The decision for physicians in a retina practice to partner with a private equity firm is one not taken lightly. In this article, we hear from two retina specialists from a practice that chose to partner with private equity and a retina specialist from a practice that has chosen to remain physician-owned. Each shares the factors that led to their decision.

CHOOSING TO PARTNER WITH PRIVATE EQUITY

PAUL S. WALIA, MD, AND MICHAEL S. JACOBSON, MD

As much as vitreoretinal surgeons must be up to date on the latest clinical and surgical advancements, they also must be current with the landscape in which we practice medicine. Change is occurring rapidly throughout numerous medical fields and especially within ophthalmology. The emergence of partnerships between ophthalmology practices and private equity (PE) groups has risen steadily since 2017. A PE partnership offers key competitive advantages to retina practices, including navigation of the ever-changing regulatory landscape and operational efficiencies. There is no question that the retina business model is changing due to external forces. The better question is, are you and your practice prepared for these changes?

The PE model is based on a partnership among successful ophthalmology practices that leverage professional management and investment of significant capital to grow the platform for a potential subsequent transaction to a larger entity, often referred to as “the second bite.” There are many types of private equity groups and successful PE groups in ophthalmology often bring a historical track record of success in health care that share a practice’s strategic vision and goals. It is a common misconception that incentives between the PE group and physicians are misaligned, but in fact, successful partnerships are proven based on aligned goals in which both parties help build shareholder value for all, including physicians and the PE group. Not all PE ventures are advantageous depending on specific practice and operational dynamics, so finding the right PE firm cannot be overemphasized.

Private equity partnerships are not a reinvention of the PPMG deals of the 1990s. Only the best and highest clinical quality practices are targeted, whereby physicians maintain significant control and autonomy in their practice of medicine. As compared to the PPMG model, physicians are compensated mostly in the form of cash, not stock, which benefits physicians of all maturity. It allows the seasoned physicians to take “more chips off the table” and younger physicians to eliminate the burden of buy-ins and buy-outs. Many physicians may not realize that by buying into a practice, they may have obligated themselves to an onerous buy-out. PE partnerships allow physicians to continue to be remunerated properly, with excellent individual incentives to help focus on long-term growth and sustainability as opposed to a pure fixed salary, including equity ownership and upside return in the larger, more diversified company. Ultimately, the physician is not selling a practice but partnering with a capital and strategic partner to generate liquidity as well as reinvesting in a piece of a much larger entity. When a second bite occurs, physicians have an opportunity to share in equity appreciation.

A PE partnership allows physicians to concentrate on their clinical expertise while bringing in top-class management to support and enhance operations and position the entity optimally for future growth and sustainability. The main priority for PE groups is to focus on improving the quality of patient care and experience while leveraging staff and resources to realize operational improvements and drive shareholder value. The relinquishment of administrative duties welcomes improved work flexibility and work-life balance for physicians.

Private equity partnerships are accelerating the consolidation of ophthalmology practices and corresponding referral networks. According to the most recent American Society of Retina Specialists Preferences and Trends survey, more than half of all retina specialists are in a retina-only practice, either solo or group. These retina-focused practices depend on the support of a referral ophthalmic community, so without support, the retina practice may incur an erosion of referrals.

Georgia Retina partnered with PE because we felt that changes in health care were accelerating the challenges of operating a retina group practice. We felt PE would be embraced by our general ophthalmology colleagues, so we had to act or we would be left out. We preferred to enter on the ground floor and be part of the building process rather to enter later on their terms or be excluded. We wanted our practice to survive well for generations of patients, but more importantly, we wanted our youngest physician associates and future associates to have an excellent opportunity with the best work life balance. We have continued to grow since the transaction in terms of office locations, doctors, administrative employees, and productivity, despite naysayers saying PE leads to less productivity.

After a thorough vetting of PE firms, we found the perfect partner in Shore Capital. After extensive deliberation, we joined EyeSouth Partners, a company in which Shore Capital had invested, in 2017 and have not looked back. We were convinced that this partnership would strengthen the core value of both entities. We chose them because they were distinctly physician centric and because of their prior track record of success in the health care space. Physicians are involved with all levels of decision making — and not just via a token physician on the board. There are several physicians from multiple practices as well as a physician advisory board and regular communication and collaboration across practices. EyeSouth Partners has provided the opportunity for our retina-only group to gain involvement in a larger eye-care entity that has a greater regional foothold, and our future is assured.

CHOOSING NOT TO PARTNER WITH PRIVATE EQUITY

DAVID EICHENBAUM, MD

Private equity purchase of private retina practices has become more common over the past several years. Most retina practices are contacted often by various representatives of firms that are offering to purchase the practice. Our practice has decided not to sell to an outside investor for both economic and noneconomic reasons.

Economically, retina practices operate essentially as small businesses of various scales. They have proven to be profitable entities over several decades, which is why they are appealing to PE investors. In the private practice model, these profits are distributed to the physician-owner(s) after paying practice overhead, including employee salaries. Retina practices, similar to other small businesses, are relatively nimble and self-governed, and run as lean as possible to maximize these profits.

Typically, in PE buy-out of a retina practice, the goal is to make the private practice more valuable to sell it, often aggregated with acquired groups as a platform, to other, larger PE groups. One of the easiest ways to increase the value of the acquired practices is to reduce profits distributed to the prior physician-owners. That exchange of future physician salary for cash is part of the deal; as stated by Eric Nudelman, “in the buyout, PE will provide some percentage of your potential future earnings as an upfront payment.”¹ The only reasonable way to do that is to decrease pay in the short- to mid-term; in a desirable practice there usually are not a lot of other places to reduce expenses. Everyone — both the PE principals and the selling physicians — is hoping to do well in the long term, but it’s a gamble. Private retina practices have done well for almost 50 years without this type of exchange of potential future earnings.

In addition to making the platform more valuable or desirable for future resale to other PE groups, the purchasing PE firm needs to allocate management fee funds to pay its internal administrative staff while improving the appeal of the aggregate financial statement of the purchased practices. That management cost is another, additional percentage from the platform revenue coming out of what used to be the profit distributed to the prior physician-owners. The management fee may increase at some point in the future if the PE principles want to make a larger profit on their investment and the second bite of the apple does not happen (more on this below). In the end, it is unknown whether the buy-out offered by PE is a better deal than staying with a successful small business model with a 50-year track record of success. There is no guarantee that a sale is a better deal.

Many physician-owners who sell are enticed by the potential second bite of the apple, because the deals often give some equity or shares in the new aggregate platform to the prior physician-owners. There are a number of caveats to this, which are unique to PE. Aggregated retina practices are illiquid. There is no public market for these shares, and matching sellers of the platform to potential buyers is a protracted negotiation. The pricing of the shares that the physician owners have will be arrived at through this negotiation with the new, purchasing PE firms, and is not subject to market forces as are publicly listed shares. In fact, the shares that the physician-owners negotiate into their practice’s sale are often valueless unless the second bite comes through. Importantly, the rights of private equity shareholders — the physicians who sell and acquire a buy-out partly paid in shares — are decided on a case-by-case basis through these negotiations. Often, the physicians are limited partners and the PE firm is the general partner, and the general partner calls all of the shots with regard to the potential, and uncertain, resale of the platform.^2-4

Another valuable economic piece of the retina practice that is sold when PE purchases a group is the revenue from buy-and-bill pharmaceuticals. Even small retina practices with 1 to 3 physicians have substantial drug revenue. Although the profit on buy-and-bill pharmaceuticals may be minimal, the revenue stream has significant nonmonetary economic value. Many retina practices leverage relationships with local banks to manage the revenue, which can help the practices or the physician-owners with favorable credit deals for acquisitions funded by their local partners to grow the business. Other practices partner with group purchasing organizations or credit card companies to realize both monetary rebates and nonmonetary reward benefits tied directly to the drug revenue. Upon the sale of the practice, the physician-partners no longer retain exclusive control of this revenue, and they risk losing the benefits of the relationships they have established.

There are also noneconomic factors that weigh against selling to PE. The life-blood of a legacy retina practice is attracting the best and brightest new associates to hire. As our practice has grown and continues to grow, the best graduating fellows find it less appealing to sign an employment agreement with a group that may sell to PE. Potential new physician candidates ask about this, and our practice has been successful with hiring in part due to our clear stance as an independent private practice without an interest in selling.

Importantly, there is only one guarantee when a practice is sold to PE: the physicians no longer own and exclusively control the practice. All physician-owners consider factors such as return-on-investment (ROI) when making staff hires or equipment purchases. However, we consider ROI through the extremely specialized lens of a fellowship-trained surgeon. The only thing a PE owner is going to consider, at then end of the day, is the ROI of the acquisition of the retina practice. Before selling, the physicians who have built a successful, profitable, desirable entity are going to have to decide if they want to share — or in the worst case, relinquish — their operational decisions with a nonphysician whose primary focus is on improving the balance sheet of their practice purely for arbitrage. The PE firm wants the machine to run well and make money, so they would be wise to let the physicians continue to “steer the ship” while being paid less to do so. However, after the physicians sign the deal in exchange for their buy-out, they are no longer the bosses. They are owned by and work for the PE firm. RP

REFERENCES

1. Nudelman E, Prenner J. Why is private equity eyeing retina? Retina Roundup. Available at: https://retinaroundup.com/2018/06/01/why-is-private-equity-eyeing-retina/ . Accessed April 8, 2019.
2. Private equity. Investopedia. Available at: https://www.investopedia.com/terms/p/privateequity.asp . Accessed April 8, 2019.
3. Mahdavi S. Private equity for the retina practice. Retinal Phys. 2018;15(4):49-50. Available at: https://www.retinalphysician.com/issues/2018/may-2018/private-equity-for-the-retina-practice . Accessed April 8, 2019.
4. Mahdavi S. Private equity update for retinal physicians. Retinal Phys. March 1, 2019. Available at: https://www.retinalphysician.com/issues/2019/march-2019/private-equity-update-for-retinal-physicians . Accessed April 8, 2019.