, the private equity firm is looking for not a completely speedy out, but something more on the shorter side, like maybe a three to five year out. They might stay a little bit longer. They're generally not gonna be able to exit sooner than three years, but three to five, maybe seven. But they want the investor to be invested and all in for a period of minimum of 10 years. And there would have to be very significant penalties for the early withdrawals and potentially also the ability to extend that term. And part of the reason for that is because they're trying to build value in this enterprise. And one of the ways they can build value is to lock down those providers that are bringing the value to the table. So if they can kind of herd them and get them to doing some things that they feel will help increase the value in the entity, then you know, it , it's a good investment for them. And somebody down the road might also be interested in that investment. And, you know, some of it, you know, you look at what particular type of healthcare segment of the healthcare market is private equity interested right now. And a lot of that is the physician practices. And so we think about the physician practices. One of the reasons they're interested is because a lot of the control of the healthcare spend and the healthcare dollars are spent is done by the physicians. They do control a lot of what happens once the patient leaves their office. They control what tester order they control, what specialists they're referred to, if they're primary care doc. And a lot of the private equity is looking at different specialties. There's a lot of private equity oncology, gastro, you know, cardiology. Now, dental is a big area for private equity investment. So a lot of different areas have been sort of targeted and focused. And the reason for that, kind of what John was saying earlier, is because they're not operating as efficiently as they could be, and there's been this historic fragmentation. And so by kind of taking that off the table, they feel like they can deliver a better product and increase the value in the healthcare entity in which they're investing. So, you know, John, how, how much money are we talking about? Has PE been investing?
Speaker 4:Oh , it's been , it's been actually a pretty amazing ride here for private equity and healthcare. And, and it really started as we started coming out of the pandemic. And , uh, back in 2021, I'm not sure anyone would've predicted that, but the number of deals rose 36% in terms of private equity and healthcare and healthcare related deals. And it went from 380 deals to 515 deals. I mean, that really like a massive increase, right? The , probably the biggest increase ever. And the value of those deals rose from 66 billion to $151 billion. So again, it, it , it doubled more than doubled , uh, just in one year. Then when you get to 2022, there was a slight slowdown, but it was still the second highest year on record for deal value and deal count. And, you know, that included even a 20% drop in deals. But again, a still massive number of deals that took place. So 20 21, 20 22 were absolutely huge in this space. Uh, and we get to 2023 there , started to see a little bit of a decrease there, you know, coming out of 2022, still a number of deals in the healthcare sector, but not like we had seen. But signs are pointing in the right direction here going into 2024, because as we got to the end of the prior year, the end of 2023, we started seeing some more growth in the buyout market. We think that inflation is leveling out due to the higher interest rates. We think that healthcare wage inflation is falling, and we think that the market is improving for private equity investors in healthcare. So all the trends are going in the right direction here, go here in 2024, moving into, you know, Q2, Q3, Q4. So again , uh, still a hot area, still an area that private equity believes in and an area that I think we're gonna continue to see investment.
Speaker 3:I think one of the things we also see is private equity is not really operating under the radar anymore. There seems to be increased scrutiny of all these healthcare deals. Why do you think that is?
Speaker 4:Yeah, it , it , it , part of it is, I , I believe that, that there's some questions right around who really owns entities, who's really making decisions around entities. Um, and there's also, let's face it, Kim , uh, you know, there tends to be a bit of a PR issue for private equity and healthcare. I mean, they, they're get , it's been pretty rough on them in the public. And so , um, two sides right to this story, like we mentioned before. So you've got the public scru increasing, right? People focusing and , and , and having concerns over cost over the quality of healthcare over access to care, right? If you think about sort of in a community and private equity comes in, let's say it's a nursing home and they invest in that nursing home or, or they eventually, you know, come into the nursing home and then the nursing home changes its operations, or it eventually dissolves, that starts creating issues of access to care. And again, this issue around transparency has been something that we're gonna continue to talk about through this podcast, but one that has really come to the forefront from a regulatory oversight perspective and even up on the hill. Um, but a , as these number of deals continue to grow, and private equity continues to be involved in healthcare, I think you're only gonna see an increase in the oversight and scrutiny because , uh, there's just a lot of questions and folks wanna know who, who can be held responsible when there are issues. And so I don't think that's gonna change at any point in time.
Speaker 3:I agree, and I think it looks like, especially as far as nursing homes, that that government scrutiny is increasing. And I think one of the reasons is 'cause nursing homes , uh, serve a very vulnerable patient population. It's definitely nursing homes. People are very elderly generally in nursing homes these days. And there have been studies that have shown that the quality's lower with PE investment, that the staffing levels are lower with PE investment. And so it's sort of the low hanging fruit. I don't think it means that their focus is stopping with nursing homes by any stretch of the imagination. I think that it was just an easy place kind of for them to start . And someplace that there had been a lot of information in the press about that, and, you know, I think that that's just something we may see a little bit more of. Uh , you know , think about that. Go ahead. I'm sorry.
Speaker 4:Yeah, no, no, no. I, I agree. I mean, and if you just read the tea leaves, right? We see the SEC comes out, right with, with rules around transparency. Then just in January of this year , uh, H-H-S-O-I-G uh, comes out with some rules around , uh, expanded ownership and understanding who's actually in control and who's making decisions. And the transparency being, again, the key word of the day when it comes to healthcare investment, especially when it's private equity. So, you know, to your point , um, there's been some data, right? That, that has been very challenging for private equity. Um, and then there's folks that really support it , uh, from an innovation and, and a need for capital. Uh, let's face it, there's a lot of healthcare services struggling, but this, this issue of transparency is only going to get, I think, louder and more aggressive. And we're seeing it not just at the federal level. We mentioned SEC and, and obviously , uh, H-H-S-O-I-G, but we're seeing it at the state level too. Um, the states and the feds wanna know who's involved. And in fact, just in , just in the last few weeks , um, there, there was an A joint FTC and DOJ and , you know, sort of step over to the antitrust world, not just sort of the just basic regulatory healthcare quality of care and access to care issues. But now the FTC and DOJ hosted a public workshop, and they literally talked about, quote , the corporate greed in healthcare consolidation and the role of private equity. So again, I, I think that this is only gonna continue.
Speaker 3:Yeah, I agree. I mean, I will say, and it does have to do a lot with, with, you know, when they see things in the newspaper. And yes, when you talk about a PR problem, some of those headlines are extremely sensational. I mean, I was looking at one the other day, and , uh, you know, you do have to wonder to some extent this was dental related . It was a 2-year-old who died after receiving six crowns. I mean, I'm not sure why a 2-year-old was going to the dentist to begin with, but apparently there was a loss of oxygen and he died. So, you know, it was a PE-backed dental practice that just makes for sensational headlines and certainly means somebody has to be looking out for all these, these issues. And, you know, some of the quality issues that, that they've seen are, you know, an increase in falls. You have double surgical site infections, even when the surgical volume has declined. You know, there seems to be higher cost and reduced staffing levels in hospitals, and there seems to be a higher death rate in nursing homes when they're private equity backed. Now, that's all the bad side that we can talk about private equity, but I agree that we've talked about, there's lots of money going into healthcare that would not be available to provide services that are available at this point without the private equity money. So it is not just, you know, some people would paint it as just the devil incarnate, you know, private equity, oh my gosh, let's get them outta healthcare. But there are lots of reasons to have private equity in healthcare, and, you know, we're not gonna argue about that one as far as, you know , whether it's a good or bad thing, because it does some very good things. Uh , you know, we go back and think about it. Um, you know, there's, there is a lot, you know, when you talk about the increased scrutiny. Uh , talk a little bit about some of what the states are doing for enforcement. I mean, you know, it's not just your federal anymore with their antitrust, with their hearts , Scott Rodino that really only looked at your very large healthcare provider transactions. Seems like the states are getting into it now as well.
Speaker 4:Absolutely. And, and again, there's been already federal oversight, right in , in this world in terms of watching what's happening when there's investments in healthcare and analyzing deals. You have F-T-C-D-O-J-S-E-C all part partaking in that H-H-S-O-I-G now as well. But what's happened is state governments are saying, Hey, wait a minute, these are our communities. We wanna understand what's happening in our communities and understand the future of healthcare delivery systems in their backyard. And so , uh, they're , they've become much more active in terms of enacting legislation that targets healthcare transactions, not-for-profit facilities, hospitals, any other types of healthcare transactions and services. And the state laws, again, focus on transparency. They wanna understand when there's gonna be a deal in advance. They wanna understand what is the deal , uh, who's involved in it, and they want to have the time to allow their attorney general or another state agency in that state to be able to conduct a thorough review, ask the right questions, and understand the nature of the deal and what the structure of the deal's gonna look like, and what is this gonna mean for healthcare and it's , and their community. So we're starting to see a lot of examples of that. New York enacted legislation back in August of 2023, requiring 30 days of notice to the New York State Department of Health of any, and I'll call , you know, in quotes, material transaction involving healthcare entity entities that provide management services. Uh, we've got other examples of this type of trans , I'll call it transparency , uh, statutes in healthcare, California, Colorado, Connecticut, Massachusetts, Nevada, Washington, Hawaii. A number of them have all been going down this road. And I think you're gonna see, of course, more to follow, right? I mean, other states are gonna see this and say, Hey, wait a minute, we need to understand this as well. So again, I think , um, no slowdown in , in , in this effort. And, and the hope is it's gonna make deals just better. Um, but to your point, I do think that, you know, there can be some good from this as well, and we can't forget that in the states and federal agencies can't forget that either. Um , but when we talk about a healthcare deal, Kim , um, you , you know, you do deal work. What are the type of compliance issues and regulatory issues that you see in a private equity deal? What are the kind of things you need to be careful of?
Speaker 3:Well, there are quite a few. I'm not go into those , but I do wanna go back just to you talking about the state oversight. Because when you think about it from a deal perspective, that's gonna be very challenging. Because if you're doing a deal and it's across multiple states, you're gonna have to know what the requirements are in each state, just like your licensure requirements in each state. This is just another layer and a level of complexity to the deal that you're gonna have to look at. So when you think, and that's, you know, so we'll add that to our list of our regulatory and compliance issues. Your state, you know, antitrust is gonna be a little bit bigger, but so you got your federal antitrust, your state antitrust, we're talking about, you know, you can have state fee splitting requirements. There might be different licensure requirements. And once again, anytime you're dealing with a state that's a state by state case by case basis, trying to deal with that, you know, your anti kickback is gonna be an issue. It's a little bit different than in a deal with , uh, you know, like provider to provider because you don't have the same, quite the same concerns because your PE company is not doing any referring, the doctor's aren't referring the PE company, the PE company's not paying them to refer to something, you know, so it's a little bit different from a regulatory standpoint, but one of the bigger issues you have to think about when they're talking about provider practices is the corporate practice of medicine. Corporate practice of medicine is still alive and well in many, many states in the United States, with each of them having their own little quirks sometimes to the regulatory framework. So that's a piece you kind of have to be looking at as well. Um, when you think about the stark and the , and our kickback issues, those aren't necessarily unique to PE transactions. They're available and, you know, have to worry about them in all healthcare. But what you do have to worry about sometimes is if it's not, you know, if it's somebody that's new to PE and healthcare, they might not really understand or have experience with the healthcare regulatory landscape. And it's hard sometimes to educate people and get them up to speed on the fact that what they might have been doing for years and all the other industries of which they've been investing money is not something that they can do in the healthcare space. And so that's sometimes difficult to do and also especially difficult depending on the client. But I think another piece of it is, you know, your risk tolerance may be different for private equity also, but no more is private equity staying, you know, out from under the lens of the federal regulators or the state regulators. They can be held liable for things that that are being done wrong as well. So, you know, the regulatory concerns that you kind of see with the PE deals are around the management fees, you know, the earnouts, the roll forward equity marketing advertising, what money is going where, and is it being, you know, kind of appropriately spent. And you know, as I said before, the real challenge is that what, you know, terms and provisions, you might have an agreement if you were dealing with an industry other than healthcare. You can't do those in healthcare. So I think that makes it , um, just makes it a little bit challenging. And also to be, you know, to be quite honest, we've talked about this a little bit before, but you know, it's one reason why the enforcement is on your private equity. I mean, John mentioned how much money there is in private equity and how much it's grown, you know, biggest growth in 21, but it's not like it's, it's , um, it's not like there's not still a lot of money going into healthcare, even though it may have slowed down a little bit. So, you know, it's increasingly important in the healthcare industry. So as it gains importance, it's gonna come under more scrutiny. It's, you know, the money can be seen as driving change in healthcare. You know, a lot of those changes are really good, but some of them, from a quality standpoint, and the headlines that we see may not be so good. So, you know, that's, that's kind of , uh, something that you have to be careful about and they wanna make sure, you know, part of it is that PE is not pressuring the providers to do things that maybe they shouldn't be doing, that they're not worried so much on the money and not really worrying about the patient care. I mean, when all said and done in healthcare , the patient care is the most important and the quality of the patient care is the most important thing that is going on in this industry. And, you know, you just wanna make sure that the financial considerations aren't gonna harm the quality and access to care. And I think that's when, you know, you're thinking about somebody who's not a provider who's got the money in healthcare. And I think that that's, you know , that's something that is looked at, especially these days. I think the enforcement agencies also, what they kind of focus on is they, you know, it's, it's , it is partly a transparency thing. And what is the PE investor's involvement? Are they really involved in the day-to-Day operations, or the day-to-day operations left to, if it's a physician practice, a physician practice, or whatever provider entity we're talking about, what is the role in decision making ? You know, they shouldn't have any say in really the individual , the physician's independent medical judgment or those clinical decisions. So you have to make sure they don't interfere with any of that. And, you know, does the PE investor understand the risks that's involved with the healthcare entity that it's dealing with? So all of those things , uh, mean that there's gonna be a focus on healthcare for some time to come, as long as the money continues to flow in that. So, you know, I think one of the things, John, that we should tell everybody next is just a little bit about , um, what , what can they do to limit the risk? And , and the risk may be , you know, one of the risks from the PE side is, you know, the whistleblower action could wipe out the entire value of the portfolio company. You know, if there has to be a settlement, if there's defense fees, their reputation, you know, the PE firm, as I said before, can have direct exposure to liability under the False Claims Act and the state law equivalents and also the H-H-S-O-I-G inclusion administrative action . So just because it's, it's handing over the money does not mean that it's free from any issues in the operation of the entity. So have to make sure how much, how much involvement there is in what they're doing, and make sure that as they're increasing the value, that they're not violating any false Claims Act or anything else. So, you know, I don't , well,
Speaker 4:That's the hammer, right, Kim? I mean that False Claims Act and, and we've seen settlements , uh, where ex you know , diabetic Care rx , uh, south Bay Mental Health Center, I mean, these different settlements that have come through where it's not just the PE firm that's paying money, but some of the individuals as well, and the millions of dollars. And so it , it's the company, it , it , it's the, it's the private equity firm. It's individuals and executives who, you know, maybe , uh, aware of issues and not addressing them. But to your point, I mean, that risk is out there. And I think that's why when , when you ask the question, what, what is really, what can you do to limit the risk? I mean, to me it's, it's, number one is just due diligence, due diligence, due diligence. I mean, you have to be out in front of this and have counsel that understands healthcare, that really understands it, that can guide you through a transaction and make sure you understand and can identify risks and deal with them before you inherit them, and it becomes your problem.
Speaker 3:No, I agree. I mean, and not just are you doing your due diligence, but what are you doing on a going forward basis? Have you got a robust compliance program? This is not a time for the PE company to come in and decide they need to cut costs , and the place to cut costs is the compliance activities. No, that is not, that is never a good idea. And definitely would not be a good look if something goes wrong later. So, you know, what are they doing? Yeah ,
Speaker 4:It's a horrible
Speaker 3:Story. How much government related business do they have? I mean, are they gonna be something, you know, do they do like more than 50% government? So they're gonna have a big target on their back from the beginning, you know, if it's something that does not do a lot of government business, but you know, a lot of 'em are involved in women's health, that's definitely a lot of government government payments. So, you know, you got , you gotta look at what is the PE company trying to do? What are their business objectives? I mean, they're trying to build volumes that increase revenue, increase value, but, but they have to do that in a legally compliant way. And so that's, that's kind of, you know, to some extent like any healthcare business. But I think it's something that with private equity that's still new enough to the healthcare world. I mean, not like it was yesterday, but there's still a lot of private equity getting into healthcare that's not been in healthcare before, and making sure that they understand the nuances and the risks involved with, with , uh, working in the healthcare space. You know, well , <crosstalk> go ahead .
Speaker 4:No, no, Kim, I was gonna just say, you know, you , and you made such a good point about the compliance piece, and that's not the place to cut costs. I mean, nowadays, right? D-O-J-H-H-S-O-I-G , they are very firm that, it's not that you should have an effective compliance program, but you must have one. And that is a very tough story to sell if you're in front of DOJ . I mean, I've been in the room on both sides of this at DOJ and now in the private sector, and they're gonna ask you about your compliance program and how did this happen and what did the compliance program do, and how did it react? And if your first message is, well, we used to have, you know, 20 compliance officers, now we have four , uh, that's gonna be a tough call <laugh>, tough,
Speaker 3:Tough conversation . That's a , that's a problem. The optics of that are not good. Unless your four people are now working four times as many hours and they get zero sleep at all, then, you know, you do not have as robust a compliance program as you had. Now. Maybe you had a robust , uh, more people because you had some issues, and now that you've cleared up the issues, maybe you don't need as many people, but 20 to four, those optics aren't good. So that's, that's just never gonna be a good idea, you know? Um, you know, when you're going back to your diligence and your compliance and everything else, you know, that's sometimes also in addition to lawyers, you need more people on your team. You need some, you know, consultants , uh, with relevant healthcare regulatory expertise. Also, you need to be looking at, you know, ongoing audits of your own business to make sure that you're being compliant in the way that you're supposed to be. You know, make sure the company understands those compliance issues, man, they gotta address those immediately. You do not say, oh , let's wait till the next quarterly board meeting to talk about that compliance issue. We've already got a full agenda this time. No, that is not, you know, all of those things just, just do not look good. And, you know, you just gotta make sure that they're dealing with that compliance. Make sure if there's incentives for anybody that they comport with the anti-kickback, the False Claims Act laws, I mean, you know, just like anything else, the government's gonna follow the trail of the money and where is the money gone and what is it being used for and what's, what's the purposes for which it's being used? And, you know, if it kind of goes back to, if it sounds too good to be true, it's probably too good to be true. So definitely be careful with what everybody's doing. Um, you know, I, I think you talked about the money before. I mean, when you look at how much money there is in private equity, you know, government might see private equity as having deep pockets. I mean, who are they gonna go after? You know, they, they have a lot of money. They have a lot of money, you know, that they have put at risk in these companies. And, you know, as we said before, they could , they could lose it all depending on how they operate. So that's not a good thing. Um, I'm sure you've probably got another couple other tidbits we can tell people about how they can mitigate the risk.
Speaker 4:Well, I, I , I think, again, you know, it's the due diligence on the front end. You, like you said, focusing on how you're gonna operate after the deal and the transaction , uh, your compliance program, making sure that it's effective. Um, and , and , and look, just keep doing , uh, you know, the right things around that program, getting the legal help. You need, don't, don't hire your buddy down the street who does real estate to advise you on healthcare. Um, but I do think, Kim , I mean, should we give a teaser for what's coming? Can we give a teaser? Um, yeah,
Speaker 3:How about that? Well, let me go back to hiring your buddy. Yeah , especially in smaller towns, you have to be really careful because you don't have the healthcare expertise that you necessarily need, but you're not doing anybody any favors if you don't hire counsel with healthcare expertise. You know, somebody that does this day in and day out, not somebody that dabbles in healthcare because it, the rules or the interpretation of the rules change so frequently that you just gotta be up to date on all of that. So yeah, a teaser things to come. Um, John and I , uh, along with another , uh, healthcare expert on the government side are going to be speaking at the annual meeting on private equity. So if you come to the annual meeting, be sure and look us up.
Speaker 4:That's right. Well, we appreciate Kim, thanks so much for this. Thanks to the HLA hope folks will join us at the annual meeting on this topic since it is , uh, continually evolving and, and gonna be here for a while . So , uh, thanks everyone for joining us today. We appreciate it.
Speaker 3:Thank you.
Speaker 2:Thank you for listening. If you enjoy this episode, be sure to subscribe to a HLA speaking of health law wherever you get your podcasts. To learn more about a HLA and the educational resources available to the health law community, visit American health law.org .