Private equity (PE) investment in healthcare is soaring, as investors have raised large amounts of capital and see attractive opportunities in the industry — especially health services.
At the same time, while hospital and health system leaders grapple with narrow operating margins and limited resources, they see exciting possibilities in partnership and joint ventures with PE-based platforms.
To better understand the forces behind these trends, Becker's Hospital Review recently spoke with Greg Koonsman, founder and CEO of VMG Health, a full-service healthcare advisory firm with extensive knowledge and expertise related to PE investments in healthcare services.
PE: an increasing presence in healthcare
There is $7.6 trillion in PE globally, according to a recent McKinsey report. According to Mr. Koonsman, these funds have grown significantly over the past 15 years, as many institutional investors have increased their allocation of assets to this asset class. As institutional allocations to private capital have swelled, the number of private capital fund managers has grown from 3,700 to more than 13,000.
In the U.S., where healthcare represents about 20 percent of the economy, a proportional amount of PE is allocated to healthcare investments, representing about $500 billion. Of the PE funds allocated to healthcare, Mr. Koonsman estimates that at any given point, there is between $80 and $120 billion in "dry capital" waiting to be invested.
"The sheer size of the market has driven the increased interest in activity by private equity in healthcare services," Mr. Koonsman said.
PE investors see attractive opportunities in healthcare services
In the late 1990s and early 2000s, many PE firms shied away from healthcare services, Mr. Koonsman said. Their reluctance stemmed from the regulatory environment; the presence of nonprofit health systems, which dominated the market; and the powerful role of physicians. "For many years, healthcare services was, in a sense, avoided by many firms," Mr. Koonsman said.
But in the past 15 years, more PE firms have started to invest in areas adjacent to the core of healthcare, as seen in veterinary medicine, dermatology, ophthalmology, contract research organizations and other ancillary healthcare services. "The oversupply of capital, together with the fact that private equity firms have gotten more accustomed to understanding the nuances of healthcare services and the regulatory environment, has resulted in more investments in healthcare services," Mr. Koonsman said.
Now, PE firms are going a step further. They're increasingly investing in healthcare services that are more fundamental to a health system's core business. This includes investments in diagnostic imaging, ambulatory surgery, cancer treatment, and physician practices in areas like orthopedics, cardiology, primary care multispecialty care and urgent care.
Even with the economic challenges of recent years, PE investment in healthcare has remained strong. An April 2023 Becker's Healthcare article highlighted key data from consulting firm Bain & Co: In 2021, $151 billion was invested in PE healthcare deals, followed by $90 billion in 2022 — the second-highest year on record. Mr. Koonsman expects this trend to continue in late 2023 and 2024.
For health systems, partnerships & joint ventures with PE platforms can provide significant benefits
As PE firms increasingly eye investments in areas of healthcare that have traditionally been core to hospitals and health systems — and hospitals and health systems struggle to grow in this capital-constrained environment — more discussions are transpiring between health systems and PE funds (or PE-backed platforms) about mutually beneficial partnerships and joint ventures.
Based on his extensive exposure to these types of partnerships and joint ventures, Mr. Koonsman sees immense benefits for both healthcare organizations and PE investors.
Health systems have strong, trusted brands within local geographies; size, scale and leverage within their respective markets; years of data; and relationships at all points in the provider chain. However, health systems, which typically provide services in dozens of verticals, have difficulty allocating their existing capital across multiple areas, lack sufficient capital for growth opportunities and lack the focus and management expertise to capitalize on promising opportunities.
These shortcomings are areas where PE funds and PE-backed platforms can bring tremendous value. PE has access to significant capital and excels in building professional management teams with a laser focus on specific growth opportunities. This combination of capital, management expertise and focus can accelerate the speed of maximizing growth opportunities and value.
"I think when you put those positive attributes together, a very good partnership can be developed," Mr. Koonsman said.
However, in building successful partnerships, there will be obstacles. Among them is achieving alignment. Mr. Koonsman has found that PE firms often lack a deep understanding of health systems, especially nonprofit systems, and health systems often don't understand or appreciate the value of a PE platform. When these parties make efforts to better understand one another's goals, strengths and time horizons, misconceptions or knowledge gaps can be reconciled.
Further, a health system might consider participating as an investor in a PE platform. This provides the health system with insight to the benefits of the partnership and the equity value created. "It has been a mistake for health systems to create significant value in a platform without participating in this value," Mr. Koonsman said. "There is an opportunity for a health system to create value in their local market through the partnership itself and also participate in a national platform that's going to create outsized returns for their investment."
Not all PE firms are equal — health systems must choose their PE partners carefully
Generally speaking, the types of PE firms looking at investments in healthcare services are funds with $500 million to $5 billion (middle market private equity) to invest. When considering a potential investor, health systems should look carefully for partners with a significant focus on healthcare. "Having a firm that understands healthcare is critical," Mr. Koonsman said. "I would say that probably the experience and expertise in healthcare is the most important differentiator."
It's also critical that health systems look for "partnership-oriented firms." Some investors will purchase 90 to 100 percent of a firm and then behave as an autocrat, which is not the type of a partner a health system wants. Health systems want investors who are collaborative and partnership-oriented. This is essential.
Partnerships between health systems, physicians & PE platforms will continue to grow
Mr. Koonsman said these partnerships are only going to expand. "They are fundamentally a part of the future of health systems," he said, adding that he foresees more partnerships involving physician organizations in various specialties, including musculoskeletal, cardiology, oncology, OB-GYN, primary care, urgent care, post-acute care and more.
He envisions a new form of three-way partnership emerging that involves the health system, physicians and a PE-based platform. "I think there's an opportunity for realignment of the relationship between health systems, physicians and private equity," he said. "I think there's a way the health system can accomplish their strategic objectives with their physician partners and roll them back into more of an ownership position alongside private equity-based businesses — almost like a three-way venture that realigns everyone's economic interests." While complex, such partnerships are possible, with the ambulatory surgery center business providing a prime example, he said.
Looking ahead: partnerships that benefit all parties
There is significant opportunity in PE investments in healthcare today, given the tremendous amount of uninvested capital and a strong demand among investors, which is likely to continue for years.
At the same time, for health systems, PE represents an important source of capital that can help fuel necessary growth. The key is to identify PE partners with deep healthcare expertise and a partnership orientation.
Through effective partnerships, where there is alignment between health systems, physicians and equity-backed platforms, all parties can realize benefits.