Cover Story

Solid finances, management attract private equity firms

Groups considering private equity acquisition should have a strategic plan, goals

The acquisition of health care-related companies by private equity firms increased by 187% and reached $42.6 billion between 2010 and 2017, according to an article in the Journal of the American Medical Association. Private equity investments are more common in dermatology and ophthalmology. These debuted in orthopedics only as recently as 2017, so the impact of private equity investments on orthopedic practices remains to be seen.

Since 2017, three more orthopedic practices completed an investment transaction with a private equity firm and about six to 10 medium to large U.S. orthopedic groups are actively looking at various strategic options, including private equity, according to Gary W. Herschman, JD, of the national health care law firm Epstein Becker & Green PC.

“Some medical specialties, such as dermatology, ophthalmology and optometry, are already familiar with private equity partnerships,” B. Sonny Bal, MD, MBA, JD, PhD, president and CEO of SINTX Technologies in Salt Lake City, told Orthopedics Today. “For orthopedic surgeons, these deals are in the early stages as surgeons understand the dynamics and advantages of having strong financial cushions to support scaling up operationally and vertically.”

B. Sonny Bal

What makes orthopedic surgery a prime target of interest for private equity firms, according to Bal, is “the increasing commoditization of certain procedures, such as hip and knee arthroplasty, the migration of these procedures away from hospitals and the recognition that certain specialties can benefit naturally from consolidation.”

“As orthopedic procedures improve with robotics, virtual reality and advances in pain control, it makes sense for private equity [firms] to create large centers that offer surgery, durable medical equipment, physical therapy, radiology and related services under one roof,” Bal, who is an Orthopedics Today Editorial Board Member, said. “These efficiencies are not possible in the sclerotic, politically entrenched bureaucracies of large hospitals and academic centers.”

Charles A. Bush-Joseph, MD, said entering into a transaction with a private equity firm means an orthopedic practice exchanges a stake in its ownership for capital. However, such agreements have the potential for increased earnings in a 5- to 10-year timeframe, he noted.

Source: Lisa Gorgen

Physician practices that want to remain independent may look at partnering with private equity firms for “additional runway and the resources to restructure, execute on a strategy and grow” by providing funds, known as capital, as well as investment expertise, Bal added.

“Private equity can help surgeons realize the goal of doing outpatient joints better, faster and cheaper than before, with standardization, cost transparency and less frustration,” he said. “At the outset, private equity can fund smaller practice roll-ups, building of an ASC and operational cash until profitability. These are all good reasons why orthopedic surgeons should be receptive to private equity partnerships.”

Set a strategic plan

David J. Jacofsky

David J. Jacofsky, MD, chair and CEO of HOPCo, which received equity financing from Frazier Healthcare Partners and Princeton Ventures, said not every orthopedic group should consider partnering with a private equity firm.

Some other strategic options that can be explored include a transaction involving selling to or joining a larger medical group, a hospital system or a national company, according to Herschman.

“The differences in possible financing options must be appreciated and understood. For example, when a hospital system acquires a private practice, this usually leads to the end of practice control and the transition of surgeons to employee status,” Bal said.

“Private equity offers more flexibility,” he said.

“Access to capital will be easier and the business sophistication, knowledgebase and skillset of the investors and equity partners will generally be far superior to that of hospital administrators,” Bal said. “Thus, there are distinct advantages to considering private equity over hospitals acquisitions of private practice.”

Jacofsky said the type of equity partner or funding source that an orthopedic group chooses should depend on the strategic plans and goals of the practice leadership.

“As it relates to physicians taking on private equity dollars, I would say the first thing the group needs to do is understand what their unified strategic plan and goal is because it is impossible to figure out what the optimal financing strategy is for a plan that people may not agree on,” he told Orthopedics Today.

Douglas W. Lundy

An orthopedic practice that lacks a strategic plan or idea of what it seeks from private equity may be one of the reasons a transaction between an orthopedic group and private equity firm fails, according to Douglas W. Lundy, MD, of Resurgens Orthopaedics in Marietta, Georgia.

“One of the biggest problems ... is many orthopedic surgeons do not know what they want out of this,” Lundy said. “They hear about [private equity acquisitions] and ... do not want to miss out on it. They get into the space and then the private equity or the investment bankers [ask what they want] and [the orthopedic group says], ‘I do not know. What is available?’ That is a dangerous conversation to get into.”

Ideal scenarios in which orthopedic practices may seek to partner with private equity firms include young, growing or mid-sized orthopedic groups, groups with physician leadership and management that are organized and energetic, and any practice that wants to take it to the next level, Charles A. Bush-Joseph, MD, said.

“You are giving capital and market experience to a group that has growth potential or the ability to be a ‘platform’ organization. The group must have energized leadership and be leaders in their local market. The capital allows them to take market share by assimilating other groups and independent practitioners and achieving scale for surgery center, imaging and physical therapy,” said Bush-Joseph, who is professor of orthopedic surgery at Rush University Medical Center and former managing partner of Midwest Orthopaedics at Rush.

Jacofsky said the biggest mistake a physician group can make when entertaining the idea of private equity acquisition is seeing it primarily as a liquidation event.

“The purpose of the money should be growth capital and increased equity value of the shareholders of the group rather than an opportunity for everybody to take money off the table and be left with an organization that is still underfunded, still without a strategic plan and still in need of a transformation to be competitive going forward in the future of health care,” Jacofsky said.

Hire an investment banker

Not only should orthopedic groups consider the source of the capital when identifying a strategic plan, they also need to consider what benefits, strategic program and infrastructure a particular partnership will bring, Jacofsky said.

“It is important to define exactly what the structure of the deal is and make sure that each individual physician understands the impact that the transaction will have on their schedule, on their income, on the age of retirement and on the direction of the practice or management company,” he said.

Sources who spoke with Orthopedics Today noted it is beneficial for orthopedic groups looking to partner with a private equity firm to hire an experienced investment banker or financial advisor, as well as a health care attorney who is familiar with handling private equity transactions.

An investment banker or financial advisor can help identify the type of equity an orthopedic group should consider based on the strategic goals of the group. Investment bankers or financial advisors can also be helpful during financial negotiations, an area in which many physicians may not be specifically skilled or sophisticated, according to Jacofsky.

“Trying to [negotiate] without getting that advice or with just listening to what your accountant says or your general attorney who has not worked on these deals a lot” does a disservice to you and your group, Herschman said.

Bal said the counsel of an investment banker or financial advisor can be expensive, but it is also a critical step to better understand the risks involved in the transaction, as well as the potential positive and negative outcomes, before it occurs.

“The structure of private equity deals can look different,” Jacofsky said. “There is not one cookie-cutter model, necessarily. The strategy, platform and experience an investor brings is more important than the capital itself.”

Acquisition process

Once an orthopedic group decides a private equity acquisition is right for its strategy, Herschman said the group’s financial advisor should include its details, characteristics and financials in a detailed presentation or memorandum about the group that is presented to private equity firms. The investment banker would then help narrow down the number of private equity firms that show interest in a partnership until such time that the orthopedic group identifies the firm that is right for its practice and growth goals.

After determining the private equity firm to partner with, a letter of intent is presented by the orthopedic group. This document includes an exclusivity clause stating that the orthopedic group will not talk to another potential partner within a certain time period, eg, 90 days. Before a definitive agreement is drawn up, the private equity firm performs extensive due diligence and generates a complete financial and business review of the orthopedic group, according to Herschman.

“Sometimes there are things in diligence they find that need to be addressed in the agreement or cause them to propose an adjustment to the purchase price that they had originally offered, but sometimes [they] do not and then they move forward with a definitive agreement,” Herschman said.

Take precautions

Herschman said an orthopedic group should perform its own “reverse” due diligence to ensure the private equity firm it has selected aligns with the group’s financial, cultural and other interests.

Gary W. Herschman

“It could be that [the orthopedic group selects] nobody,” Herschman said. “They do not have to. They could go through the process and [if they] do not think any of the financial proposals are good enough or did not connect culturally with any of these groups, no one is forced to do anything until they sign a definitive agreement and go to closing.”

Although private equity firms may bring management expertise to the orthopedic group, Bush-Joseph, who is an Orthopedics Today Editorial Board Member, said he has found some private equity firms lack insights into the orthopedic market.

“In meetings I have been involved in with private equity groups, I have been disappointed about their local knowledge of markets and how markets work,” Bush-Joseph told Orthopedics Today. “They can provide business expertise, but as far as knowing the orthopedic market in your region and your area, I do not think that is a source of knowledge that private equity can provide to the surgeon or that the local owners do not already have.”

Orthopedic groups should also be aware that entering into a transaction with a private equity firm means the equity firm receives a certain ownership percentage of the company, depending on the agreement, he said.

“It is not like going to the bank where I have to put up my house or my pension or some other asset to back a loan from a bank,” Bush-Joseph said. “I am exchanging ownership, whether it be a minority — a 20% or 30% stake — or a majority — a 60% or 70% stake — of my practice with somebody in exchange for capital.”

Practice changes are inevitable

Bush-Joseph said such agreements have the potential for increased earnings during a 5- to 10-year timeframe.

However, Lundy, said they also mean changes are in store for how the practice is structured, and not all of these changes are advantageous.

Bal said, “Disadvantages include the loss of physician control of the business and perhaps loss of the traditional physician hierarchy and leadership structure that is usually encountered in long-standing group practices. Private investor capital at-risk necessarily means that surgeons will not be in the driver’s seat. It is the risk-takers who will call the shots.”

The acquisition can also potentially cause a dramatic change in the culture of the organization, particularly if a significant liquidation event leads to non-alignment of long-term goals between partners of different ages, according to Jacofsky.

“Many times, after closing of the transaction, it becomes clear that the strategic direction of the group is actually more different from the strategic direction of their investor than they had initially anticipated,” he said.

Despite the management changes that occur within the practice after a private equity acquisition, Herschman said equity firms cannot tell physicians how to practice medicine. In fact, in most states, private equity firms do not actually own the medical practice entity. Instead, he said, the private equity firms ultimately invest in administrative or management service companies that purchase medical practice assets and employ their non-clinical staff, and then put capital to work to expand the practice, such as by adding locations and ancillary services.

“[It] professionalizes and corporatizes the management of the organization and expands it in the local region and in a multi-state region and sometimes nationally,” Herschman said. “They do not tell doctors how to treat patients. They take over the administrative business end of health care and make capital investments to improve the revenues and efficiencies of the practice, all of which will help it to better perform and compete in transforming the population health and value-based care environment.”

Effect of private equity

The addition of private equity in the orthopedics market has added an entirely new player to the space with regard to physician employment, according to Lundy. However, he said its effect on the orthopedics industry as a whole is still unknown.

“If we make money by practicing high-value, high-quality orthopedic surgery, then it is good for the industry,” Lundy said. “If we have to make money by cutting and slashing, cutting corners and doing whatever we have to do, it is bad for the industry, it is bad for health care. So, it could be good, it could be bad. It is all based on how the deal works out and how the environment rolls after the acquisition is completed.”

Jacofsky believes the implementation of private equity in the orthopedics industry may improve the ability of groups to manage data, track outcomes, partner with larger organizations in more robust ways and access capital to continue to fund growth needs that may lead to greater consolidation within the specialty.

As the demands of modern health care continue to emphasize costs, value delivered, quality metrics, transparency, patient feedback and efficiency, Bal contends the increase in private equity acquisitions and the harsh, but fair, reward system in related financial models will help orthopedic groups from a business standpoint.

“More importantly, it will allow surgeons to focus on patient care, new knowledge, academic accomplishments and professional enjoyment; all of which the present models are increasingly failing to deliver on,” he said. – by Casey Tingle

Disclosures: Bush-Joseph reports he is a board member of The OrthoForum. Bal, Herschman, Jacofsky and Lundy report no relevant financial disclosures.

Click here to read the POINTCOUNTER, “Is private practice acquisition by a hospital or private equity firm preferred?

The acquisition of health care-related companies by private equity firms increased by 187% and reached $42.6 billion between 2010 and 2017, according to an article in the Journal of the American Medical Association. Private equity investments are more common in dermatology and ophthalmology. These debuted in orthopedics only as recently as 2017, so the impact of private equity investments on orthopedic practices remains to be seen.

Since 2017, three more orthopedic practices completed an investment transaction with a private equity firm and about six to 10 medium to large U.S. orthopedic groups are actively looking at various strategic options, including private equity, according to Gary W. Herschman, JD, of the national health care law firm Epstein Becker & Green PC.

“Some medical specialties, such as dermatology, ophthalmology and optometry, are already familiar with private equity partnerships,” B. Sonny Bal, MD, MBA, JD, PhD, president and CEO of SINTX Technologies in Salt Lake City, told Orthopedics Today. “For orthopedic surgeons, these deals are in the early stages as surgeons understand the dynamics and advantages of having strong financial cushions to support scaling up operationally and vertically.”

B. Sonny Bal

What makes orthopedic surgery a prime target of interest for private equity firms, according to Bal, is “the increasing commoditization of certain procedures, such as hip and knee arthroplasty, the migration of these procedures away from hospitals and the recognition that certain specialties can benefit naturally from consolidation.”

“As orthopedic procedures improve with robotics, virtual reality and advances in pain control, it makes sense for private equity [firms] to create large centers that offer surgery, durable medical equipment, physical therapy, radiology and related services under one roof,” Bal, who is an Orthopedics Today Editorial Board Member, said. “These efficiencies are not possible in the sclerotic, politically entrenched bureaucracies of large hospitals and academic centers.”

Charles A. Bush-Joseph, MD, said entering into a transaction with a private equity firm means an orthopedic practice exchanges a stake in its ownership for capital. However, such agreements have the potential for increased earnings in a 5- to 10-year timeframe, he noted.

Source: Lisa Gorgen

Physician practices that want to remain independent may look at partnering with private equity firms for “additional runway and the resources to restructure, execute on a strategy and grow” by providing funds, known as capital, as well as investment expertise, Bal added.

“Private equity can help surgeons realize the goal of doing outpatient joints better, faster and cheaper than before, with standardization, cost transparency and less frustration,” he said. “At the outset, private equity can fund smaller practice roll-ups, building of an ASC and operational cash until profitability. These are all good reasons why orthopedic surgeons should be receptive to private equity partnerships.”

PAGE BREAK

Set a strategic plan

David J. Jacofsky

David J. Jacofsky, MD, chair and CEO of HOPCo, which received equity financing from Frazier Healthcare Partners and Princeton Ventures, said not every orthopedic group should consider partnering with a private equity firm.

Some other strategic options that can be explored include a transaction involving selling to or joining a larger medical group, a hospital system or a national company, according to Herschman.

“The differences in possible financing options must be appreciated and understood. For example, when a hospital system acquires a private practice, this usually leads to the end of practice control and the transition of surgeons to employee status,” Bal said.

“Private equity offers more flexibility,” he said.

“Access to capital will be easier and the business sophistication, knowledgebase and skillset of the investors and equity partners will generally be far superior to that of hospital administrators,” Bal said. “Thus, there are distinct advantages to considering private equity over hospitals acquisitions of private practice.”

Jacofsky said the type of equity partner or funding source that an orthopedic group chooses should depend on the strategic plans and goals of the practice leadership.

“As it relates to physicians taking on private equity dollars, I would say the first thing the group needs to do is understand what their unified strategic plan and goal is because it is impossible to figure out what the optimal financing strategy is for a plan that people may not agree on,” he told Orthopedics Today.

Douglas W. Lundy

An orthopedic practice that lacks a strategic plan or idea of what it seeks from private equity may be one of the reasons a transaction between an orthopedic group and private equity firm fails, according to Douglas W. Lundy, MD, of Resurgens Orthopaedics in Marietta, Georgia.

“One of the biggest problems ... is many orthopedic surgeons do not know what they want out of this,” Lundy said. “They hear about [private equity acquisitions] and ... do not want to miss out on it. They get into the space and then the private equity or the investment bankers [ask what they want] and [the orthopedic group says], ‘I do not know. What is available?’ That is a dangerous conversation to get into.”

Ideal scenarios in which orthopedic practices may seek to partner with private equity firms include young, growing or mid-sized orthopedic groups, groups with physician leadership and management that are organized and energetic, and any practice that wants to take it to the next level, Charles A. Bush-Joseph, MD, said.

PAGE BREAK

“You are giving capital and market experience to a group that has growth potential or the ability to be a ‘platform’ organization. The group must have energized leadership and be leaders in their local market. The capital allows them to take market share by assimilating other groups and independent practitioners and achieving scale for surgery center, imaging and physical therapy,” said Bush-Joseph, who is professor of orthopedic surgery at Rush University Medical Center and former managing partner of Midwest Orthopaedics at Rush.

Jacofsky said the biggest mistake a physician group can make when entertaining the idea of private equity acquisition is seeing it primarily as a liquidation event.

“The purpose of the money should be growth capital and increased equity value of the shareholders of the group rather than an opportunity for everybody to take money off the table and be left with an organization that is still underfunded, still without a strategic plan and still in need of a transformation to be competitive going forward in the future of health care,” Jacofsky said.

Hire an investment banker

Not only should orthopedic groups consider the source of the capital when identifying a strategic plan, they also need to consider what benefits, strategic program and infrastructure a particular partnership will bring, Jacofsky said.

“It is important to define exactly what the structure of the deal is and make sure that each individual physician understands the impact that the transaction will have on their schedule, on their income, on the age of retirement and on the direction of the practice or management company,” he said.

Sources who spoke with Orthopedics Today noted it is beneficial for orthopedic groups looking to partner with a private equity firm to hire an experienced investment banker or financial advisor, as well as a health care attorney who is familiar with handling private equity transactions.

An investment banker or financial advisor can help identify the type of equity an orthopedic group should consider based on the strategic goals of the group. Investment bankers or financial advisors can also be helpful during financial negotiations, an area in which many physicians may not be specifically skilled or sophisticated, according to Jacofsky.

“Trying to [negotiate] without getting that advice or with just listening to what your accountant says or your general attorney who has not worked on these deals a lot” does a disservice to you and your group, Herschman said.

Bal said the counsel of an investment banker or financial advisor can be expensive, but it is also a critical step to better understand the risks involved in the transaction, as well as the potential positive and negative outcomes, before it occurs.

PAGE BREAK

“The structure of private equity deals can look different,” Jacofsky said. “There is not one cookie-cutter model, necessarily. The strategy, platform and experience an investor brings is more important than the capital itself.”

Acquisition process

Once an orthopedic group decides a private equity acquisition is right for its strategy, Herschman said the group’s financial advisor should include its details, characteristics and financials in a detailed presentation or memorandum about the group that is presented to private equity firms. The investment banker would then help narrow down the number of private equity firms that show interest in a partnership until such time that the orthopedic group identifies the firm that is right for its practice and growth goals.

After determining the private equity firm to partner with, a letter of intent is presented by the orthopedic group. This document includes an exclusivity clause stating that the orthopedic group will not talk to another potential partner within a certain time period, eg, 90 days. Before a definitive agreement is drawn up, the private equity firm performs extensive due diligence and generates a complete financial and business review of the orthopedic group, according to Herschman.

“Sometimes there are things in diligence they find that need to be addressed in the agreement or cause them to propose an adjustment to the purchase price that they had originally offered, but sometimes [they] do not and then they move forward with a definitive agreement,” Herschman said.

Take precautions

Herschman said an orthopedic group should perform its own “reverse” due diligence to ensure the private equity firm it has selected aligns with the group’s financial, cultural and other interests.

Gary W. Herschman

“It could be that [the orthopedic group selects] nobody,” Herschman said. “They do not have to. They could go through the process and [if they] do not think any of the financial proposals are good enough or did not connect culturally with any of these groups, no one is forced to do anything until they sign a definitive agreement and go to closing.”

Although private equity firms may bring management expertise to the orthopedic group, Bush-Joseph, who is an Orthopedics Today Editorial Board Member, said he has found some private equity firms lack insights into the orthopedic market.

“In meetings I have been involved in with private equity groups, I have been disappointed about their local knowledge of markets and how markets work,” Bush-Joseph told Orthopedics Today. “They can provide business expertise, but as far as knowing the orthopedic market in your region and your area, I do not think that is a source of knowledge that private equity can provide to the surgeon or that the local owners do not already have.”

PAGE BREAK

Orthopedic groups should also be aware that entering into a transaction with a private equity firm means the equity firm receives a certain ownership percentage of the company, depending on the agreement, he said.

“It is not like going to the bank where I have to put up my house or my pension or some other asset to back a loan from a bank,” Bush-Joseph said. “I am exchanging ownership, whether it be a minority — a 20% or 30% stake — or a majority — a 60% or 70% stake — of my practice with somebody in exchange for capital.”

Practice changes are inevitable

Bush-Joseph said such agreements have the potential for increased earnings during a 5- to 10-year timeframe.

However, Lundy, said they also mean changes are in store for how the practice is structured, and not all of these changes are advantageous.

Bal said, “Disadvantages include the loss of physician control of the business and perhaps loss of the traditional physician hierarchy and leadership structure that is usually encountered in long-standing group practices. Private investor capital at-risk necessarily means that surgeons will not be in the driver’s seat. It is the risk-takers who will call the shots.”

The acquisition can also potentially cause a dramatic change in the culture of the organization, particularly if a significant liquidation event leads to non-alignment of long-term goals between partners of different ages, according to Jacofsky.

“Many times, after closing of the transaction, it becomes clear that the strategic direction of the group is actually more different from the strategic direction of their investor than they had initially anticipated,” he said.

Despite the management changes that occur within the practice after a private equity acquisition, Herschman said equity firms cannot tell physicians how to practice medicine. In fact, in most states, private equity firms do not actually own the medical practice entity. Instead, he said, the private equity firms ultimately invest in administrative or management service companies that purchase medical practice assets and employ their non-clinical staff, and then put capital to work to expand the practice, such as by adding locations and ancillary services.

“[It] professionalizes and corporatizes the management of the organization and expands it in the local region and in a multi-state region and sometimes nationally,” Herschman said. “They do not tell doctors how to treat patients. They take over the administrative business end of health care and make capital investments to improve the revenues and efficiencies of the practice, all of which will help it to better perform and compete in transforming the population health and value-based care environment.”

PAGE BREAK

Effect of private equity

The addition of private equity in the orthopedics market has added an entirely new player to the space with regard to physician employment, according to Lundy. However, he said its effect on the orthopedics industry as a whole is still unknown.

“If we make money by practicing high-value, high-quality orthopedic surgery, then it is good for the industry,” Lundy said. “If we have to make money by cutting and slashing, cutting corners and doing whatever we have to do, it is bad for the industry, it is bad for health care. So, it could be good, it could be bad. It is all based on how the deal works out and how the environment rolls after the acquisition is completed.”

Jacofsky believes the implementation of private equity in the orthopedics industry may improve the ability of groups to manage data, track outcomes, partner with larger organizations in more robust ways and access capital to continue to fund growth needs that may lead to greater consolidation within the specialty.

As the demands of modern health care continue to emphasize costs, value delivered, quality metrics, transparency, patient feedback and efficiency, Bal contends the increase in private equity acquisitions and the harsh, but fair, reward system in related financial models will help orthopedic groups from a business standpoint.

“More importantly, it will allow surgeons to focus on patient care, new knowledge, academic accomplishments and professional enjoyment; all of which the present models are increasingly failing to deliver on,” he said. – by Casey Tingle

Disclosures: Bush-Joseph reports he is a board member of The OrthoForum. Bal, Herschman, Jacofsky and Lundy report no relevant financial disclosures.

Click here to read the POINTCOUNTER, “Is private practice acquisition by a hospital or private equity firm preferred?

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