CEDARS/ASPENS Debates

Should a practice partner with a private equity firm?

Mark Kontos, MD, and James C. Loden, MD, take a look at these partnerships and what they mean for practice owners.

Welcome to another edition of CEDARS/ASPENS Debates. CEDARS/ASPENS is a joint society of cornea, cataract and refractive surgery specialists, here to discuss some of the latest hot topics in ophthalmology.

One of the more frequently asked questions for those owning a practice is whether to partner with a private equity firm. These partnerships have become more popular recently, but it may not work for everyone. This month, Mark Kontos, MD, and James C. Loden, MD, discuss the pros and cons of partnering with private equity and share their personal experiences. We hope you enjoy the discussion.

Kenneth A. Beckman, MD, FACS
OSN CEDARS/ASPENS Debates Editor

Mark Kontos

Ophthalmologists may need outside help in coming years

Without a doubt, over the past several years, there has been ever increasing interest in ophthalmology by private equity investment firms. Whether this trend will continue or not is not known, but all indications are that it will. The question is whether this is a positive occurrence or a negative one. I feel that there are several reasons why, for the most part, it is a positive event.

Over the last year or so, most ophthalmology news journals have devoted an article or two on this subject. They have outlined the various pros of this process, as they relate to the ophthalmic practice. The most common ones include a way for a retiring physician to extract the equity in his practice in an efficient manner, a pathway to grow and expand the practice, and a method to provide access to capital to help in the mergers of additional practices. For a physician nearing the end of his career, one of the most difficult events to navigate is a successful transfer of the practice to ensure its continuance. I have watched practices in our region close when the retiring doctor was unable to effect a transfer of the practice. The involvement of private equity can solve that issue. But I would like to spend some time discussing a more global positive impact that private equity can have on the way eye care is delivered in the future.

We all have heard of the enormous need for eye care resources in the near future as the baby boomer generation becomes active in the eye care space. It is also clear that in many areas ophthalmic practices are not ready to provide the services that this tsunami of patients is going to require. More often than not, practices are understaffed and underresourced to be able to expand their services in any meaningful way. Most are slow to modernize their equipment and do not have the OR capacity that will be needed in the future. In addition, the capital to change this situation is hard to come by for the average medium to small ophthalmic practice. Not to mention the fact that most doctors do not have the time or training to address these issues in a dynamic way. As practice owners, we like to think that we run lean, efficient practices but the fact of the matter is that we rarely do. This is where the impact of private equity on a large scale can make a game-changing difference.

Imagine the effect that billions of dollars invested in ophthalmology practices all over the country could have on the way eye care is delivered in this country or even across the globe. Practices could modernize their equipment, add lanes to be able to see more patients efficiently, add staff to enhance the experience and build out more operating room capacity. Regional mergers could add additional levels of efficiency and bring a more cohesive level of care to patients. More patients are cared for and more revenue is generated. It is not hard to imagine this should result in a nice return on investment for the shareholders of these entities.

We are lucky as ophthalmologists that we have a nearly infinite number of patients on the horizon who want and need our services. Patients in this country expect the best care possible, and they do not want to have to wait for it. We are more than capable of providing just that. But we are going to need some outside help to be able to get the job done. Working cooperatively with the private equity sector will allow us to do it.

Disclosure: Kontos reports he consults for Johnson & Johnson, Allergan, Sun, Omeros and Zeiss.

James C. Loden

Focus on well-defined plan, not short-term money

In an article I read several years ago, one of the partners in Bain Capital said that doctors, lawyers and accountants differ from trained business entrepreneurs in that the former have a major aversion to risk and debt. Many of us as doctors like to know that a stable income is coming monthly. I feel like the recent influx of private equity is likely based on this characterization.

Past experience

Twelve years ago, at the encouragement of my unscrupulous practice administrator/accountant, I sold 51% of my ASC to a publicly traded ASC company. Naive with a poor adviser that was unbeknownst to me working both sides, I was enticed with upfront monies and promises to add efficiency and grow the business. Twelve years later, none of the promises have come true. Thankfully, I did not blow the money but invested in another ASC and commercial real estate. I have now realized that the only person that grows the business is you, the entrepreneurial physician, and what these ASC companies do is piggyback off your growth that you spend your time and monies to fund.

At an Ophthalmology Innovation Summit meeting, I remember a Silicon Valley banker stating, “The most expensive source of capital is selling your equity.” With analysis, this has proven true in my life. By selling at a seven multiple, I essentially borrowed about $3.5 million at a 15% interest rate for the rest of my life. In a decade of cheap money at 5% on the very high side, you can see I have lost 10% per year over going out and borrowing the money for expansion. If you simply need cash to expand, it is much cheaper to borrow than sell equity, and the interest may even be deductible.

Private equity (PE) says that it is different from the failed physician practice management company (PPMC) industry of the late 1990s, but only time will tell. For many, the PPMC exercise ended badly. Scalability has worked in hospitals and diagnostics for years but has rarely worked long term in the surgical subspecialty business. It takes a meticulous surgeon with a great personality and 24/7 work ethic to produce double-digit growth, and these providers are not found for cheap on every corner.

Reasons to sell/partner

I have attended two lectures on PE over the last year, one by Bruce Maller and one by Anthony D’Eredita. From what I can gather, there are two scenarios in which a PE partnership makes sense. The first and most viable reason is if a practice has a clearly defined goal and needs cash and management to help it reach the scalable goal. The second is that you see the multiples being paid and you just want out. But remember, the most expensive source of money is giving up equity. Do not just look at upfront money as I did.

Cost of the sale ongoing

The PE partner is paying you money upfront for your earnings later. You will make less after the sale unless the business grows significantly. If you are 45 years old and want to practice until age 65, you have to ask yourself if you are OK taking less earnings over the next 20 years. If you are 55, the deal may make sense as a 10-year window is likely not far off from your break-even point with not selling. Remember, the PE company has to squeeze the turnip. Are you going to be happy paying management fees, making less and asking permission for vacation?

Who really is your partner?

With PE, your partner hopefully will not be you partner in 7 years. There seems to be all sorts of dialogue about choosing the right partner. The fact is that a successful PE partner will not be your partner in 3 to 5 years. PE wants to double then exit as soon as possible. If the PE firm is still your partner at year 8, then you probably did choose the wrong partner. Are you prepared for not knowing who your partner will be for the rest of your career?

Final suggestions

Do not make this decision on your own. Enlist the advice of unbiased experts who have worked on the side of the physician with multiple deals under their belt. Do not look at upfront cash. Set a strategic, well-defined business plan, and analyze whether you are seeing the glitter of short-term money or you are seeking to grow a scalable business.

Disclosure: Loden reports no relevant financial disclosures.

Welcome to another edition of CEDARS/ASPENS Debates. CEDARS/ASPENS is a joint society of cornea, cataract and refractive surgery specialists, here to discuss some of the latest hot topics in ophthalmology.

One of the more frequently asked questions for those owning a practice is whether to partner with a private equity firm. These partnerships have become more popular recently, but it may not work for everyone. This month, Mark Kontos, MD, and James C. Loden, MD, discuss the pros and cons of partnering with private equity and share their personal experiences. We hope you enjoy the discussion.

Kenneth A. Beckman, MD, FACS
OSN CEDARS/ASPENS Debates Editor

Mark Kontos

Ophthalmologists may need outside help in coming years

Without a doubt, over the past several years, there has been ever increasing interest in ophthalmology by private equity investment firms. Whether this trend will continue or not is not known, but all indications are that it will. The question is whether this is a positive occurrence or a negative one. I feel that there are several reasons why, for the most part, it is a positive event.

Over the last year or so, most ophthalmology news journals have devoted an article or two on this subject. They have outlined the various pros of this process, as they relate to the ophthalmic practice. The most common ones include a way for a retiring physician to extract the equity in his practice in an efficient manner, a pathway to grow and expand the practice, and a method to provide access to capital to help in the mergers of additional practices. For a physician nearing the end of his career, one of the most difficult events to navigate is a successful transfer of the practice to ensure its continuance. I have watched practices in our region close when the retiring doctor was unable to effect a transfer of the practice. The involvement of private equity can solve that issue. But I would like to spend some time discussing a more global positive impact that private equity can have on the way eye care is delivered in the future.

PAGE BREAK

We all have heard of the enormous need for eye care resources in the near future as the baby boomer generation becomes active in the eye care space. It is also clear that in many areas ophthalmic practices are not ready to provide the services that this tsunami of patients is going to require. More often than not, practices are understaffed and underresourced to be able to expand their services in any meaningful way. Most are slow to modernize their equipment and do not have the OR capacity that will be needed in the future. In addition, the capital to change this situation is hard to come by for the average medium to small ophthalmic practice. Not to mention the fact that most doctors do not have the time or training to address these issues in a dynamic way. As practice owners, we like to think that we run lean, efficient practices but the fact of the matter is that we rarely do. This is where the impact of private equity on a large scale can make a game-changing difference.

Imagine the effect that billions of dollars invested in ophthalmology practices all over the country could have on the way eye care is delivered in this country or even across the globe. Practices could modernize their equipment, add lanes to be able to see more patients efficiently, add staff to enhance the experience and build out more operating room capacity. Regional mergers could add additional levels of efficiency and bring a more cohesive level of care to patients. More patients are cared for and more revenue is generated. It is not hard to imagine this should result in a nice return on investment for the shareholders of these entities.

We are lucky as ophthalmologists that we have a nearly infinite number of patients on the horizon who want and need our services. Patients in this country expect the best care possible, and they do not want to have to wait for it. We are more than capable of providing just that. But we are going to need some outside help to be able to get the job done. Working cooperatively with the private equity sector will allow us to do it.

Disclosure: Kontos reports he consults for Johnson & Johnson, Allergan, Sun, Omeros and Zeiss.

PAGE BREAK
James C. Loden

Focus on well-defined plan, not short-term money

In an article I read several years ago, one of the partners in Bain Capital said that doctors, lawyers and accountants differ from trained business entrepreneurs in that the former have a major aversion to risk and debt. Many of us as doctors like to know that a stable income is coming monthly. I feel like the recent influx of private equity is likely based on this characterization.

Past experience

Twelve years ago, at the encouragement of my unscrupulous practice administrator/accountant, I sold 51% of my ASC to a publicly traded ASC company. Naive with a poor adviser that was unbeknownst to me working both sides, I was enticed with upfront monies and promises to add efficiency and grow the business. Twelve years later, none of the promises have come true. Thankfully, I did not blow the money but invested in another ASC and commercial real estate. I have now realized that the only person that grows the business is you, the entrepreneurial physician, and what these ASC companies do is piggyback off your growth that you spend your time and monies to fund.

At an Ophthalmology Innovation Summit meeting, I remember a Silicon Valley banker stating, “The most expensive source of capital is selling your equity.” With analysis, this has proven true in my life. By selling at a seven multiple, I essentially borrowed about $3.5 million at a 15% interest rate for the rest of my life. In a decade of cheap money at 5% on the very high side, you can see I have lost 10% per year over going out and borrowing the money for expansion. If you simply need cash to expand, it is much cheaper to borrow than sell equity, and the interest may even be deductible.

Private equity (PE) says that it is different from the failed physician practice management company (PPMC) industry of the late 1990s, but only time will tell. For many, the PPMC exercise ended badly. Scalability has worked in hospitals and diagnostics for years but has rarely worked long term in the surgical subspecialty business. It takes a meticulous surgeon with a great personality and 24/7 work ethic to produce double-digit growth, and these providers are not found for cheap on every corner.

Reasons to sell/partner

I have attended two lectures on PE over the last year, one by Bruce Maller and one by Anthony D’Eredita. From what I can gather, there are two scenarios in which a PE partnership makes sense. The first and most viable reason is if a practice has a clearly defined goal and needs cash and management to help it reach the scalable goal. The second is that you see the multiples being paid and you just want out. But remember, the most expensive source of money is giving up equity. Do not just look at upfront money as I did.

PAGE BREAK

Cost of the sale ongoing

The PE partner is paying you money upfront for your earnings later. You will make less after the sale unless the business grows significantly. If you are 45 years old and want to practice until age 65, you have to ask yourself if you are OK taking less earnings over the next 20 years. If you are 55, the deal may make sense as a 10-year window is likely not far off from your break-even point with not selling. Remember, the PE company has to squeeze the turnip. Are you going to be happy paying management fees, making less and asking permission for vacation?

Who really is your partner?

With PE, your partner hopefully will not be you partner in 7 years. There seems to be all sorts of dialogue about choosing the right partner. The fact is that a successful PE partner will not be your partner in 3 to 5 years. PE wants to double then exit as soon as possible. If the PE firm is still your partner at year 8, then you probably did choose the wrong partner. Are you prepared for not knowing who your partner will be for the rest of your career?

Final suggestions

Do not make this decision on your own. Enlist the advice of unbiased experts who have worked on the side of the physician with multiple deals under their belt. Do not look at upfront cash. Set a strategic, well-defined business plan, and analyze whether you are seeing the glitter of short-term money or you are seeking to grow a scalable business.

Disclosure: Loden reports no relevant financial disclosures.