Private Equity Investment in the Healthcare Industry Reviewed by Momizat on . Private Equity’s Fast and Furious Entry into Healthcare (Part III of III) The third of this three-part series examines why private equity and venture capital fi Private Equity’s Fast and Furious Entry into Healthcare (Part III of III) The third of this three-part series examines why private equity and venture capital fi Rating: 0
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Private Equity Investment in the Healthcare Industry

Private Equity’s Fast and Furious Entry into Healthcare (Part III of III)

The third of this three-part series examines why private equity and venture capital firms are targeting the healthcare industry and the issues that they encounter managing their healthcare portfolio.

Private equity (PE) and venture capital (VC) firms are attracted by the potential for growth that exists in the healthcare industry; however, significant barriers also exist that may limit the expansion of PE and VC in healthcare, including the requirement for specialized knowledge to understand the operations of a clinical services provider, healthcare industry specific regulatory issues, latent long lasting risks underlying the provision of clinical services, i.e., malpractice liability, and a competitive marketplace dominated by larger national healthcare providers.

VC, and to a lesser extent PE, have been exceedingly successful as engines of innovation, particularly with their investments in software and technology. However, the portfolio strategy of investing in multiple start-ups with the expectation that some or most will fail, but the successful investments will outweigh the losing investments, may be less suited to the healthcare industry, in which the failures represent potentially catastrophic results for patients. Accordingly, the adoption of innovative techniques in the healthcare industry is a slow process of testing and verification prior to widespread use. As a consequence, potential breakthrough techniques may not produce positive results within the typical three- to seven-year investment horizon of PE and VC investors.

Despite these barriers, the steady march of PE in the healthcare industry continues. Questions remain as to where the structure of the marketplace will settle, e.g., as an industry dominated by PE investment similar to the software and technology industries, a market dominated by traditional health services providers with the specialized knowledge to own and operate healthcare enterprises, or as a hybrid industry with both PE and traditional providers claiming those practice areas containing the greatest opportunity to leverage their specific knowledge, skills, and abilities. Regardless of the outcome, the recent PE and VC interest in the healthcare industry will only hasten the decline of the smaller independent physician practices and feed the healthcare trend of agglomeration and consolidation.

Healthcare PE Market Place

PE and VC investments are continuing to expand in the healthcare industry. Currently, there are at least 734 PE groups actively investing in the U.S. healthcare industry.[1] From 2006 to 2018, the VC deal volume for the healthcare services and systems sub-sector increased from 126 deals to 541 deals (a CAGR of 12.9 percent) and a commensurate increase in dollars invested from $1.13 billion to $6.8 billion (CAGR of 16.2 percent).[2] Average dollars invested per deal also increased in the healthcare services and systems sub-sector, from $8.9 million in 2006 to $12.6 million in 2018 (a CAGR of 2.9 percent).[3] Over the same period, total VC deal volume increased at a CAGR of 8.5 percent, with dollars invested growing at CAGR of 13.3 percent, and average dollars invested per deal grew at a CAGR of 4.4 percent.[4] Over the 2006–2016 period, the healthcare services and systems sub-sector grew from 3.85 percent to 5.19 percent of total dollars invested by VC firms, and deal volume grew from 3.77 percent of VC transactions to 6.05 percent of VC transactions.[5]

Regulatory Concerns

Corporate Practice of Medicine (CPOM) Laws

Almost all states have provisions against CPOM.[6] Although the regulated content of CPOM provisions varies across states, these laws generally prohibit unlicensed individuals or corporations from engaging in the practice of medicine by employing licensed physicians.[7] CPOM laws were established with the intent of ensuring that licensed physicians could practice medicine without pressure from a lay person or being “subject to commercialization or exploitation,”[8] and dictate what type of relationship healthcare entities may have with physicians (i.e., employment versus independent contractor).[9] Of note, these regulations are not always codified—they may instead be inferred through state Attorney General guidance, case law, and/or state medical board decisions.[10] The specific provisions of these laws wherein the target company is located will likely drive the scope of the PE firm’s involvement in the venture, and may also impact upon the provisions included in the management agreement between the parties.

Other Legal Considerations

Other regulatory hurdles that may impact PE and VC investment in healthcare include, but are not limited to, the following:

  1. State Certificate of Need (CON) Laws
  2. Insurance Laws
  3. Fee-Splitting Prohibitions
  4. Restrictions on Restrictive Covenants
  5. Federal and State Licensure, Accreditation, and Permitting (especially when a change of ownership or control is involved)
  6. Fraud and abuse laws[11]

In regards to fraud and abuse violations, it is important to note that, just because a PE firm is not a healthcare provider, does not mean that they are immune to fraud and abuse enforcement. For example, one federal lawsuit currently before the Southern District of Florida alleges that a PE fund directly funded certain marketing schemes that were actually illegal kickbacks, violating the False Claims Act.[12] A second lawsuit, in the District of Massachusetts, asserts that the PE fund was directly involved in the operations of the facility such that the PE fund can be held liable for the submission of false claims to the federal government.[13]

Deal Structures between PE and VC Firms and Healthcare Enterprises

PE and VC funds have numerous options available to them regarding the structure of their healthcare industry investment. Including:

Direct/Majority Ownership

Joint Venture

Management Services Organizations

Real Estate Investment Trusts

Many factors will impact on a firm’s decision as to the most effective investment structure to employ, including the competitive, regulatory, reimbursement, and technological environments in which the target company operates.


PE and VC investment in the healthcare industry has been on the rise over the past few years and is expected to continue. The search for profits to feed PE investors’ appetite for risk/profit have lead PE and VC firms to expand their scope beyond the more traditional roles of investing in healthcare software and technology to operating companies with direct patient care responsibilities. However, healthcare market entry barriers, arising from regulatory concerns, have led to PE/VC groups relying on alternative deal structures that allow the funds to avoid restrictions arising from healthcare industry regulations such as CPOM laws.

This shorter-term focus of PE/VC funds may make the industry better suited to turn-around investments in the healthcare industry. By investing in struggling healthcare providers, PE/VC funds can be directed toward stabilizing and improving the management practices of these providers and avoiding access to care issues arising from failing healthcare providers. Although PE and VC investment is no panacea for the healthcare industry, as profit maximizing motives and the invisible hand of the market will still direct when, where, and how PE and VC firms enter the marketplace, it does provide an alternative source of financing. Under the right circumstances, these investment sources can have a beneficial effect on the ability of some providers to meet the needs of their patient populations, and, as is evinced by the REIT investments, PE and VC investments may help to alleviate the potential for future shortages in the provision of healthcare services.

Not only may the increased PE/VC investment in healthcare be a considerable value driver in the valuation of healthcare enterprises, but is also changing the universe of hypothetical “willing buyers,” as considered in the fair market value (FMV) analysis.[14] Because these transactions are susceptible to allegations of CPOM, fee splitting, and fraud and abuse law violations, healthcare and PE entities typically seek an opinion as to the FMV of the prospective transaction, which presents an opportunity for those valuation professionals with an understanding of how valuation approaches and methods are employed within the context of the unique attributes of the healthcare industry, i.e., reimbursement of services, increased regulatory scrutiny, competitive forces within the ever-expanding marketplace, and technological impact on the delivery (and sites) of care.

To read this article in its entirety, please see The Value Examiner, March/April 2019.

Todd A. Zigrang, MBA, MHA, ASA, FACHE, is president of Health Capital Consultants, where he focuses on the areas of valuation and financial analysis for hospitals and other healthcare enterprises. Mr. Zigrang has significant physician-integration and financial analysis experience and has participated in the development of a physician-owned, multispecialty management service organization and networks involving a wide range of specialties, physician owned hospitals as well as several limited liability companies for acquiring acute care and specialty hospitals, ASCs, and other ancillary facilities.

Mr. Zigrang can be contacted at (800) 394-8258 or by e-mail to

[1] M&A Research Database, Private Equity Info, (Accessed 3/19/19).

[2] “The 4Q 2018 PitchBook-NVCA Venture Monitor” PitchBook Data Inc., National Venture Capital Association (NVCA), 2019, Table Deals by Sector.

[3] CAGR = Compound Annual Growth Rate. “The 4Q 2018 PitchBook-NVCA Venture Monitor” PitchBook Data Inc., National Venture Capital Association (NVCA), 2019, Table Deals by Sector.

[4] “The 4Q 2018 PitchBook-NVCA Venture Monitor” PitchBook Data Inc., National Venture Capital Association (NVCA), 2019, Table Deals by Sector.

[5] Ibid.

[6] “Advocacy Handbook, 4th Edition” EMRA, (Accessed 1/29/19).

[7] “The Corporate Practice of Medicine” TMA Office of General Counsel, Texas Medical Association, September 2016, p. 1.

[8] People v. United Medical Service 362 Ill. 442, 200 N.E. 157, 163 (1936), p. 6.

[9] “Advocacy Handbook, 4th Edition” EMRA, (Accessed 1/29/19).

[10] “Important Transactional and Regulatory Issues in Health Care Private Equity Transactions” Lisa Genecov and Michele Masucci, ABA Emerging     Issues in Healthcare Law Conference, March 13–16, 2019, Slide 9.

      [11] Ibid, Slide 10, 18.

[12] United States ex rel. Medrano and Lopez v. Diabetic Care Rx, LLC dba Patient Care America et al., No. 15-CV-62617 (S.D. Fla.), First Amended Federal Civil False Claims Act Complaint and Request for Jury Trial, p. 1–2.

[13] United States ex rel. Martino-Fleming v. South Bay Mental Health Center, Civ. Action No. 15-13065 (D. Mass.), Introduction, p. 1–2.

[14] “Healthcare Valuation: The Financial Appraisal of Enterprises, Assets, and Services” By Robert James Cimasi, MHA, ASA, FRICS, MCBA, AVA, CM&AA, Volume 2, Hoboken, NJ: John Wiley & Sons (2014), p. 18–19.

The National Association of Certified Valuators and Analysts (NACVA) supports the users of business and intangible asset valuation services and financial forensic services, including damages determinations of all kinds and fraud detection and prevention, by training and certifying financial professionals in these disciplines.

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