Private equity infusion: A question of balance of growth vs. control for doctors

For the last few years, a growing pool of private equity investment money has been pouring into health care firms, swelling these enterprises until they are big enough to crest in rewards for investors.

The dollars have streamed into biotech, pharmaceutical, device and equipment companies as well as into hospitals, ambulatory surgery centers and even physician networks, providing relief for businesses that were thirsty for capital to grow and expand.

But implications for physicians are murky. Certainly some physician-led enterprises have benefited from the financial infusions. Yet those physicians may also be losing some control of their businesses as the private equity investors gain a stake. And, the increased leveraging of those enterprises may spell more risk for the physicians who have to make the businesses financially successful.

The same possible benefits and risks may be true for other health care companies that receive private equity infusions. Observers say physicians who do business with those companies may see anything from no change to drastic transformations with the investment strategy.

Though definitions vary, in broad terms private equity investment means a capital investment into a company by a private group of investors. This could mean anything from a large-scale buyout of a public company to take it private, such as the $33 billion offer that the hospital giant HCA accepted last summer, to smaller capital infusions into private enterprises, to companies selling off divisions. In such an example, Emdeon Corp., formerly WebMD Corp., announced Sept. 26 that it agreed to sell 52% of its business services division -- which provides claims clearinghouse services to physicians and hospitals -- to General Atlantic LLC, a private equity firm, for $1.2 billion in cash.

Venture capital, sometimes referred to as seed money for emerging companies, is included as a subcategory in the broadest definitions of private equity. The growth in this arena has been significant. According to a report by PricewaterhouseCoopers, the National Venture Capital Assn. and Thomson Financial, venture capital investment from seed money to later stage deals in the biotech and medical device and equipment sectors grew from about $5 billion in 2002 to $5.9 billion in 2005. By contrast, in 1995 there was just $1.4 billion of venture capital in those sectors.

But the biggest share of private equity funding comes from so-called buyout funds, which, as in the case with HCA, purchases stakes in publicly traded or otherwise mature businesses through a combination of equity and debt, in the form of bond offerings.

Another report from Thomson Financial and the NVCA examined buyout fund raising and found that 93 funds raised a total of $31.4 billion in the first quarter of 2006, the lion's share of which came from 42 buyout vehicles that raised $24.9 billion. In fact, buyout funds, which often represent the megabucks behind private equity investment, posted a record the quarter before, when they raised $31.9 billion.

The trend may be fueled in part by advances in technology and medicine that have created more opportunities in the health care sector, said Richard Gundling, vice president of the Healthcare Financial Management Assn., a Westchester, Ill.-based association of health care financial executives.

On a broader level, the trend in health care may be mimicking an overall surge in private equity investment, said Paul Hughes, a corporate health care attorney with Wiggin and Dana in New Haven, Conn. "The overall, macro driver is probably funds having more funds to invest."

Hughes said the dollars are going into ventures that are driven by the aging population or in places where there is fragmentation in the market, such as home care and elderly-focused behavioral health. He also has seen private equity money in ventures related to in-office ancillary services and PPOs.

The money also is flowing into health care services such as integrated health care delivery systems, said Craig Frances, MD, a principal with the Palo Alto, Calif.-based private equity firm Summit Partners. "You're seeing the resurrection of people believing after all there is a lot of value to some of these physician networks that are built differently, ... as long as you are able to appropriately align incentives with doctors," said Dr. Frances, who was trained as an internist but no longer practices medicine.

In general, he said there seems to be more private equity interest in organizations where physicians are in the engines. That includes physician-led ambulatory surgery centers and other types of ancillary facilities.

Of course there is less private equity interest in the smallest ambulatory surgery center operators, said Dr. Frances. But the industry has grown so much in recent years -- as physicians have been forced to seek alternative streams of revenue -- that larger businesses, including chains of ASCs, have sprung up in many places.

The increasing availability of capital likely means that such physician enterprises also will see more competition. "If there are easier sources of capital, that's one barrier that comes down from a competitor entering," said Gundling. The competition could be good news or bad news for physicians, depending on whether they are the ones getting squeezed, he added.

Another potential problem is that although the capital infusion may provide an inroad for physicians to achieve business goals, it may also be a road in for outside investors, Gundling said.

"The difference with private equity is that although it's a good source of capital, it also comes with owners and investors. And they will want results," he said. "Those private equity investors may want a seat at the table to govern changes. And you may have to give up some control."

Additionally, Gundling said physicians should be aware of the obligations of paying back capitalization to investors under these deals, even if they end up struggling to make the business profitable.

On the other hand, bringing in those outside investors also could help relieve financial headaches by allowing physicians to reduce how much of their own money is tied up. "Now they have access to bringing on capital and they can sell off a minority stake in the company and diversify their wealth," said Dr. Frances.

Hughes said the infusion of money may have two seemingly opposing effects: providing funding for more physician-led ventures and producing more consolidation among smaller ancillary services providers, forcing them to become more professional and provide better services.

"The physicians can benefit on both sides of that by being involved in the provision of services or, as a consumer of them, having them available at a higher level," he said.

Using similar logic, some observers say that physicians may see a benefit from more private equity money in device and equipment companies, as well as in hospital chains.

For example, manufacturers and pharmaceutical companies that have more money may be able to create new and improved products. "[Physicians] will feel that, longer term, when some of those products come to the marketplace and they can prescribe them or those devices come out and they can use them," said Jeffrey Kraws, chief executive of the New York-based research firm Crystal Research Associates.

But Hughes said that as other health care companies get more private equity investment, there may be more consolidation, which would mean fewer choices for the physicians who do business with them.

Still, many observers say it's hard to predict how companies will react to private equity infusions. When HCA agreed in July to a massive leveraged buyout offer by a consortium of private investors, analysts were unsure about whether the new ownership structure would change the company in any way that physicians or patients would notice.

Dr. Frances said the Nashville, Tenn.-based hospital chain would have new owners focused on the bottom line but that wouldn't necessarily affect the quality of care. Still, he said there was not "enough data either way" to predict what changes might arise.

For now, many observers predict that the surge in private equity investment in health care will persist.

"The wind is at our back with the aging of the population and all that. So with the macro factors so strong, it really allows us to really look forward," said Dr. Frances.

In the meantime, many of the ramifications of that trend remain up in the air.