The role of private equity in hospital, health system, and medical group ownership has received increasing coverage over the past few years, spiking any time a PE firm makes a big acquisition. And let's face it: the news coverage is frequently negative. In the past three months, government scrutiny of PE's involvement in the healthcare world has ratcheted way up, driven by some high-profile struggles and failures surrounding both PE stewardship, and more important, exit strategy. In particular, the PE penchant for funding acquisitions by debt that has to be paid down by the acquired entity has been increasingly seen by media observers as an unsustainable financial burden. These challenges have prompted series of scholarly policy recommendations (Health Affairs subscription required) aiming to increase regulatory oversight, increase reporting requirements, and restrict flexibility around staffing and future buyers. I'm here neither to pile on nor to excuse those failures, nor to endorse or reject any recommendations.
Instead, let's step back from the oft-heated rehtoric and look at some context to help anyone who's looking to navigate this topic objectively—and perhaps to assess a potential (or existing) PE play in their own backyard:
Contextual point #1: For-profit structures among providers are neither new nor rare—and increasingly, neither is PE ownership.
Contextual point #2: Knowing a health system's ownership structure and profit-seeking status offers limited insight into its strategy—or prospects. A more telling distinction is the extent to which any enterprise owner/operator is focused on value creation vs. value extraction.
Contextual point #3: While it's impossible to precisely predict how a given PE investment will play out, there are a series of smart questions that sellers/regulators/investors/bystanders can ask—and track over time—to assess any given deal's prospects and impact.
Contextual point #1: For-profit structures among providers are neither new nor rare—and increasingly, neither is PE ownership.
While a healthy dose of the recent scrutiny on PE's role in healthcare has centered on a series of particularly high-profile stories making headlines in recent months, an important and consistent undercurrent is a clear ideological opposition to adding a profit motive to erstwhile not-for-profit health systems.
As any industry insider will know, for-profit ownership structures are nothing new in healthcare—as of 2024, roughly a quarter of community-based hospitals are estimated to be investor-owned, and the share of hospitals that are for-profit continues to grow with time. (It's worth a reminder, as always, that even not-for-profits have a profit motive—and when they appear to be overweighting revenue/investment returns compared to the community benefit they provide, they, too, routinely attract scrutiny from regulators and the public).
The share of hospitals owned specifically by PE firms is smaller, but similarly growing. By at least one count, 460 hospitals in the U.S. are under PE ownership, accounting for more than one in five for-profit orgs. And many of them provide access in historically underserved areas, with 26% of PE-owned facilities serving rural areas. And for certain types of services, corporate ownership has enabled access expansion, according to a recent study.
Contextual point #2: Knowing a health system's ownership structure and profit-seeking status offers limited insight into its strategy—or prospects. A more telling distinction is the extent to which any enterprise owner/operator is focused on value creation vs. value extraction.
To hear most press accounts, if I may be a bit crass here, you'd think that PE ownership of a hospital is akin to buying a dilapidated house, adding some new fixtures and a coat of paint, and flipping it at a grossly inflated markup to naive buyers who make homebuying decisions on House Hunters based on wall color.
And, yeah, there's been some of that in healthcare in recent years. But unlike unscrupulous house-flippers, that's almost never the strategy at the outset. The stakes are just too high. And while all private equity firms look to profit off their investments, those investment goals can vary widely. But the two most common are (1) generate stable long-term cash flow that can be used to fund future investments, or (2) produce a market-beating return via an exit over a predetermined period of time.
Few observers would quarrel with the first goal (unless you were hoping that some of your excess cash flow would be funneled back into the business; more on that below), so let's focus on the second. How can PE do this? Fundamentally in just two non-mutually-exclusive ways: value creation and value extraction.
For a community-based health system that plays the critical dual role of providing access to healthcare services and a source of employment for the local population, value creation—i.e. efforts to accelerate growth or improve efficiency by investing back into the organization—is obviously the approach preferred by practically everyone. Nearly every PE firm will claim that value creation is the goal, and it almost always actually is the goal, at least at the outset.
But when value creation fails to deliver the necessary returns (or when it proves impossible for some parts of the organization), investors turn to the shovels and pick-axes. It's worth noting that while value extraction is typically never the first choice, it is sometimes a necessary one to keep the rest of the organization afloat. And there are better and worse ways to go about value extraction, often related to whom the parts of the business are ultimately sold to, and how effectively those new owners can be expected to operate a community asset.
Contextual point #3: While it's impossible to precisely predict how a given PE investment will play out, there are a series of smart questions that sellers/regulators/investors/bystanders can ask—and track over time—to assess any given deal's prospects and impact.
The key to knowing how things are likely to end up (i.e. the extent to which value creation is likely to be emphasized over value extraction AND/OR whether any necessary value extraction is likely to be handled with as much finesse as possible) is to examine the potential exit path. Here are four questions to ask at the outset—and continue seeking answers to over time:
What are the top three growth investments? Whether the goal is to spin off the company or sell to another investor, value creation is rarely achieved without a viable path to increase and accelerate revenue growth. What services, technologies, markets, and reimbursement strategies will generate that revenue? You should be able to easily name the top three.
How are relative costs getting streamlined? 'Relative' is the keyword. Cost cutting is typically painful, but it's always worth examining which costs are getting streamlined. Centralizing administrative services, eliminating obsolete functions, and aligning costs with established benchmarks are all tried-and-true strategies for value creation. Eliminating key services simply because they fall below the firm's cash flow line are a key sign of extraction. In many cases, that may be necessary, especially on the rare occasion where there is a glut of a particular service in a market. But it's rarely a sign that "going concern" is a long-term exit priority.
What's the time horizon? This one is tricky, but it's typically telegraphed during deal negotiations. PE firms looking to do a long-term hold will typically focus on cash flow and cash acceleration. (And this isn't always a good thing. Firms looking for a long-term hold typically want to make the venture work long-term--hence the name--but if cash flow is modest yet reliable, it could also mean that it's going to use the asset as a piggy bank, and reinvestment will be negligible.) PE exits for hospitals can be as little as three years and occasionally greater than 10, recently averaging a bit over seven years. A general rule of thumb: the shorter the exit, the greater the likelihood that the firm is looking for the next buyer (typically another financial institution), and won't be focused on long-term viability. Which brings me to the last point.
Who's the exit buyer? This is often impossible to know from the outset, but if you have solid answers to the first three questions, you can intuit the last one. Will the business be spun off as its own publicly traded organization? Will it be sold to another health system? Or more likely, if it's a medical group/ambulatory asset, is it Optum? (You knew I was going to bring that up.) Will it be partially sold to another PE firm (typically as a diversification strategy)? Or perhaps another form of financial institution (a big bank, or a REIT, perhaps)? This isn't a hard and fast rule, but in general, the more of a "pure-play" financial services firm the buyer is, the risk is rising that you're getting closer to extraction—either because the PE owners have given up, or they have concluded that individual assets are more valuable than the sum of the health system's parts.
PE ownership was just one topic of discussion, among many others, in the recent Board Briefing webinar we hosted on the state of health systems. Members now have access to both the ready-to-use slides and an on-demand recording of the session.
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