Should your practice be acquired by private equity?

A note of caution

Is private equity good for gastroenterology? The answer is not a definitive “yes” or “no”; it is “depends”. That said, private equity is here so you must understand the implications.

Private equity is an alternative investment strategy focused on assets not listed on a public exchange. Capital usually is derived from investors who can tolerate risk with the hope of a high return such as pension funds, university endowments, and high net-worth individuals. Capital is collected within a fund (or funds) managed by a professional team who invests in, or buys private companies using internal capital leveraged with debt (leveraged buy-out or LBO). Assets and governance both are sold to fund managers, who restructure operations, centralize or standardize workflows, acquire similar companies to achieve economies of scale, and eventually resell the new company to another entity (usually a larger private equity fund). Typically, the resale (second bite) occurs 5-7 years after initial acquisition and during that 5-7-year period, Private equity funds expect a substantial (10%-20%) annual return on investment resulting from revenue enhancement, new service lines, and overhead reduction.

Since 2016, private equity has actively courted GI practices and there now have been over 20 closed deals. Private equity fund managers have specific expertise in valuing GI practices, enhancing revenue, reducing overhead, collecting other regional (and sometimes distant) practices, centralizing operations, converting all practices to a single EMR, payer negotiations, and other practice functions, while leaving clinical care decisions to providers. Although this postacquisition scenario sounds attractive, there are downsides.

First, let’s review the upsides. As a mature partner in a highly valued practice, you could expect an acquisition payment in the range of $1 million (subject to capital gains tax). You receive a gross distribution based on a purchase multiple (9-12 times EBITA – a measure of your annual profit), minus investment in the new company, and annual payments to the Management Services Organization or MSO. Your income going forward will be reduced by annual obligations to the private equity fund, about 10%-40% of your production. Typically, a second sale occurs between 5 and 7 years after acquisition (yet to occur in GI), where the new company sells for another EBITA multiple (so it is in your financial interest to keep increasing practice value). Even with a modest EBITA multiple, you might net an amount that is double the initial acquisition payout. A senior partner could benefit financially in ways not readily available through other avenues of retirement.

Another benefit is access to capital to acquire more practices, bring new technology, improve facilities, integrate clinical and practice information, and weather reduced demand (like occurred with COVID-19). Independent practices are struggling to incorporate digital technologies that patients now expect, enhanced (and more expensive) endoscopes, new service lines, and the demand for real patient outcomes data during payer or health system negotiations.

So, what takes private equity from a clear “yes” to a “depends”? During COVID-19, physician incomes dropped substantially, since any revenue went first to pay bank debt, then fund fees, payment of overhead (leases, vendor commitments, residual staff), and finally to the doctors. A recent Medscape survey of 5,000 US physicians, revealed that 62% of MDs saw their income drop (23% by more than 50%). Physicians employed by health systems did not see nearly that income drop.

Once a practice is sold, physicians lose autonomy. When you are acquired by a private equity fund, the primary goal of the fund is a financial target. Long-term staff may be downsized, you may be asked to use equipment or supplies that are not to your standard, relationships with regional payers or health systems may become adversarial, productivity targets may alter your patient care decisions (more procedures, less external referrals), and relations with your partners may be strained (younger versus older).

A young physician who enters a private equity–acquired practice may work for decades at an income level discounted from preacquisition levels. They face a substantial buy-in if they hope to benefit from the second sale. Of course, one might argue that future salaries for all gastroenterologists will be reduced by increasing technology costs (endoscope companies are adding AI – can’t wait to see their pricing), reduced reimbursements, and increasing labor and supply costs. Serious threats to colonoscopy-based cancer screening are here, a development that makes future values of GI practices more tenuous. Finally, our payer mix will be worse than before COVID-19 because of long-term financial strains on the US economy.

We have to reflect on a similar practice acquisition trend that occurred in the 1990s, where practice management companies bought independent practices. While times are different now (for many reasons), all but one of those companies went bankrupt and the acquired practices had to rebuild from the ground up. Private equity funds that are heavily leveraged are especially vulnerable, as can be seen by current bankruptcies of large established companies (Hertz, Neiman-Marcus, and others).

Finally, we have to ask ourselves how patients will view your practice as more of us become acquired by financially driven partners. No matter how we paint private equity acquisitions, people understand that these funds are financially driven and practice sales are an income enhancement play for physicians. In 1986, Arnold Relman (Editor of the New England Journal of Medicine) gave two Tanner Lectures on human values at the University of Utah. He asked the following question:

“Is medical care a consumer good like any other, a commercial service provided by skilled vendors for consumers willing to pay the market price, or is there something fundamentally different about the relation between doctor and patient?”

I am not a Luddite, nor am I Don Quixote jousting at windmills. I do, however, want you to consider carefully before giving up on the traditional practice models that made our specialty what it is.
 

John I. Allen, MD, MBA, AGAF, is clinical professor of medicine, department of internal medicine, division of gastroenterology and hepatology, Institute for Healthcare Policy and Innovation, University School of Medicine, Chief Clinical Officer, University of Michigan Medical Group, Ann Arbor. He has no disclosures and takes full responsibility for the content.