a growing dynamic: private equity transactions pre- and
TRANSCRIPT
A Growing Dynamic: Private Equity Transactions Pre- and Post-COVID Issues
Speaker name:Holly Buckley, JD McGuireWoods LLP, Chicago, IL
Colin McDermott VMG Health, Dallas, TX
Holly Buckley, a partner in the Chicago office, is co-chair of the firm'shealthcare and life sciences industry team. Holly focuses on corporatehealthcare transactional work and regulatory matters. She primarilycounsels private equity funds and healthcare clients, including hospitalsand health systems, medical practices and physician-owned hospitals,and ambulatory surgery centers, on a variety of matters, includingstructuring transactions, regulatory due diligence, affiliation agreementsand compliance matters.
Colin McDermott, CFA, CPA/ABV is a managing director with VMG Health and is based in the Dallas office. He specializes in providing financial, valuation, and transaction advisory services to clients in the health care industry. His clients have included hospitals, hospital systems, ambulatory surgery centers, imaging centers, laboratories, physician groups, and other healthcare entities. Mr. McDermott received a Bachelor of Business Administration in Accounting and a Master of Science in Finance from Texas A&M University. Mr. McDermott is a licensed Certified Public Accountant (CPA) in the state of Texas and holds the Chartered Financial Analyst (CFA) designation.
Disclosure Slide
• Holly Buckley has no conflicts nor disclosures
• Colin M. McDermott has no conflicts nor disclosures
Market Overview
Physician Market Components
Cardiology, 9.2
Behavioral, 10.3
Orthopedics, 4.7
Urology, 4.5
Other, 7.9
Oncology, 5.1GI, 3.2
Dermatology, 2.6
General surgery, 5.6
Hospital based, 47
Specialty, 61.8
Primary Care1, 38.2
Notes: (1) Primary Care: Family Medicine, Internal Medicine, Pediatrics, OB/GYN, Preventative Medicine
>1MActive physicians in US
38.2%Physicians in primary care
620KPhysicians in specialties
4.7%Specialists in Orthopedics
Key TrendsSpecialty BreakdownPrimary vs Specialty
Overview of Physician Market
Independent, 31.4%
Direct hospital employment, 19.1%
Hospital owned medical group, 17.4%
Othe…
Physician owned medical group, 12.6%
2018 Detailed Results
OBSERVATIONS
❑ From 2012 to 2018, independent physicians declined from 48.5% of the workforce to 31.4%
❑ Physicians continue to shift into an employed setting either through a health system or a large
group setting
Employment Trends
48.5%
34.6% 32.7% 31.4%
43.7%
52.8%57.9%
49.1%
7.80%12.60%
9.40%
19.50%
0%
10%
20%
30%
40%
50%
60%
2012 2014 2016 2018
Independent Employed Other
Independent CAGR: (13.5%)
2018 Meritt Hawkins Physician Foundation Survey
Overview of Physician Market
Overview of Physician MarketDecreased Risk – Physician Perspective
14%
19%
29%
38%
0% 5% 10% 15% 20% 25% 30% 35% 40%
Other
Better hours/work-life balance
Fewer administrative responsibilities
Financial security/Less risk
Primary Reason for Choosing Employment
Medscape “Employed Doctors Report”
OBSERVATIONS: The most common reason physicians cited for leaving private
practice and choosing employment was for financial security / less risk
Drivers of Private Equity Interest
The Preqin Q2 2019 report estimates available capital (“dry powder”) – money raised
but not invested – has approached $1.54 trillion across most private markets.
GLOBAL FUNDRAISING TRENDS
➢ Available capital has
increased each year on
average since 2012
➢ Investors have poured
money into PE funds
➢ PE managers struggling to
find attractive deals with
such high asset values
Source: Preqin Quarterly Private Equity Update Q2 2019
-
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Q1 2019 Q2 2019
Estimated Private Equity Dry Powder2009 – Q2 2019
Buyout Venture Capital Growth Other PE
Private Equity: Dry Powder Available
U.S. Healthcare Spending Continues to Increase
Data through 2018HEALTHCARE SPENDING TRENDS
8.9%➢ Spending as % of GDP,
1980
13.3%➢ Spending as % of GDP,
2000
18.2%➢ Spending as % of GDP,
2018 (Estimated)
1980 - 8.9%
2000 - 13.3%
2018 - Estimated at 18.2%
-
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
20.0%
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
National Health Expenditures as a % of GDP1960 - Estimated 2018
Source: CMS and Bureau of Economic Analysis
Private Equity: US Healthcare Spending
➢ Healthcare accounts for a large share
of GDP
➢ Sector has historically yielded good
returns
➢ Projected healthcare spending by
2027 = $6 Trillion
Source: Bain Global Healthcare Private Equity and Corporate M&A Report 2018 Bain Insights; CMS.gov; McKinsey & Company – “Capturing returns in healthcare”
2027
$6 Trillion2020202
Healthcare17.7%
Other82.3%
Healthcare Spending as a % of GDP
2018
Why is Healthcare Attractive to Private Equity?
HEALTHCARE PE ACTIVITY
$63 billion➢ Healthcare M&A value -
2018
~14.5%➢ Healthcare’s share of total
deal value
316➢ Healthcare PE deals –
2018*
*Excludes add-ons, loan-to-own transactions, andacquisitions of bankrupt assets
Source: Pitchbook; Bain Global Healthcare Private Equity and Corporate M&A Report 2018
2 6 6
21 18
77
47
17
6
15
30
21 16
30 23
36 43
63
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Global Healthcare PE M&A Valuein Billions
54 70
88 125
168
236 213
195
142 179
163 195 209
188 199 206
265
316
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Global Healthcare PE M&A Count
Multiple Trends
• Pursue “bolt-on” acquisitions for efficiency and scale
• Small acquisitions are “rolled up” into platforms
Deal CountPhysicians Acquired
• Target ancillary revenue performed in hospital/OP
setting
• Target specialties w/ high prospect of additional
income from elective procedures
PE Deal Count and Physicians Acquired
30%
23%
9% 8%5% 4% 3%
19%
0%
10%
20%
30%
40%
50%
60%51%
10% 10%8% 7% 6% 5% 3%
0%
10%
20%
30%
40%
50%
60%
Majori ty of Hospitalists acquired from Sound Inpatient Physician Holdings transaction
Management Service Organization and Corporate Practice of Medicine
The MSO Model
• Typically Private Equity Backed
• Management Service Organizations (”MSO”). Investor creates MSO as a mechanism for investment in the physician practice.
• ASC investments can be structured through MSO or Investor can make a stand alone investment
• Increasingly active in the space and acutely interested in addition of ancillaries such as ASCs
• Goal is to create integrated care model, economies of scale, access to ancillaries & rate lift
McGuireWoods | 16
Not Legal Advice
Corporate Practice of Medicine –Overview
• In many states, corporations and other non-licensed entities are prohibited from providing medical services using licensed physicians and from splitting fees between physicians and non-physicians (i.e., non-physicians cannot own)
• Violations can result in professional sanctions against the physicians and perhaps criminal and civil penalties against the officers and directors of the corporation
• Rationale
‒ Avoid “lay person” control of clinical decisions
‒ Avoid subordinating patient care to profit motive
• To avoid these rules, platforms often use a management services organization (MSO) structure
McGuireWoods | 17
Not Legal Advice
MSO-PC Structure
• PC owns clinical assets, which are limited to medical records, certain licensed equipment and drugs
• PC employs providers/clinical staff
• PC holds all payor agreements, all money/business through it
• Investor connection to the business is limited to ASA, so often uses other tools (e.g., liens, rollover equity, transfer restrictions)
• MSO owns all non-clinical assets, which is the bulk of the assets
• MSO employs any non-clinical staff involved in the operations of the business
• MSO contracts with as many third-parties as we can assign, including real estate contracts
• Often will have Physician Owners as co-investors in the MSO, as well as lenders and co-investors
Physician Owner(s)
Administrative Services Agreement
MSOPC/PA/
PLLC
Investors
Administrative Fee ($)
Non-Clinical
Administrative Services
Other agreements
McGuireWoods | 18
Not Legal Advice
State Law CPOM Developments
• California• Vigorously prohibits corporate practice and limits the types of activities
management organizations can participate in
• California Medical Board has listed certain “management” decisions that should be made by licensed professionals and not by unlicensed individuals, which includes decisions regarding billing and coding procedures and selection of medical equipment/supplies
• Some argue that recent case law (e.g., Epic Medical Management, LLC v. Paquette) may mark a more liberal shift in thinking about MSO arrangements, with the focus being whether arrangement is at FMV
• Florida• Aggressive stance on corporate practice of dentistry issues
• Pathway for clinic licenses that allow non-professional ownership of medical practices
• Recent anti-trust bill was proposed (and defeated) that would require greater disclosure and approval of transaction structures
McGuireWoods | 19
Not Legal Advice
State Law CPOM Developments (cont’d)
• New Jersey and New York• Control elements of an MSO-PC structure are under increased scrutiny after
Allstate Ins. Co. v. Northfield Medical Center, PC (NJ) and In the Matter of Aspen Dental Management, Inc. (NY)
• Recently, Carothers v. Progressive Insurance Co. (NY), where highest state court invalidated arrangement for non-FMV services, and nominee owner did not hire the employees or have involvement in compliance/billing
• Rise in insurers asserting corporate practice claims
• Texas• Longstanding CPOM/CPOD prohibition, stemming from case law, statutes, and
regulations
• Requires DSOs to register with the state on an annual basis, providing information regarding practices manages, dentists to whom it provides administrative services, etc.
• Although no bright line test for how much control is too much control, courts look to, among other factors, who: (i) hires physicians/dentists and sets compensation for the same; (ii) engages in marketing efforts; (iii) contracts with payors and managed care contracts; and (iv) how the administrative fee is determined (i.e., does it involve a percentage of physician profits?)
McGuireWoods | 20
Not Legal Advice
Key Takeaways
• Each state is different and should be treated as such
• Valuation of management agreement to ensure fair market value is helpful to defend arrangement
• Operational considerations are as, or more, important than legal document, i.e. how is the business operated
• Robust clinical leadership structures can create stability and appropriate governance
• Some states do not have corporate practice restrictions and direct ownership is sometimes advantageous; however, clinical autonomy is still critical
• Other, related laws, are also important, e.g. fee splitting, control of bank accounts, etc.
FMV ASA Fee
❑ Best practice is to obtain valuation to support fee
❑ Best practice: fixed fees or cost-plus are more defensible, can adjust annually
Elements of a Transaction
Transaction Process
• Pre-Transaction Strategy
• Transaction Process (3-6 months):
• Self-Diligence/Housekeeping
• Restructuring (if needed)
• Go to Market – Confidential Information Memorandum
• Letter of Intent
• Due Diligence
• Negotiate Documents and Prepare Disclosure Schedules
• Signing
• Third Party Consents/Notices
• Closing
Purchase Agreement
• Purchase price (cash and rollover)
• Scope of purchase
• Closing conditions
• Representations and warranties / risk allocation / indemnification
• Covenants
Key Deal Terms to Consider:
✓ Capitalized Earnings
✓ Purchase Multiple
✓ Form of Consideration (Stock vs. Cash)
✓ Post-Transaction Synergies
✓ Governance Terms
Private Equity Valuation Methodology
Potential Acquisition Scenario
Historical Compensation (30 MDs) $10,000,000
Capitalized Earnings % 20.0%
Physician Compensation Sold $2,000,000
Transaction Multiple 7.5x
Total Purchase Price $15,000,000
Pre-Transaction Compensation $500,000
Post-Transaction Compensation $400,000
TRANSACTION MULTIPLES
8.5%➢ Growth in EBITDA
multiples, 2016-2018
➢ Multiples remain
elevated
5.3x➢ Debt Leverage
Multiple in 2018
Source: Pitchbook
9.0x 8.5x
12.0x
7.0x
8.1x
9.2x
8.6x
10.2x
12.4x
10.3x 10.6x
12.0x 11.5x
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
U.S. Median PE EBITDA Multiples2006 - 2018
Debt / EBITDA Equity / EBITDA Total
Private Equity Deal Multiples Continue to Rise
COVID-19 Impact
• Investment has slowed since the start of the pandemic, but is starting to pick up again
• Buyers are forced to re-look at valuation because trailing performance is generally materially different for the prior 6 months as compared to 2019
• Sellers frequently availed themselves of government relief programs, such as PPP loans, advanced Medicare payments and Provider Relief Fund grants – these programs need to be accounted for in transactions
• General uncertainty regarding the future of the pandemic has created increased closing risk
• Earn-Back / Earn-Out
Employment Agreement
• Duration
• Duties
• Schedule
• Call
• Termination events
• Covenants
• Competition/solicitation/disparagement/confidential information
• Outside activities
Compensation Models: Private Equity
Base
compensation
Production
Incentive
Leadership
Role
Equity
Interest+ + +
Based on professional
collections
Key Considerations
❑ Compensation surveys may be considered, but are usually not the primary basis for
compensation models
❑ Physician practice profitability plays a significant role in determining physician
compensation
❑ Fair market value documentation less of a focus
• Employed
physicians to
become partners
• Profits Interest
• Opportunities to
purchase equity
29
Tied to value and/or
quality measures
Rollover equity
• Often, selling physicians will receive a portion of their purchase price in the form of equity in the buyer
• This means that if the business does well, the physician may get a “second bite at the apple” when the buyer sells the business to another party
• It is important to understand the nature of the equity that is offered and how it compares to other equity
• Receipt of rollover equity will be conditioned on signing onto the governing documents of the buyer
• There may be circumstances where the physician could forfeit, or be forced to sell the rollover equity at a discount
Associate Physicians
• May not have participated in the sale transaction since not a partner in the practice
• Want to create a path to partnership with the new company
• Different ways of accomplishing this, including:
• Offering equity in the buyer
• Creating different classes of units with lower point of entry
• Transaction bonuses from proceeds
The Physician Perspective
Physician Considerations
• Purchase price
• Go-forward liability for prior operations
• Employment agreement• Duration of contract with ability to walk without cause
• Non-compete and other covenants
• Call coverage
• Compensation
• Scheduling
• Outside activities
• Ownership of practice post-closing
• Real estate
Physician alignment
• What does the future look like? How are my economics aligned with the business?
• Rollover equity
• Profit sharing through compensation
• Board membership/observer rights
• Is this partnership right for me?
• Are other physicians happy with their decision?
• How much autonomy will I have over my day to day life?
• If I don’t like it, can I do something else?