The origins of the modern private equity (PE) industry date back to the late 1940s with the creation of the first venture capital firms.
However, it was not until the 1980s, with the changes in the regulation of the US financial and labor markets, that PE firms became prominent. The last 2.5 decades have seen explosive growth in the expansion of PE firms into the healthcare sector.
Acquisition of hospitals, ambulatory surgical centers, nursing homes, fertility clinics, imaging centers, and medical practices, as well as retail health and mobile application companies, are numerous. In 2018, the valuation of PE deals in the US healthcare sector surpassed $100 billion with $1 trillion invested in the last decade.1,2
As of 2022, the American Hospital Association estimated that of the 5,129 US community hospitals, approximately one-quarter are owned by a for-profit entity.1 Among these, PE firms now own approximately 460 hospitals, an estimated 25-fold increase over the last 2 decades.2,3
Understanding How PE Works through Leveraged Buyout
The arrival of for-profit institutions and PE firms in the healthcare sector is seen as contributing to an overall investment strategy now recognized and referred to as the “financialization” of healthcare. Financialization can be described as the “transformation of public, private, and corporate entities into salable and tradable assets from which the financial sector may accumulate capital.”4,5
PE firms operate using the concept of a leveraged buyout to acquire ownership of hospitals, medical practices, and similar entities. Under a leveraged buyout, the PE firm uses a small amount of capital from investors but primarily borrows a large loan (debt) to purchase a healthcare entity.
This debt is placed (leveraged) on the acquired entity, and its physical assets (i.e., land, buildings) are used as collateral for the loan. This is unlike transactions by for-profit, non-PE firms that make similar transactions by leveraging their own capital and physical assets.
Investors in PE firms defer financial returns (capital illiquidity) and accept greater financial risk in the interim in the hopes of astronomical returns (20%–30% annualized) on the sale of the healthcare entity in 3–7 years.1
Further, US tax policy allows the interest accrued on these loans to be treated as a deductible business expense and the profits from the sale of the entity to be taxed as capital gains (20%).
When examined from the purview of its size, stable cash-flow status, prevalence of valuable fixed assets, and recession-proof nature, the encroachment into the healthcare sector by PE firms would seem inevitable.
Benefits of PE Acquisition
PE investment into the healthcare sector can result in positive changes regarding workforce shortages, increased access to resources, and enhanced patient care. Specifically, PE acquisition can offer the following:
Capital investment
PE can provide capital investment for start-up practices to purchase office space, equipment, and improved electronic health record processes, hire personnel, and analyze big data to handle capitated contracts. For established and thriving practices, PE may offer the opportunity to enhance one’s business footprint, increase efficiency, and expand ancillary services. The use of PE capital to invest back into the practice and generate additional cashflow without acquiring debt can be advantageous. Physician owners, wary of the economic trajectory of medicine, may find realizing future revenue to be extremely appealing.
Market consolidation
Physician groups being squeezed into a competitive market may find a PE investment as a way to remain viable through consolidation with similar practices, thereby reducing operations costs through professional management strategies and economies of scale, which they may not currently possess.
Avoiding bankruptcy
In extreme cases, certain practices may choose selling to PE rather than being acquired by the local hospital to gain financial liquidity. The stakeholders in these groups are often of the mindset that hospital acquisition is the worse choice.
Leveraged buyout
There are markets where the physicians’ future earnings are legitimately in crisis. In these circumstances, a guarantee of future income “right now” may be in the practice shareholders’ best interest.
Through careful investment of proceeds from the acquisition by PE firms, physicians and practices can supplement future cashflow and avoid potential catastrophic downturns in practice revenue. Undisciplined financial behavior after the windfall can leave physicians struggling to make ends meet, demonizing the PE deal.
Physicians within 10 years of retirement typically see the benefit of PE partnership, though many question the advantage of those with more than 20 years left to practice. Younger physicians need to understand that any PE revenue represents their future earnings and that responsible investment and a disciplined approach to spending is paramount for future success.
Disadvantages of PE Acquisition
Possible drawbacks of PE investment in healthcare could include diminished quality of care and increased costs as described in the following:
An overarching profit motive
Creating a short-term focus on maximizing profits for investors rather than developing long-term healthcare solutions can occur. For example, cost-cutting measures through reduced services, staff layoffs, and organizational restructuring with a focus on more profitable services at the expense of essential but less-profitable service lines. Subsequently, health outcomes and access to quality of care are adversely affected, especially in smaller cities.
Lack of transparency, accountability, and oversight
Acquisitions with conflicts of interest involving the investors and owners of PE firms allow such transactions to continue unchecked with little consequence to the PE firm when they make windfall profits at the expense of hospital foreclosures.
Access and affordability
Healthcare can diminish, as increased costs for services (to maintain a higher profit margin) are eventually passed on to patients.
Leveraged debt
The purchase of the healthcare facility puts the burden of loan repayment on the acquired institution. If an institution cannot generate adequate revenue to repay the loan, it is forced to file bankruptcy.
Eileen Appelbaum, codirector of the Center for Economic and Policy Research, has stated that PE firms in the healthcare arena are “Turning healthcare from a social good into a commodity.”3 Profits are generated by extracting wealth through complex financial manipulation schemes rather than by producing goods and services. Medicare and Medicaid payments (taxpayer funded) are thereby transferred to PE firms rather than remaining in the healthcare sector for which they were intended.
Current Legislative Action to Regulate PE in Healthcare
PE deals often involve confidentiality agreements and limited public disclosure, leading to a lack of transparency about decision-making processes, ownership, financial performance, and quality of care in healthcare institutions owned by PE firms. Until recently, legislative efforts to curtail the unfettered acquisition of healthcare entities by PE investors have been modest due to concerns of expanding regulatory overreach into the free market and the potential for partisan political abuse.
Recently, regulatory agencies in the executive branch have turned their sights on these financial transactions in the healthcare sector given the public outcry and media scrutiny over the collapse of an iconic institution such as Hahnemann University Hospital in Philadelphia, Pennsylvania, and Steward Health, an eight-hospital consortium in Massachusetts.6
