Having closely observed the recent trends toward private equity transactions and having advised a growing list of surgeons who are trying to figure this out for themselves, it is a good time to pause, step back, and offer input to retina specialists.

Private equity is nothing new. For the past generation, capital has been pooled from wealthy individuals and estates and invested in company offerings not readily available to the public. In the stock market (ie, the public equities market), anyone can buy, sell, or hold an ownership position in a publicly traded firm. Private equity, in contrast, offers a different risk/reward scenario, is limited to high-net-worth individuals, and typically locks up your investment for a 10-year period.

PRIVATE EQUITY IS NOT VENTURE CAPITAL

Private equity should not be confused with venture capital (VC). Venture capital funds typically invest in early-stage companies with a much higher risk/reward profile. Many of their investments yield zero return, while the few that succeed create outsized returns to investors, a high-stakes game investing in unproven technologies. Many ophthalmic projects are financed by VC; not all of them make it to become commercially available.

Private equity funds are managed by a team of individuals whose job is to deploy the capital they have raised and create a significant return for their investors in exchange for the size of the investment (large), the relative risk (often greater), and the lack of liquidity over many years. There are thousands of private equity funds covering just about every industry sector; health care has become increasingly attractive as a place to invest.

HOW PRIVATE EQUITY WORKS

Private equity funds typically invest in late-stage companies that generate revenue and may have been around for years or decades. They are attractive because the private equity fund sees an opportunity to invest in such a way to gain not only ownership but also control over management. Private equity views ophthalmology as a category that is highly fragmented, has a strong future demand profile, and could benefit from more efficient delivery of care. This perspective has led to funds offering to buy large practices with the goal of growing the practice’s EBITDA (“earnings before interest, tax, depreciation, and amortization,” an accounting term for profit that is normalized to account for physician owner salaries after a transaction).

To date, approximately 20 transactions have taken place in which large practices (ie, generating a minimum of $3 million to $4 million in normalized EBITDA) are now owned by private equity firms. Practices are valued based on a multiple of this normalized EBITDA, and we are seeing transactions anywhere from 4 to 10 times EBITDA. It is no surprise that practice owners are interested in these new buyers, because a much higher price is paid than what could ever be reasonably expected as a buy-in from a younger associate. This buyer is rapidly disappearing due to the burden of medical school debt and a generational difference with respect to career/life balance exhibited among newly trained surgeons.

Most transactions require physician owners to remain on board and take part of their windfall as equity in the new entity. This requirement means that physicians will continue to have ownership (typically 20% to 35%) in the new entity as a way to keep incentives aligned for future growth. While each firm has its own specific goals and plans, the general pattern is as follows:

• Establish an identity for the new “platform” practice entity, with a CEO and management infrastructure that can be shared as the entity expands through both internal growth and acquisitions of other practices;
• Focus on increasing EBITDA, because doing so creates greater “free cash flow” that can be used to pay down the debt that the private equity firm incurs to partially fund the transaction; and
• Look to sell the entity in the next 5 to 10 years to another, often larger private equity firm that would be interested in purchasing this entity and others to continue consolidation on a wider regional or national basis. In private equity terms, this process is commonly referred to as “climbing the ladder.”

CONSIDERATIONS BEFORE SECURING PRIVATE EQUITY

At first glance, this process seems like a very good deal for the selling physician. Indeed, it can create a new level of wealth that was never attainable with traditional transactions. Given the unknowns of health care and future reimbursement, it provides a way to continue practicing with less risk. The income windfall often qualifies for capital gains treatment, making the up-front payment even more attractive.

However, there are downsides. The biggest of these, as expressed to me by physician clients, is control. Once you sell, you no longer have control. No matter how friendly the new owner is and how much they intend to respect the culture you have created, all of this will take a backseat to EBITDA and the pressure to quickly grow the business. For some practices, this is “just what the doctor ordered,” as the private equity firm will bring in professional management and truly help a practice to run more efficiently as it grows. If this plan is executed well, satisfaction can increase among doctors, staff, and patients. That is a great outcome.

However, for other practices, it changes the flavor of what happens on a daily basis. “The income was great, but everything else changed,” said one surgeon who sold his ASC ownership. “The pressure to meet the numbers was like the fine dust that gets on everything when you remodel your kitchen. It is ever-present and affects everyone in the practice.”

Retina practices require an even more delicate analysis since their dependence on access to covered lives, as well as referrals from primary eye care MDs and ODs, amplifies the risk of an unknown future. Unlike subspecialties for cataract, refractive, and dry eye, there are few self-pay offerings for the retina specialty to add as a hedge against changing reimbursements, which will decline over time.

Retina specialists who are not part of a multispecialty group must carefully devise strategies to manage the inevitable consolidation that is still in its early stages in ophthalmology. As alternatives to an outright sale to a private equity firm, here are several options that should be considered.

• Merger: Combining forces with another retinal practice, which you may currently view as a competitor, can provide efficiencies through combining back-office functions, better pricing through combined volume of similar purchases, and higher utilization of diagnostic equipment. On the growth side, a combined practice may be able to expand the coverage region. All of these changes may ultimately lead to a private equity transaction; as mentioned above, practices with greater overall EBITDA tend to obtain higher multiples. Also, in theory, a combined practice will be more valuable than the sum of the two as individual practices.
• Private debt: A practice seeking to grow by adding facilities or acquiring practices should explore access to lower-cost capital than what is readily available at a local bank. Unlike the commercial rates and terms offered (typically in the 5% to 7% range with a 10- to 15-year maximum life), there are boutique banks specializing in capital markets financing for practices that need at least $3 million of capital. Because they work bank to bank, they are able to secure loans at 20% to 40% below prime and are able to customize the loan terms to the needs of the practice.

SUMMARY

While it may be tempting to just ignore all the “noise” generated by the recent interest in private equity, the ever-changing dynamics of running a medical practice require a business mindset that is taken as seriously as patient care. Private equity is a relatively new option that has its pros and cons, and it is one of several paths to consider. RP