Three keys to investing in physician-led practices

Healthcare private equity (PE) deals are booming, up over 50% in 2018, reaching $63.1 billion, according to a recent report by Bain & Company. Transactions involving physician-led practices are complex, and often reflect the evolving landscape of healthcare in general. Unless carefully managed, such deals can fail to meet a PE firm’s goals.

There are three key areas that can influence the success or failure of these deals: how seller expectations are set and managed, how effectively data and analytics are used to achieve visibility into operational and financial performance, and how the physician practice and the PE firm assimilate post-transaction.

Managing expectations: A better bedside manner

Independent, physician-led practices usually focus primarily on patients and their clinical needs, rather than business issues. They therefore may require some subject-matter expertise when considering a sophisticated PE transaction. Engaging a firm with this expertise can help prepare the owners to participate in the due diligence process as well as for what may occur after the transaction is completed.

The firm should explain to the physicians what’s likely to happen, both pre-close and post-close, and why. During due diligence, the practice’s accounts receivable will be analyzed to determine its cash equivalent value, which may be a unique exercise for a physician practice. Post-close, the PE firm may suggest the addition of more experienced financial and operational personnel to meet the business needs of the practice. For example, the PE group may suggest bringing in a CFO to replace the part-time accountant the practice had been using.

The PE firm should create economies of scale and enhance business efficiency to allow the physicians to resume pre-deal compensation levels, adding value to enterprise.

In a PE transaction, the physicians may voluntarily reduce their compensation in order to create more cash flow/EBITDA to increase the value, and — the purchase price of their practice. Oftentimes, physicians sell only a portion of their business to the PE firm, allowing them to retain some ownership and decision-making authority. This model retains the physicians’ pride of ownership and financial interest to enhance operations, improve efficiency, and grow the business. The PE firm should create economies of scale and enhance business efficiency to allow the physicians to get back to pre-deal compensation levels, which is how they add value to enterprise.

Using data to diagnose business health

The ability to collect, maintain, and analyze large sets of clinical and financial data quickly and accurately is becoming a competitive advantage. This is a significant component of value that’s largely untapped, and one that the PE firm can help the practice better capitalize on.

A physician practice can increase its collections through various revenue cycle enhancements using data analytics and subject-matter expertise. For example, Plante Moran has employed data analytics to identify the sources of increased claim denial activity and to assist its clients with prioritization of work efforts to optimize recoveries upon appeal. This activity also assists clients with the reducing future claim-denial activity as protections are enabled to identify potential denials prior to claim submission.

By tracking patterns of claims denials, a practice can identify and pursue flagrant denials and, ultimately, adjust its business model to avoid them.

Being careful with managed care contracts

A PE firm can add significant value by helping to evaluate, monitor, and negotiate managed care contracts for the physician group. This is a skill set that some physician groups struggle with on their own, which can cause margin deterioration and business interruption. Commonly, an “equity-of-the-portfolio” philosophy can be implemented, which means making sure that the best rates are offered only to the managed care organizations providing the highest patient volumes. Surprisingly, many practices fail to do this, and end up giving discounts where they aren’t warranted. The primary reason to give a discount is to fill capacity. Yet, practices will still give a discount to a managed care company even when their practice doesn’t have room to take on more patients. These practices should be advised against collecting managed care contracts like gumdrops. Word of advice: the practice doesn’t have to be in every plan.

An “equity-of-the-portfolio” philosophy can be implemented, ensuring that the best rates are offered only to the managed care organizations.

Another common challenge is regional overexpansion. Even when a geography is saturated, it’s tempting for a PE firm to continue to grow the top line by acquiring more local practices, but that can actually lead to deteriorating margins. The incremental costs of acquiring the remaining smaller practices in a region can lead to diminishing returns as economies of scale aren’t always available. The overall goal is to create scale in a particular geographic region so that the practice can’t be “contracted around,” in which a managed care company contracts with another local practice rather than yours. It’s not necessary to accumulate every practice in the region to accomplish this goal.

As the number of PE deals for physician groups continues to rise, they can provide significant rewards for the physician owners and also create a platform for future growth. But the complexity of these transactions requires specialized expertise to optimize the enterprise value of the practice and to manage through post-transaction issues. By bringing in disciplined management and the tools by which to collect and analyze data on which to make decisions, a PE firm can improve a practice’s financial footing and its ability to deliver quality healthcare.