Questions From Episode 13 About PE

[Chip]

During the webinar last night, we had a few hundred distinct comments and questions. I gathered up the outstanding questions and collated them into what you have below. I’ll seek some professional input, but I invite anyone to add their $.02 about the topic of Private Equity in this thread!

1. Can we identify some well known PE-backed firms presently running and/or purchasing independent pediatric practices?

2. How does a practice become attractive to a PE firm?

3. Are PE firms replacing physicians with mid-levels in order to reduce cost and increase return on investment?

4. What is the typical timeframe for a PE investor to want to sell its investment? Does that time start when my practice sells to them or when previous practices join?

5. What effect will the potential FTC ruling on non-competes have on these investments? If there isn’t a non-compete, could a pediatrician sell to PE and then just start another practice next door?

6. How is a hospital purchasing a pediatric practice different from a PE purchase?

7. Can anyone share outcomes - quality of care, patient satisfaction, cost of care, clinician satisfaction - from practices who have been bought out by PE? How does it compare to being purchase by a hospital?

8. What do typical employment agreements look like in a PE practice? What kind of autonomy do physicians have?

9. Is owning the real estate a key piece of this transaction?

10. What are typical “multiples” for what PE is paying for practice? Can we put that in terms of $$ per doctor?

11. How can we negotiate better non-competes for ourselves?

12. What alternatives are there to being purchased by a PE firm if the owners are looking to retire but don’t want to close the practice?

13. Who are the PE firms hoping to sell their pediatric practices to?

[Paulie]

PE versus Hospitals for $500, please, Alex…

Q6- How is a hospital purchasing a pediatric practice different from a PE purchase?

Paulie’s answer:
One key distinction is Stark Laws. While there are many ways around initial limitations when a hospital purchases any practice, the general approach is that the payment for the practice cannot be seen as an inducement for referrals. Basically, the hospital cannot be viewed as paying physicians crazy amounts of money so they get their referrals. Personally, it’s not as big a deal for pediatrics as cardiothoracic surgery or orthopedics. But it is a compliance issue that needs to be satisfied.

In addition to the due diligence surrounding the prudence of the investment, the hospital has to do additional compliance work to make sure the purchase price is justifiable AND the compensation for the providers after the purchase meets the “fair market value” standard. This is a fairly gray area, in my opinion, as I’ve personally seen a wide interpretation of such “market research” to suit the hospital’s needs. Additionally, the hospital sometimes has to justify their acquisition of the practice via its own “Community Needs Assessment”- which is a laughable process that allows for shoddy “market research” to suit its needs.

To determine the reasonableness of the purchase price, they may hire a third party to provide an opinion. For compensation, the hospital will consult with recruitment firms and review national surveys to make sure the compensation going forward are within industry norms. Again, both have a lot of wiggle room.

Here’s where selling to a hospital gets stinky…in addition to giving up your autonomy and being subject to their bureaucratic way of doing things, the initial purchase price is generally limited to the “book value” of the practice (thanks to Federal Stark Laws). I’ve personally seen several deals where the amount was not at all impressive. Adding to this is the reality that pediatricians do not refer much business to hospitals versus surgical specialties. The reality is that since the “downstream” revenue a pediatrician provides to the hospital’s bottom line is negligible, pediatricians cannot command a purchase premium like their surgical colleagues. What’s interesting about Stark Laws is that while hospitals cannot consider the value of your referrals when determining your purchase price or compensation, such information CAN be used in evaluating the merits of the investment. It’s splitting hairs but remains an important distinction.

Even if selling to a children’s hospital, they would rather, in general, structure a deal with as high as possible ongoing compensation in exchange for a lower initial purchase price. The expectation should be that the hospital will pay “book value” of your practice and provide a market-supported compensation package. Most offers I have seen show a significant increase in ongoing compensation as the hospital has better contracts with payers- which allows them to net out more compensation to the provider, even after the fluff of higher benefit costs and additional cost allocations. There are a variety of “affiliation” arrangements floating out there where practices receive minimal, if any, up front compensation in exchange for higher expected annual salaries/compensation.

There is a fairly new thing (last 5-7 years) popping up more that I’ve only seen the details on a few times. These involve “joint ventures” between a hospital and a pediatric practice. Basically, it creates a new entity jointly owned by the hospital and the physician group- which then provides maneuverability in terms of how much can flow back into the pediatrician’s pocket (initially and annually). I’m not the expert on this and only mention this as an option to consider asking about.

In general, unless there are some unique features of the transaction or there are simply no other options for the owners of the practice, a pediatrician selling to a hospital is asking for the lowest upfront payment in the market to buy your practice primarily due to the Stark limits.

Private Equity (PE) has much more latitude- driven by their analysis and financial goals after evaluating the practice’s financials via a due diligence period. They are not limited by Stark Laws or “fair market” value for compensation unless the same PE firm happens to own a hospital in your area (not likely, but possible). In general, PE firms also can provide flexible upfront or deferred purchase price payments via stock/equity options as well as rain as much money as they want without fear of government objections (aka fines and penalties).

While the hospital may have a consistent methodology to determine how much to pay the practice and the ongoing compensation, the PE firms are only limited by their desire to purchase a given practice. In a single market, the same PE firm could pay one pediatrician 4 times their annual earnings and another 10 times simply based on their desire to have the second pediatrician on their team. Hospitals are much more predictable within a given market thanks to government involvement whereas PE firms are wildly variable based on their appetite for risk and fixation on having a specific practice listed on their website, etc.

If given the choice between a hospital and a PE firm, I’d go with a PE firm. Worse case, the loss of autonomy is potentially greater with a hospital. Depending on the PE firm you go with, they may focus on a given specialty and provide more options to provide feedback/influence on their strategic plan.

Quoting a friend of mine from this evening…“Pediatricians have [been] giving their practices away for nothing for far too long and finally someone is valuing them [properly]…much like the ice cream shop” (reference to my analogy in last night’s webinar.

All the above assumes that there are no FTC/monopoly concerns- which is another whole ball of wax…

-Paulie

[Chip]

Great response from @Paulie. I’ll add a few things to this specific question:

• whether you are purchased by a hospital or a PE-backed entity, the hospital is almost always going to require you to get onto their hospital-focused software. Which usually means Epic. I realize that there are practices here who like their Epic implementations, but it’s generally safe to say that the hospitals aren’t at all interested in paying for Epic to be ambulatory pediatric friendly. The PE groups are more likely to be on a platform with more ambulatory focus (Athena, NextGen, eCW, etc.).

• joining the hospital is about joining their biosphere. If you somehow end up on the outside of it later on (as so, so many do), you can find yourself excluded by narrow networks or other clinical limitations. If all of your friends are tied into the same Epic system that, federal laws notwithstanding, you can’t seem to get access to for clinical records, that can be painful. The PE firms are much less likely to have the same local impact as your hospital, which will sit on top of your town whether or not you join them.

• IMO, hospitals have a much larger appetite for poorly run practices. In fact, in the previous national consolidation runs that seem to happen every 10y in this business, the hospitals almost always ended up with most of the weaker practices in town. After all, who else sells out so cheaply? Fast forward 5 years and the hospital has lost a ton of money, those practices start getting kicked out. A PE firm has much bigger bosses to please and is not only less likely to start with a bad practice, their less likely to keep them. Harder to hide in the PE situation.

• If you get purchased by a hospital, you’ll still be owned by the same hospital in 10y. Or, at least, a hospital. In the PE space, you will have had multiple owners in that 10y time, including potentially public shareholders. There is MUCH more ownership continuity in the hospital space.

• Perhaps most importantly: the hospitals almost always have better fee schedules from day one. But their billing departments are generally worse. PE firms often don’t have better fee schedules because they haven’t reached the leverage point in their market to dominate the way a local hospital has. But their billing departments are better.

Your mileage may vary on all this and obviously its incredibly specific to each situation. These are very broad brush strokes!

[Chip]

I was able to get more input about the questions from the other night from an educated source. I hope these questions/answers are helpful!

Can we identify some well-known PE-backed firms presently running and/or purchasing independent pediatric practices?

KKR, Apollo, Blackstone Group, Summit Partners, Veritas, Shore Capital, Audax Group, EQT, TPG, and Welsh Carson Anderson Stowe, amongst others

Are PE firms replacing physicians with mid-levels in order to reduce cost and increase return on investment?

Yes and no. There is a limit to the replacement of physicians by mid-level providers both from a skill standpoint and regulatory standpoint. Example: If you are part of a practice where a physician is administering every shot for every patient, a PE firm would likely have a nurse do this. Its unlikely physicians are administering all vaccines but this highlights an area for “improvement” PE firms would look at.

What is the typical timeframe for a PE investor to want to sell its investment? Does that time start when my practice sells to them or when previous practices join?

From the original acquisition of a Company A, a PE firm will have an investment horizon of roughly 5 years. This can be shorter or longer for ± 2-3 years. You should not think about their investment time frame as 5 years after they acquire your practice, its 5 years after they acquired the Company A. Example: Company A is acquired by PE Firm B in 2023 and they acquire the practice of Physician X in 2024. Company A will be sold by PE Firm B in 2028 even though Physician X practice was acquired 4 years before.

What effect will the potential FTC ruling on non-competes have on these investments? If there isn’t a non-compete, could a pediatrician sell to PE and then just start another practice next door?

Roll-up strategies rely heavily on non-competes. When a PE firm acquires a medical practice, it relies on having physicians stick around so patients stick around. If there are no non-competes, its difficult to see roll-ups working. That’s because if there’s no non-compete, a pediatrician could sell to PE and open another practice next door. For this reason, a PE will not buy your practice without a non-compete.

What do typical employment agreements look like in a PE practice? What kind of autonomy do physicians have?

Employment agreements are 1 - 3 years with 100% fixed compensation or, a portion in fixed and a portion in performance based compensation. Non-competes are 6 - 18 months with physicians being prohibited from practicing within a radius of 3 - 10 miles from an existing practice.

Is owning the real estate a key piece of this transaction?

It is not. Your practice and the real estate should be considered two separate transactions. You get paid for the practice in one and get paid for the real estate in another.

What are typical “multiples” for what PE is paying for practice? Can we put that in terms of $$ per doctor?

Multiples can range widely but for healthcare roll-ups, multiples have been 3x to 17x, with larger “platform” acquisitions going for a higher multiple. Pediatrics would likely be in the 3x to 10x range.

Who are the PE firms hoping to sell their pediatric practices to?

PE firms have four options when they are exploring selling their companies: 1) another PE firm, 2) a publicly traded company (e.g., HCA), 3) a large healthcare system (e.g., United, Ascension), or 4) they take the company public.