Page 20 - OctSam2019

CORPORATE
MEDICINE

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onerous covenants not to compete. to the public market
The purchasers of the specialty practices at that time were pri- because the equity
marily private-equity-backed management companies intending to markets will often
aggregate sufficiently large footprints of practices across the coun- value an enter-
try to allow the management company to go public. The shares of prise at a mul-
the management company would be offered to the public for pur- tiple of its
chase through an initial public offering. The IPO was the private cash flow.
equity firms’ “exit” strategy, allowing it to sell its shares in the man- S t a t i n g
agement company through the stock exchanges. This spate of med- the obvious
ical practice acquisitions has continued unabated since the 1990s, – positive
but through much more sophisticated business models. Most re- cash flow
cently, dermatology practices have caught the eye of management occurs only
companies. when
The business model of medical practice acquisitions is simple and revenues
meets the needs of the dominant segment of private practice physi- exceed oper-
cians, to wit, those baby boomer physicians looking to retire or cut ating costs.
back but having no ready “plan b” to sell to the next generation of Revenues in a
physicians. Non-physician entities, such as hospital systems, insur- medical practice
ance companies or management companies backed by private eq- are influenced by
uity, acquire the assets of a medical practice and employ the these variables: the
physicians associated with the practice through an approved em- number of patient en-
ployer of physicians (commonly called 501a corporations). The ac- counters, payment rates
quiror has capital, meaning it has a ready source of money to buy for encounters, and oppor-
the practice’s assets. Hospital systems and insurance companies are tunities to capture related in-
well-financed industries with positive cash flow, reserves and access come, i.e., ancillary income from
to low cost capital. Privately-owned management companies rely referrals for diagnostic testing such as
on private equity. imaging and laboratory tests. If each of these
Private equity funds are “alternate” investments for high net components can be increased after the acquisition, cash
worth and institutional investors. Private equity creates a ‘fund’ flow goes up. Conversely, operating expenses are influenced by
which has as its investment purpose investment in management these variables: labor costs, occupancy costs, and the cost of goods,
companies that manage medical practices. The fund attracts private e.g., injectables, infusion pharmaceuticals, dME and the cost of an-
investors who are willing to tie up their money for a relatively short cillary services. As costs go down, cash flow goes up. basically, it is
term, usually five to seven years, to achieve a total annual return of a very simple model – increase top line revenues and decrease op-
20 to 30 percent. The fund promoters are richly rewarded with a erating costs to increase “free cash flow” then apply a valuation mul-
carried interest in the success of the fund. In other words, the fund tiple to that number.
promoters can receive 20 percent of the gain on the original invest- Knowing the motivation driving management companies to ac-
ment in the management company. Thus, there is an overwhelming quire medical practices, we come to the core question. When does
incentive to focus on achieving short-term profitability. the management company’s objective of increased cash flow en-
The private equity backed management company has a singular croach on the practice of medicine? The answer is readily apparent
goal – to achieve positive earnings, that is total profit before interest, – when the control of the management company prevents the
taxes, depreciation and amortization, the proverbial EbITdA; com- physician from doing what is best for the patient because it could
monly called “cash flow”. Positive cash flow that consistently trends negatively impact profitability. Control is the issue. Has the man-
upward over the years has an exponential, positive impact on the agement company made its profit motive the ultimate priority, and
value of the acquired enterprise. Similarly, for management compa- has it tried to assure continuing profitability by directing patient
nies, the increase in enterprise value justifies an exit through the sale care, either by mandate or more likely by subtle, nevertheless coer-

20 San Antonio Medicine • October 2019