Private Equity in Healthcare: Unveiling the Controversy and Reality

The Controversy:

When it comes to private equity’s involvement in healthcare, an immediate visceral reaction is often violently erupted via smokestacks from the ears of everyday Americans. Afterall, healthcare is potentially the most personal part our lives. In the U.S., many of us saunter the streets with a thin veil of paranoia, waiting for a personal financial crisis to strike because a trip in the ambulance could mean certain pecuniary doom. Feeding that paranoia further is the thought of private equity – who are known as the world’s prima-donna money grabbers – using their profit-first driven motives to squeeze what little retirement funds are left from our ever-aging, geriatric grandparents. This perceived list of infractions against private equity in this market is almost unending and, to be truthful, there are a number of occasions where, in isolation, it’s hard to make an argument in favor of private equity.

Private equity has somehow built itself a reputation for destroying businesses, not building them. The common tale prescribes that private equity takes a multi-step process: (i) initiate mass layoffs quickly and minimal notice (ii) cut back on vital spending to pay for the expensive debt they load onto the business and (iii) reduce the breadth of product offerings; all in the name of short-term profit and at the expense of a long-term vision. And often running otherwise healthy companies into bankruptcy.

In healthcare, private equity can have a reputation for a lack of understanding in the market; especially compared to traditional providers, leading to a reduction in care quality. Opponents of the private equity business model may exclaim that to compensate for this knowledge gap and to stay profitable, they cut important costs and charge more – creating a two walled compactor that crushes some of the least fortunate members of our society: the ill.

So, if large companies are failing because of greedy, incompetent prima donnas who are leaving behind a trail of fire in their wake, then does private equity have any place in healthcare or even the broader market for that matter?

The Reality:

In truth, private equity has been under a microscope since inception. From the media’s perspective, the only thing that can top a headline of an underdog prevailing is one where a dominant player falls from grace. Who doesn’t like to see a giant fall? It’s biblical.

The fact is that private equity affords stakeholders lower prices with higher value. In the wise words of the world’s most successful investor, Warren Buffet, “Price is what you pay; value is what you get.” Yes, the goal of private equity at the end of the day is to provide an ROI acceptable to their limited partners; but how does private equity generate those returns?

The obvious and somewhat facetious answer is that private equity follows a three-step process: (i) purchase an equity stake in a company (ii) increases the price of the equity and (iii) sell that stake for a profit. But I digress, because the second piece of that ROI equation is largely the focus of the controversy.

By all accounts, the quickest way to price appreciation is by achieving value appreciation; though, it isn’t always a 1:1 correlation. Thus, private equity hires top talent to run their companies that compete in the marketplace for the best product, at the lowest price, and with a sustainable business model; whereby another buyer in 3-7 years will want to acquire a substantial equity stake at a higher price than was purchased. In the healthcare industry especially, this ‘value creation strategy’ comes in several different flavors that will be discussed in our next article.