We take the mystery out of private equity recapitalization and help physicians understand what that means for them as an employee and shareholder of the new practice management company. This recapitalization cycle is an important part of the private equity ecosystem and physicians are wise to understand how it may affect their future. Because of the structure of private equity investments, it’s not uncommon for physicians to outlast the private equity firm that acquired their practice ... hence the concern surrounding potential new employers in the future.
Eric: What we're seeing, very common, and almost universal is that the physicians have stock that is what we would call pari passu with the investor, meaning that it's the same type of stock as the investor. And essentially the physicians participate in the upside the same way that the private equity investors and the private equity fund participates.
Narrator: Welcome to PF Insights, hosted by the leadership of PhysiciansFirst Healthcare Partners. If you're a physician practice owner or an ambulatory surgery owner and you're wondering how to navigate the Mergers and Acquisitions Glucose System, this is the podcast for you.
Andy: Hello everyone, welcome back to PF Insights. This is your host, Andy Snyder, Managing Director at PhysiciansFirst Healthcare Partners. With me, as always, I have our Managing Partner, Eric Yetter.
Eric: Andy, how are you?
Andy: Hello Eric. Thanks for always being here and leading these podcasts. Today we are on Episode 13, Lucky Number 13, and the topic today is Private Equity Recapitalizations Demythed.
A common question we hear from some of our physician clients is, "I understand that a private equity fund has to turn over every so many years the fund harvests, and then there's an exit after five, seven years, and you plug in the number. But if I'm going to be working for longer than three to five to seven years in my career, ... We can keep this in ophthalmology, in my ophthalmology career ... how is life going to change for me when there is a private equity recapitalization, when it goes on to the next buyer?
That seems like the people who are investing in me right now aren't going to be the same people I'm seeing in the later stage of my career, and how do I deal with that lack of control?
So there's the fear, and I'll let you answer that question.
Eric: Yeah, it's a good question and we get asked it a lot. I think that a good way to start answering it is to explain a little bit about how this private equity ecosystem works.
When you think about a PE firm, when we talk about PE firms, what we're usually talking about is the general partner. That's typically the name that people associate with a private equity firm, so Kohlberg Kravis Roberts is a PE firm, but it's really the name of the General Partner. The General Partner is a company that is made up of individuals, and the job of those individuals is to raise money and manage that money and how it's invested.
But General Partners aren't asset rich entities. They don't hold cash, and they don't hold assets. They don't hold practices or other companies that are acquired. The structure is a little bit more complicated than that.
What PE firm is made up of is the General Partner and then funds, and funds are essentially pools of money that the General Partner raises from investors. Those investors are Limited Partners in the funds. So every fund has a pool of money, is a Limited Partnership typically, and it has both a General Partner which is the PE firm per se, and the investors which are Unlimited Partners.
Private equity firms typically have multiple funds that they're managing at the same time. One of the key components of a fund is that it has a defined life cycle, meaning that the investors in a fund commit to provide their capital to the fund for investment for a certain period of time.
Typically that money isn't even put into the fund until it's needed for an investment so they have an agreement with the fund that they will provide money when it's needed to invest in some company or some other asset.
So the fund is the legal entity that's buying things. It's out buying practices or buying other companies, and the fund has a finite life cycle.
Let's say it's a ten year fund. That would mean that the investors would go raise money. Once that was finished the fund would essentially ... You'd press go on it, and there'd be ten years. Some of that time would be dedicated to making investments and some of that time would be dedicated to "harvesting investments."
During that ten year period the fund and the PE firm that manages it would deploy that capital by acquiring companies including physician practices. Then later during that ten year period, they would sell those things to somebody else, and that's how they ultimately make money.
They make money from buying something and improving or growing it and then selling it later for more money than they paid for it, and they get the cash flow in the interim. That's part of their profit as well.
That's why, just because of the nature of how private equity works, that there are these things called recapitalizations. What that means is that the PE firm is basically selling the company that it bought and built to another investor, to another private equity fund probably.
It might not be the ultimate buyer, but what we typically see in these situations, and we've seen it in other specialties ... We've seen it with surgery centers and is common in private equity ... is for a smaller PE firm, smaller PE fund, to start something, to start buying ophthalmology practices and build a company around that.
Then once it gets to a certain size, probably after seven years or ten years, whatever that is, sell it to a little bit larger PE firm. That PE firm runs it and grows it for another five or ten years, and then they sell it to another PE firm that's even bigger. Then they run it for awhile and eventually they sell it to somebody else.
That would be kind of a typical ladder, and the ultimate buyer, it could be the public. It could go public, and go on a stock exchange and shares of the company could be sold publicly. That's one option for the ultimate owner.
Another option would be that it gets sold to some kind of a strategic investor which might be an insurance company. It might be a health insurance company. It might be a big healthcare company like Hospital Corporation America or a big company like Amsurg Envision Healthcare.
Could be a lot of different ultimate buyers, but for the foreseeable future in ophthalmology, these companies are probably going to be owned by a series of private equity investors. That's what we've seen so far.
So the concern you're talking about, Andy, is that I know who the PE firm is right now, but I don't know who the PE firm's going to be in five years, it could be somebody else.
People don't really know what that means. How is that going to change things? Really, for physicians, the answer is it's not really going to change things much. The reason for that is that these PE firms in addition to buying practices, they're really building companies. They're building management teams and they're building corporate infrastructure around ophthalmology. Those companies are the companies that own practices, that own individual practices, and those holistic ophthalmology companies, including their management teams, are what's ultimately going to be sold to another PE buyer.
The management people, the corporate people that physicians deal with, people that are running the company, are going to stay the same unless there's a problem, and the PE firm needs to replace them. Those people are probably going to stay the same, and the experience is really going to stay the same.
We had some experience with this before we founded PhysiciansFirst, we had some experience in our old company, Covenant Surgical Partners, which during our time there was owned by several different PE buyers. Now it's owned by Kohlberg Kravis Roberts.
In terms of what the physicians' experience that we worked with, it didn't really change for them when different PE buyers were involved on a day to day basis. It was more about what kind of direction were these investors telling us at the corporate level. They wanted us to grow. They wanted us to do more of this, or they wanted us to do more of that, but the impact would be felt much more at the corporate level than it would by the physicians.
I think that really this is a concern where I'm pretty comfortable telling physicians, "You probably don't have a lot to worry about in terms of how your life is going to be day to day. You certainly should be interested in it for the ultimate success of the company. You want to have a good strong private equity investor for that reason, but in terms of who you're going to show up to or who you are going to report to ... You really don't report to anybody, people ask that ... that's not really going to be an issue with these recapitalizations.
Andy: Right. They just add a little bit of color there too as far as the relationship between the private equity group and the management company. The private equity guys are probably going to have insight as far as like an investment committee looking in your future acquisitions. And they're probably going to have quarterly board meetings or maybe even monthly board meetings with the C level of the management company, but like you said, "That's a little bit"-
Eric: It's very high level.
Andy: ... separate from the physicians. The management company executives, they're going in as far as doing the quarterly meetings with the physicians or their ASC Board, such as that. That's all separate. It's pretty much untouched.
Andy: Recapitalizations can be a good thing as far as a physician who had stock as a part of their deal, right? That's another good question, kind of followup to this.
When there is that recapitalization does the equity hit every time? Is that when you get out or does it carry over to the next?
Eric: Yeah, that's the other thing about recapitalizations is, it is the way that physicians who have stock in the ophthalmology company are able to capitalize on the value of that stock. It's not a publicly traded security. You can't go and sell it to anybody. There are restrictions about when you can sell and who you can sell it to.
The recapitalization is the event when a physician who owns stock can cash it in basically. The rules around that, when that's an option to do, and when it isn't, and on what terms, are going to vary based on the investor and based on the transaction.
What we're seeing, very common, and probably almost universal, is that the physicians have stock that is what we would call pari passu with the investor, meaning that it's the same type of stock as the investor or it's very close. Essentially the physicians participate in the upside the same way that the private equity investor or the private equity fund participates.
In that sense they have the same ... They would have the opportunity to reap the rewards at the same time as the selling private equity firm would.
We've heard about situations where physicians have had an opportunity to do it at the first recapitalization, meaning the first PE firm sold to the second PE firm, and did it and got their money out. But then during the second to third recapitalization, so the second PE firm selling to the third, they would have made a lot more money if they cashed out then, then if they cashed out the first time.
It's a personal investment decision. How long do you want to hold?
Just like anything else, but the recapitalizations are the point when physicians ultimately have the opportunity to decide if they want to do that or not.
Andy: Go ahead. I think I'm going to wrap it up there. This was a timely topic because there have been some of these ophthalmology platforms that have gone thorough private equity recapitalizations. There are a lot of questions of what exactly that means. If you have any more questions, please go in to Physiciansfirst.com, look up our Advisory Resources materials, find our information there. Contact us at any time.
As always, we thank you for being here with us and we'll catch you next time.
Eric: Yeah. Thank you.