What is the most important consideration when selecting a private equity partner?
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Experience in health care is ideal
Alignment with the right private equity partner can accelerate growth and profitability and give individuals a ready infusion of cash and equity.
However, the wrong partner or a poorly constructed deal can lead to tremendous unhappiness along with loss of hard-earned income and control.
The ideal phenotype for this partnership is a smaller (five to 10 people) group that is relatively independent, has not built an abundance of ancillaries and is not deeply aligned with a larger hospital partner. That said, the ideal private equity partner should have deep health care experience and a history of partnership with like health care organizations. Additionally, your partner should be focused on building an organization for the long-term as opposed to pursuing transient value creation activities that maximize exit potential in 5 years.
The private equity acquisition model relies on investing in a newly formed management services organization (MSO) and typically results in a loss of governance and operational control for the practice. As such, it is important to choose a financial sponsor who is sensitive to the needs of the organization and its patients, with a vision compatible with most of the present partners. Selecting a partner based on short-term gains can lead to significant unhappiness, with potential to jeopardize the culture of the practice over the longer term.
A foundational feature of the right private equity partner is one who supports the expansion of your capabilities (through investment in prosthetics/orthotics, ASCs, physical therapy, imaging and pharmacy) to provide patients with a comprehensive care experience while upholding the values of the practice. When evaluating potential partners, consider the following questions:
- How many physician practice acquisitions have you done? What were the outcomes at 5 and 10 years?
- What is your experience in orthopedics?
- What is your vision for this partnership?
- What metrics do you use to assess quality of care?
- What is your strategy to improve care quality over time?
- What will our post-acquisition physician representation consist of on the MSO board?
- What is the size of your fund allocated to musculoskeletal acquisition and how many practices do you plan to put under this umbrella?
- What economic alignment models (ie, profits interest program) do you employ and how do these impact economic upside for high-performing physicians in various scenarios?
- How will we incentivize, recruit and retain young physicians?
Todd J. Albert, MD, is surgeon-in-chief emeritus at Hospital for Special Surgery and a member of the Orthopedics Today Editorial Board.
Define goals, visions
As an increasing number of orthopedic surgery groups are entering into relationships with private equity firms, there are many important elements to consider — the first being do we really need (or want) an equity partner. The most common reason to enter into such a relationship is to monetize a portion of the practice income, distribute some of that income to the partners as an equity payout and deploy the rest to leverage and strengthen the group’s business services in competitive markets.
There is no such thing as “free money.” So the physicians must understand that after a capital placement, they will be working to repay this money, as well as a return on the investment to the private equity firm. This usually means lower take-home pay (20% to 30%), as well as fulfilling performance/productivity benchmarks. The younger surgeons with longer career timelines will shoulder this burden for a greater amount of time than the senior/retiring partners. Therefore, contract terms and company vision must support junior partners’ economic viability so that the joint venture sustains over time.
Orthopedic groups should define their own goals and visions before soliciting private equity capital. A smaller group may simply be looking to provide some capital to the partners and grow ancillary revenue stream opportunities. Some may be looking to consolidate with other local groups, but lack the business infrastructure to do so. Partnering with an equity firm that shares this vision, and has experience, may be a solid fit.
Larger orthopedic practices may be exploring aggressive geographic expansion plans or considering managing financial risk-bearing contracts (bundled payments). As strategic orthopedic businesses grow, the capital provided by a private equity firm, coupled with their financial analytic skills, could prove effective.
There is significant momentum and financial opportunity as private equity firms move into this space. It is imperative to meet and interview at least three to five firms to understand the management team and their personalities. Do due diligence and check reputations independently. Introduce executive teams early as both will be contractually bound with high stakes to deliver results.
Additionally, a key consideration is to understand the high likelihood that in 5 to 7 years (or sooner) another transaction will occur (“second bite of the apple”) as most private equity firms will look to exit, distributing cash back to their investors. Have candid discussions early to ensure strategic alignment and control over the decisions regarding future transactions.
Finally, do not be naïve or underestimate your market power as a successful, independent orthopedic surgery practice. Demand strong representation and control in operations, as well as on the board of directors in the new company’s organization. Your bargaining power is strongest before you sign the contract.
Paul J. Slosar, MD, is a spine surgeon at Peninsula Orthopedic Associates in Daly City, California, and chief medical officer of Episode Solutions in Nashville, Tennessee.
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