As we all know, times change and healthcare trends re-emerge. In recent years, private equity has successfully consolidated and strengthened several specialties, including dermatology, dentistry, and ophthalmology. The focus has now turned to orthopaedics/musculoskeletal care.
As copresident and executive director of Resurgens Orthopaedics, a large practice in metropolitan Atlanta with 102 orthopaedic surgeons and physiatrists, I feel it is important to consider any opportunity that may potentially increase shareholder value. In the past, Resurgens politely turned investors away as it was our strong intent to remain independent. Although our dynamic practice is more fiscally sound than ever, we have contemplated discussions with private equity (PE) firms to determine if PE investment is something we should consider.
Essentially, PE refers to organized groups of private investors who wish to put their money to work in diverse investments. Countless opportunities exist for people to invest their money—they can very easily put it in the stock market or other common investment vehicles. The equity markets offer variable degrees of risk and reward with significant liquidity.
For example, investors can buy risky micro-cap stocks that offer significant return on investment if they choose, or invest in solid large-cap value mutual funds that will pay out dividends for years. So why would they want to park their resources as PE in a medical practice? Although the sales pitch may sound attractive, practices should make sure they know ahead of time what PE investors expect to get out of the deal.
PE firms balance the risk of the investment against the return it will generate, with a focus on ensuring they can get their money out at some point (liquidity) while realizing above-average returns. Practices should ask themselves the following questions: Why would an outsider want to buy part or all of my practice? Is the return more than investors can achieve through other similar risk investments? What would the exit strategy be for the investor? Who will they sell their interests to when they want to divest and move on?
Many people mistakenly believe that PE firms want to invest in a practice’s cash flow. They believe that investors want to give orthopaedic surgeons a significant amount of money now so that they can skim off a percentage of earnings into the future. If you do the math, it really doesn’t work that way. Savvy investors want more than your practice’s existing cash flow; they are only successful if you significantly increase the practice’s cash flow by expanding your practice with their equity. They want you to take the practice to the next level (or higher) in profitability. They want to make a significant return on their investment in your practice, and then they want to divest their capital and move on to something else.
PE firms want to invest as a minority or majority owner in the orthopaedic practice with the clear understanding that the organization’s leadership will use a meaningful portion of the investment to develop the practice into a much stronger and more financially viable entity than it is currently. An example is a strong local orthopaedic group that wishes to extensively increase its footprint. PE capital can help the practice merge with other groups, purchase ancillary services (surgery centers, physical therapy, imaging, durable medical equipment, real estate), or provide other options to increase the practice’s profitability. The ideal practice must have both the opportunity and the desire to expand rapidly and seize a large part of the orthopaedic/musculoskeletal market. If that proposition was easy, it would be happening all the time. Practices seeking to sell to PE must have a compelling vision for growth.
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How it works
Generally, PE firms will pay a multiple of earnings to gain a minority or majority share in a practice. The PE firms will look at the practice’s finances and calculate the value based on many factors, particularly earnings before interest, taxes, depreciation, and amortization (EBITDA). EBITDA represents the profitability of the practice after most expenses have been paid. You can be sure that the principals in PE firms are very savvy, and they will categorically protect their investment in the terms of the contract. They will issue funds to the practice in exchange for some degree of ownership and control. The practice can then distribute these funds among the shareholders however they feel appropriate.
Opinions on PE investment will likely differ among a practice’s current physicians, which we’ve categorized into the following three groups:
The “Buy Me Out and You’ll Never Hear from Me Again” group. Physicians in this group are looking for their own exit strategy—either to retire or work elsewhere. PE firms obviously don’t want too many of these physicians in the practice. However, we know there are physicians approaching retirement or other stages in their careers who will leave the practice after they receive their buyout. This group is extremely interested in the PE idea and will urge the leadership to engage in the venture.
The “My Practice is Mature and I Have a Few More Years of This” group. These physicians are a little wary—although they may see the benefits, they don’t want to relocate their practice if things go sour. They need to see the value in expansion of the practice, knowing that they will probably have less control over the group as the situation evolves. They may realize a second return on their money if they invest in the new entity with the PE firm.
The “I Just Became a Shareholder Here, What Are You Doing?” group. Physicians in this group have many different motivations. Because they may be less committed to the practice, they could be a flight risk if the new entity doesn’t live up to their expectations.
It’s easy to see that gaining consensus regarding PE investment in a large practice can be difficult. Clearly, gaining buy-in from the younger physicians is vital to the long-term success of the organization.
To accomplish this goal, the business plan for growth must be compelling and attainable. The physicians with 20 or more years left to practice will have to realize that giving up near-term income in exchange for ownership in a larger, more profitable venture is not just possible, but probable.
An orthopaedic practice must be very diligent in assessing PE offers and analyzing projected returns. The value proposition must be compelling, and it is incumbent on the practice’s executive team and board of directors to thoroughly investigate the opportunity, understand the risks and rewards, and ultimately determine if a PE-backed venture is best for the long-term success of the practice and the physician shareholders. Although it can be a very beneficial enterprise for a physician group, the principals must move carefully and thoughtfully through the process.
Alex L. Bateman, MBA, is market president of United Surgical Partners International and executive director of Resurgens Orthopaedics.
Douglas W. Lundy, MD, MBA, is an orthopaedic trauma surgeon and co-president of Resurgens Orthopaedics. He is also a member of the AAOS Now Editorial Board, treasurer of the AAOS Political Action Committee, president-elect of the American Board of Orthopaedic Surgery, and chief financial officer-elect of the Orthopaedic Trauma Association.