The Search for Capital

As private equity sets its sights in GI practices, is this funding option right for you?
Contributor: Scott Fraser

Generally speaking, the objective of a private equity firm, in its efforts to make money for its investors (typically large pension funds, wealthy investors and major institutions), is to outpace the market. To do so, firms look for strategic market areas that present unique opportunities, such as those experiencing significant pricing changes and new technology developments.

These firms also look for high levels of market fragmentation. That is why GI practices are starting to find themselves in the private equity spotlight.

Why GI? Why Now?

Over the past several years, healthcare has experienced massive consolidation in areas including payors, hospital systems and suppliers (pharmacy chains and pharmaceutical and medical device companies). Providers have experienced little or no consolidation other than large hospital systems buying their practices to secure referrals.

Tremendous fragmentation in GI groups exists today. Less than 5 percent of all gastroenterologists work in a group of 20 or more physicians, according to publicly available information. This presents an opportunity to aggregate physician practices to achieve economies of scale and market density, which private equity firms find appealing.

Also appealing are ambulatory surgery centers (ASCs), which have been a tremendous boon for the private practice of GI. When gastroenterologists invest in themselves in the form of opening and owning ASCs, they gain access to a model for providing better clinical care in a more efficient manner while saving money for the healthcare system. Private equity firms recognize the current and likely future value of ASCs and the importance they will serve in the efforts to provide more effective healthcare delivery.

While private equity firms, as non-healthcare entities, may seem like odd bedfellows for GI groups, a private equity investment in GI is possible under a management service organization (MSO). An MSO is essentially an investment vehicle that allows a non-provider to invest in a medical practice in a manner compliant with the corporate practice of medicine.

The Appeal of Private Equity

Why do private equity firms believe GI groups are interested in investments?

GI groups are experiencing the growing administrative burden every medical practice faces. Couple this with increased costs in all areas of a practice operation, investment in electronic medical records, complexity with contracting, operational and financial challenges with new technology implementation, regulatory and reporting requirements, and physicians are being asked to do more administrative work unrelated to delivering patient care than ever.

Organic practice growth in GI is possible but difficult. It takes strong leadership, but more importantly, it takes time and capital. It is not surprising that most practicing gastroenterologists lack the time and willingness to invest the capital needed to merge entities.

Enter private equity and the MSO vehicle, which not only provide the capital needed to accomplish successful mergers but also accelerate the process. The MSO structure allows GI groups to pursue forming a consolidated practice under a single tax identification number, with the ability to grow and prosper. Other areas of medicine, including dentistry, dermatology, urology, primary care and women’s health, have widely adopted the MSO model. It is a model GI groups may find appealing as they continue to face mounting internal and external pressures, including the continued focus on consolidation within healthcare.

Potential Risks of Private Equity

Like any investment, private equity investments carry risks. Private equity firms invest in strategic assets. Medical groups are financial assets—just like factories or retail chain stores—that are meant to grow in value and be sold.

Before you move ahead with agreeing to a private equity investment, understand that the firm you partner with today will not be your partner in the future. The typical investment window for a private equity firm is 3–5 years. Eventually, the firm will look to sell your practice. You can fall in love with one private equity firm, only to be later sold to another firm or strategic buyer you dislike.

While you might be eager to secure a private equity investment, do not rush into a deal without the appropriate support. These are complex transactions. Private equity firms are extremely savvy investors with every resource, from personnel to data, needed to secure the best financial terms possible for them as the acquirer of your practice. You will want to surround yourself with an experienced MSO legal counsel, accountant and perhaps an investment banker (note: investment bankers tend to charge very high fees for these transactions). If you try to make this deal without an experienced “deal team,” the results are not likely to be in your favor.

It is very easy to be swept off your feet with the terms of the transaction. By securing a private equity investment, you will likely earn a significant initial cash payout. But placing too much importance on this figure can hurt your practice long term. Rather, focus on what happens to your group post-transaction—specifically, what the influx of capital will mean to your group and how it will allow you to grow and deliver better clinical care, enhance ancillary service lines and secure better payor contracts.

That is why selecting the right partner is so critical.

Choosing a Private Equity Partner

As you vet potential private equity firms or strategic buyers like Physicians Endoscopy (PE), keep in mind these questions:

  • Does this firm have experience in the GI space or other sub-specialties like dermatology or urology that have substantial ancillary lines of income in their respective practices? The value of an experienced buyer should far outweigh the cash transaction in your decision, as an experienced buyer focuses on proven strategic growth initiatives post-transaction.
  • Does this partner truly understand and appreciate the uniqueness of the GI subspecialty? This concerns the sources of revenue that help drive a group beyond practice revenue, including investments in endocenters, additional ancillary service lines and skilled management that will help position your group for the future.
  • How will this firm help my practice grow both in my local market and regionally?
  • Does the firm understand alternative payment models (e.g., episode of care bundles, shared savings/risk arrangements) and have experience with self-insured employer contracting?

Ultimately, can this firm offer my group anything other than a cash transaction?

Look for a private equity firm that avoids short-term decisions to drive investment value and jeopardize long-term goals of providing better GI care. If your group approaches private equity investments in this way, you are more likely to maximize the benefits of the partnership and deliver the private equity firm a strong return.