Sustainable Health Private Equity Fund (PEF)

“Health financing is not merely about generating funds. It concerns the mobilization, accumulation and allocation of money to cover the health needs of the people, individually and collectively, in the health system…” (WHO, 2000).

Strengthening financing for health calls for a holistic focus that prioritizes improvements to the efficiency and strategic use of existing resources as much as efforts to generate revenue, both domestic and international, in alignment with national development strategies. This includes the integration of health into national budgets for development, innovative financing and co-financing approaches, understanding and addressing co-morbidities, strengthened governance, and ensuring appropriate focus on key populations and synergies with other development objectives.

Health financing is a core function of health systems and a key enabling factor in the ability of countries to achieve universal health coverage. As part of its focus on promoting resilient and sustainable systems for health, UNSHP works with partners to support investment strategies, national policies and regulatory frameworks to strengthen financing and public financial management for health.

What Is Private Equity?

Private equity firms use capital from institutional investors to invest in private companies with potential to return a profit. That potential is realized if private equity firms manage to add value to the company and subsequently sell their stake at a price higher than the purchase, typically within 3 to 7 years. Private equity firms use several strategies to raise the value of practices, such as reducing costs (often through layoffs) and improving efficiency by consolidating and internalizing previously outsourced processes like billing. However, in physician practice acquisitions, key private equity tactics also include increasing prices and volume. Private equity firms typically purchase an established group practice and acquire smaller practices to establish regional brands that can exercise greater bargaining power with insurers and medical suppliers. As ownership shifts from physicians to private equity firms, more emphasis might be placed on extracting higher contracted payment rates, lowering overhead, and increasing volume and ancillary revenue streams (eg, imaging or procedures)

Private equity is an alternative form of private financing, away from public markets, in which funds and investors directly invest in companies or engage in buyouts of such companies.

Private equity firms make money by charging management and performance fees from investors in a fund.

Among the advantages of private equity are easy access to alternate forms of capital for entrepreneurs and company founders and less stress of quarterly performance. Those advantages are offset by the fact that private equity valuations are not set by market forces.

Private equity can take on various forms, from complex leveraged buyouts to venture capital.

Private equity offers several advantages to companies and startups. It is favored by companies because it allows them access to liquidity as an alternative to conventional financial mechanisms, such as high interest bank loans or listing on public markets. Certain forms of private equity, such as venture capital, also finance ideas and early stage companies. In the case of companies that are de-listed, private equity financing can help such companies attempt unorthodox growth strategies away from the glare of public markets. Otherwise, the pressure of quarterly earnings dramatically reduces the time frame available to senior management to turn a company around or experiment with new ways to cut losses or make money.

Growth of Private Equity in Health Care

In 2017, the value of private equity deals in health care totaled $42.6 billion globally, up 17% from 2016.1 The number of deals also increased to 265, from 206 in 2016. Health care deals comprised 18% of all private equity deals globally in 2017. Physicians, hospitals, and other facilities accounted for the most buyout activity, with 139 of the 265 health care private equity deals announced worldwide involving care delivery companies. Sectors of interest include retail health, behavioral health, free-standing medical centers (eg, for ambulatory surgery), and physician practice management, especially in highly paid specialties such as dermatology, ophthalmology, orthopedics, gastroenterology, urology, and allergy. Several attributes of health care markets may help to explain why private equity investment in health care is increasing. First, groups that deliver care are often fragmented geographically, which allows private equity funds to consolidate market power and strive for economies of scale. Second, demand for health care is often considered recession resistant, with valuations remaining high despite turbulence in the economy. Third, the delivery system has numerous inefficiencies, which attracts private equity firms with a core competency of reducing waste. An aging population and the increasing prevalence of chronic disease also contribute to a growing demand for health care services. Physicians may be attracted by private equity buyouts for several reasons, including the appeal of large upfront payments from the sale of their practice (often at double-digit multiples of earnings). These up-front payments are attractive because they replace future income but are taxed at capital gains rates, which are significantly lower than income tax rates. New requirements and mounting uncertainty as the health care system moves toward value-based purchasing may have also made physicians more interested in selling their practices. Some physicians may sell because of concern that they can no longer compete for insurance contracts as an independent practice in an increasingly consolidated market. Other motivating factors for physicians to sell include relief of financial pressures from increasing expenses for billing and technology and the opportunity to use an infusion of capital to grow the practice. These factors may outweigh any salary reductions or loss of autonomy from a buyout.

In light of increasing health care spending nationwide, the potential effects of private equity buyouts on spending deserve further study. Although hospital ownership of physician practices has been associated with higher prices and spending, private equity ownership has yet to be rigorously evaluated. As both hospitals and private equity firms benefit, under a fee-for-service model, from acquisitions that garner higher prices and higher volume (through internalizing referrals and ancillary revenue streams), private equity ownership may have similar effects as hospital or health system ownership of physician practices. However, given that hospitals and academic medical centers, unlike private equity firms, use revenues from some insurers to subsidize care for low-income patients and to fund medical education and research, private equity may have different implications for spending. Even though consolidation may create economies of scale and layoffs and other cost-cutting measures may reduce operating costs, increased market power over price negotiations with insurers and boosting volume for ancillary revenue streams may increase spending. Empirical analysis is needed to understand the net consequences and to compare spending among private equity–owned, hospital-owned, and independent practices.

How Does Private Equity Work?

Private equity firms raise money from institutional investors and accredited investors for funds that invest in different types of assets. The most popular types of private equity funding are listed below.

Distressed funding: Also known as vulture financing, money in this type of funding is invested in troubled companies with underperforming business units or assets. The intention is to turn them around by making necessary changes to their management or operations or make a sale of their assets for a profit. Assets in the latter case can range from physical machinery and real estate to intellectual property, such as patents.

Leveraged Buyouts: This is the most pop form of private equity funding and involves buying out a company completely with the intention of improving its business and financial health and reselling it for a profit to an interested party or conducting an IPO. Firms use a combination of debt and equity to finance the transaction. Debt financing may account for as much as 90 percent of the overall funds and is transferred to the acquired company’s balance sheet for tax benefits. Private equity firms employ a variety of strategies, from slashing employee count to replacing entire management teams, to turn around a company.

Real Estate Private Equity: There was a surge in this type of funding after the 2008 financial crisis crashed real estate prices. Typical areas where funds are deployed are commercial real estate and real estate investment trusts (REIT). Real estate funds require higher minimum capital for investment as compared to other funding categories in private equity. Investor funds are also locked away for several years at a time in this type of funding.

Fund of funds: As the name denotes, this type of funding primarily focuses on investing in other funds, primarily mutual funds and hedge funds. They offer a backdoor entry to an investor who cannot afford minimum capital requirements in such funds. But critics of such funds point to their higher management fees (because they are rolled up from multiple funds) and the fact that unfettered diversification may not always result in an optimal strategy to multiply returns.

Venture Capital: Venture capital funding is a form of private equity, in which investors (also known as angels) provide capital to entrepreneurs. Depending on the stage at which it is provided, venture capital can take several forms. Seed financing refers to the capital provided by an investor to scale an idea from a prototype to a product or service. On the other hand, early stage financing can help an entrepreneur grow a company further while a Series a financing enables them to actively compete in a market or create one.