The Looming Future of Private Equity in Plastic Surgery

Abstract

Private equity acquisition of independent private practices has grown dramatically in the last decade, with private equity firms increasingly investing in surgical specialties that practice in outpatient ambulatory centers. This trend has slowly started to creep into plastic surgery; therefore, understanding the concepts of private equity ownership in healthcare and its benefits and risks is critical. This article provides a fundamental economic background on private equity, describes its current state in healthcare, including trends in plastic surgery, and provides recommendations for plastic surgeons considering private equity acquisition.

In recent months, there has been increasing media coverage on private equity in healthcare, with a New York Times article reporting on private equity firms’ current monopolization of certain medical specialties, particularly dermatology, gastroenterology, radiology, and emergency medicine.¹ However, this model of private equity–owned physician practices has been gaining traction over the last decade.² Although there has been little attention on private equity in plastic surgery to date, its involvement in our field is not only inevitable but already occurring. Therefore, for graduating trainees and practicing plastic surgeons, understanding the concepts of private equity ownership in healthcare, and its benefits and risks, is critical. In this article, we provide a background on the economic principles of private equity (Table 1), the potential future implications private equity growth holds for plastic surgery, and recommendations for surgeons considering an acquisition.

DISENCHANTMENT WITH THE PRIVATE PRACTICE MODEL

The rapidly changing healthcare environment has made physicians and surgeons increasingly interested in selling their practices. From 2012 to 2022, the share of physicians in private practice decreased from 60.1% to 46.7%.³ This transition away from individual ownership has occurred for at least 3 reasons. First, the increasing complexity of care delivery is forcing practices to obtain sufficient capital to manage clinical and financial risk. Second, individual physicians are finding it harder to negotiate higher reimbursement rates with insurance companies or payors. The vast majority of private practice physicians (81%) work in solo or single-specialty practices, and therefore have limited bargaining power to improve reimbursement rates, especially when competing against larger entities.⁴ Third, private practice physicians have limited access to costly resources that are more easily purchased in bigger groups, such as electronic medical records or operating room and radiology equipment.

With these increased demands, along with long-term practice uncertainty, physicians and surgeons are experiencing greater financial and psychological stress along with worsening burnout and satisfaction.⁵ These factors have opened the door for physicians to transition to pursuing ownership by corporate entities such as hospitals, health systems, or, more recently, private equity groups. By 2021, nearly 70% of all doctors were employed by a hospital or corporation.⁴ While acquisition by a hospital system can decrease the individual burden, physicians increasingly see private equity as an attractive alternative due to directly receiving investment profit and practice efficiencies (eg, office administration and technology). As a result, private equity firm acquisition has expanded in the healthcare sector.

WHAT IS PRIVATE EQUITY?

Private equity is the short- to medium-term, approximately 3 to 7 years, investment of capital in private companies by private equity firms. Firms can purchase all or part of a business with pooled capital from institutional and individual investors, along with debt financing. Upon acquisition of the practice, the physicians will receive payment for their share of ownership, and the private equity firm may subsequently assume partial or full ownership. The acquisition price is normally based on EBITDA (earnings before interest, taxes, depreciation, and amortization). EBITDA is optimized by maintaining price stability, maximizing cost reduction (eliminate expenditures, leverage volumes), improving inventory management, and increasing revenue (by raising fees to stay competitive locally, increasing production capacity, expanding high-profit procedures, offering financing options, and improving referral patterns).

Once the EBITDA value is established, it is multiplied by a “valuation multiple.” In healthcare, variables that determine the multiple can include multiples previously set for other practices acquired in the region, durability of the practice, number of employed practitioners, practice location and growth potential, amount of local competition, quality of facilities, and current state of the economy such as market demand. While the specific attributes in a practice that provide the greatest value to a private equity firm are unclear at this time (eg, owning an accredited ancillary surgical center), anything that increases revenue and minimizes expenses is beneficial.

If the private equity firm takes partial ownership, it will usually have a controlling share. Generally, physicians are included as partners in the practice to contribute to the investment and maintain commitment and motivation. However, after the acquisition, the physicians relinquish all additional revenue from ancillary services to the private equity firm and may also be expected to agree to a “lock-up” period, during which an investing physician is prohibited from selling their shares. The private equity firm may expect to receive a majority of the profits, typically 60% to 80%.

It is important to distinguish between private equity firms, venture capitalist firms, and angel investors. Angel investors are individuals who finance startup companies at their infancy. These individuals finance the company with their own capital, with amounts generally ranging from US$5000 to US$150,000, in exchange for a minority stake in the company. Venture capitalists finance, through a combination of personal and outside funds, established startups with high growth potential. Venture capitalists invest 50% or less of equity in the company. This tactic allows them to invest in multiple companies, thereby distributing risk. Both angel investors and venture capitalists commonly focus on biotechnology and technology startups. Private equity firms buy, using both debt and equity, mature companies that are deteriorating or failing to make profits due to inefficiency, with the goal of streamlining and improving operations to improve revenue. Unlike venture capitalists, private equity firms generally acquire a majority stake in a company and are more involved in the company’s operations.

HOW DO PRIVATE EQUITY FIRMS GENERATE PROFIT?

The ultimate goal of private equity acquisition is to increase the value of the investment and make a profit at resale. Practice value is increased through expanding and streamlining current systems and establishing new lines of business. Firms focus on acquiring a large, well-managed “platform practice” that costs 8 to 12 times EBITDA. From there, smaller practices are bought or “rolled up” at 2 to 4 times EBITDA. Once practices are merged, the value of the smaller practice becomes that of the larger, allowing for a significant arbitrage opportunity. This growth allows the private equity firm to spread fixed practice costs, expand ancillary revenues, and increase negotiating leverage with insurance companies.

Private equity firms may also operate on a “two and twenty” fee model in which private equity firms take up to 2% of the funds under management and 20% of profits above a predetermined “hurdle rate,” or the minimum rate of return on a project or investment that must be achieved.⁶

Additional sources of profit include management and consulting fees, supply agreements and licensing deals, and the sale of assets. Positive margins are also achieved by cutting costs by firing ancillary staff, replacing doctors with less expensive providers (eg, nurse practitioners or physician assistants), and using less costly supplies.^7,8

At the end of the private equity firm’s investment timeline, the practice is liquidated, also known as the “second bite of the apple.” The “second bite” size depends on how successful the private equity firm was at growing the practice value. Additionally, a “waterfall event” occurs in which payments are distributed sequentially, starting with those with the greatest percentage of investment, who receive the largest return.

Occasionally, management services organizations (MSOs) are implemented to protect against the short-term nature of private equity firms. They serve as an intermediate management company, bridging the private equity firm and physician practices. The MSO provides nonclinical administrative services to medical practice in exchange for a fixed fee. Importantly, contracts with the MSO do not change when the practice held by the private equity firm is sold.^9,10 The economic goal of the private equity firm is to increase the value of the practice and then sell it to a larger firm for a much higher profit.

CURRENT STATE OF PRIVATE EQUITY IN HEALTHCARE

A little over a decade ago, private equity firms began to increase their acquisitions of private practices. From 2012 to 2021, there was a 6-fold increase in private equity firms acquiring physician practices, and these numbers continue to grow.¹¹ From 2020 to 2021 alone, there was significant growth in outpatient clinics acquired by private equity firms, with a 37% increase.¹¹ This resulted in a nearly US$5 billion annual increase in capital invested.¹¹

This growth has occurred in 4 separate areas of healthcare. The first is within the emergency department (ED). It is estimated that 25% to 40% of EDs are owned by private equity companies.^12,13 EDs provide essential care both in- and out-of-network with minimal previous authorization from insurance companies, making them an attractive source of capital from private equity firms. Even with the passing of the No Surprises Act, private equity firms can generate revenue with expensive tests. Janke et al reported that private equity–run EDs had a 400% increase in service costs over 15 years.¹²

The second area is specialty services in hospital-based departments such as anesthesia, radiology, and pathology. These groups join with private equity firms to negotiate exclusivity, which boosts prices and, therefore, physician incomes. Once these private equity groups have obtained exclusivity of these services, they are able to demand 25% or more on per-case prices.²

The third area of private equity investment is in individual physicians within procedural specialties such as dermatology, ophthalmology, gastroenterology, and, more recently, orthopedics, urology, and plastic surgery. By bringing doctors in a community into a single specialty group, the economies of scale drastically change to force insurers to include facilities and in-network services. However, a recent study showed that when a private equity firm controls over 30% of the market, the cost of care nearly doubles as competition within the region severely drops.^11,14

The fourth and final area of focus for private equity firms is within ambulatory surgical centers (ASCs). Since 2005, the proportion of surgeries occurring at ASCs has increased by 41%.¹⁵ As such, they have become an attractive target for private equity investment to control the surgical and procedural market share without acquiring a hospital facility. However, this does require the private equity firm to rely on surgeons to find patients with insurance covering higher prices for outpatient procedures. The patient ultimately pays the same or slightly more out of pocket, but the ASC and its private equity owners profit significantly.

ADVANTAGES OF PRIVATE EQUITY OWNERSHIP

Acquisition by a private equity firm offers numerous potential attractions to a practice, contributing to its popularity. In addition to receiving a generous infusion of capital from the sale of the practice, investing physicians expect continued investment capital from the eventual resale (Figure 1). Physicians may also have more time for clinical care and an improved lifestyle due to having fewer administrative concerns. Additionally, the initial lump-sum payment is taxed at capital gains rates, which are significantly lower than the ordinary income tax rate.¹⁶

For smaller private practices with local competition and difficulty obtaining resources, joining a private equity group dramatically changes the economies of scale and subsequent market share. Not only are the private equity firms able to promote and financially support infrastructural developments such as the opening of ancillary facilities, administrative assistance, centralization of services, and adoption of clinical metrics and compliance systems, but they also allow for improved distribution of knowledge and promotion of innovation within a group due to the consolidation.

Most important is the relief that practices are given in negotiating insurance contracts. By becoming part of a larger group with greater administrative resources, the private equity firm can leverage market power to obtain higher margins for the practice. In one study by Cerullo et al, practice and hospitals acquired by a private equity firm demonstrated significant improvement in financial performance after controlling for hospital characteristics and geographic variation.¹⁷ This was further supported in a study comparing dermatology, gastroenterology, and ophthalmology practices acquired by private equity firms with nonacquired controls between 2016 and 2020, where an 11% increase in the amount per claim was reported.¹⁸ However, this may come at a cost to patients.

DISADVANTAGES OF PRIVATE EQUITY OWNERSHIP

Despite the alluring incentives, the goal of private equity groups to generate a return on investment has raised concerns within the medical community.¹⁹ A systematic review published in the BMJ reported that private equity ownership was associated with increased patient costs, mixed impacts on healthcare quality, and no consistently identifiable benefits.²⁰

The increasing cost to patients is the most consistent trend within the literature, with no current studies showing lowered costs after private equity acquisition.^20,21 A report published in JAMA noted that when comparing 204 hospitals acquired by private equity firms to 532 control hospitals, the acquisition was associated with increased hospital charges, charge-to-cost ratios, and a decreased proportion of Medicare patients.²² As a result, despite private equity firms being able to negotiate better fees from insurance companies, this cycle contributes to the continued increase in payor prices, leaving the patient with a greater amount to pay out of pocket.²³ Private equity firms also risk overdoing capital expansion while purchasing ancillary facilities. These facilities are used as debt collateral, and when the private equity firm resells, the practice owners are left with burdensome debt that was not initially accounted for. The private equity firm might use and add debt to finance expansion and practice expenses.

According to the current literature, most studies analyzing the impact of private equity acquisition on healthcare quality have found harmful effects. This is due to the prioritization of commercial payors, lower employee quality, higher turnover, the preferential hiring of advanced practice providers over physicians, and an emphasis on seeing as many patients as possible.²⁴ The concern with increased nonphysician practice providers is that this may lead to inappropriate resource utilization, incorrect diagnoses, and decreased oversight. Furthermore, hiring advanced practice providers instead of physicians costs less for the private equity firm. Additionally, to maximize profits, there can be pressure from the private equity group for physicians to see more patients. Singh et al reported that practices acquired by private equity firms increased the number of patients seen by 25.8%, with a 37.9% increase in new patient visits.¹⁸ For procedural specialties, the pressure is to perform more elective procedures, prioritize care for commercially insured patients, and perform lower-complexity, cost-effective procedures.²⁵

The last concern is the impact of private equity on patient outcomes. A significant factor contributing to this concern is that after the acquisition, physicians no longer own the practice and may lose autonomy over practice management decisions. This is despite a physician’s promise to “do no harm.” Although the literature is inconclusive and primarily focuses on outcomes of patients in nursing homes, the National Bureau of Economic Research reported that private equity–acquired nursing homes demonstrated 11% higher mortality.²⁶ Conversely, there was no significant change in unplanned hospital visits after procedures were performed at private equity–owned ambulatory surgery centers in a study by Bruch et al.^27,28 Additional studies are needed to follow the long-term impact on patient outcomes in practices owned by private equity firms. Nevertheless, although the success of a practice can lead to financial gains, this is not assured for the physician or patient, and the ethical implications should not be ignored.

TRENDS OF PRIVATE EQUITY ACQUISITION IN PLASTIC SURGERY

As seen with dermatology, orthopedics, and urology private practices, private equity firms have started to focus more on the potential of low-complexity outpatient procedures and the ancillary revenue opportunities that come with them. Although plastic surgery has not historically been a focus of private equity firms, this trend is changing. A retrospective review of private equity deals in plastic surgery by Khetpal et al noted that from 2011 to 2019, 368 deals were made by private practices to 299 private equity companies, totaling over US$3.3 billion. The therapeutic areas of greatest investment were devices and lasers (US$1.6 billion), followed by regenerative medicine and biotechnology (US$694 million).²⁹

The delay in acquiring plastic surgery physician practices is likely due to operational challenges and a potential lower return on investment. However, with the increasing number of plastic surgery private practices associated with ancillary nonsurgical procedures, such as med spas and aestheticians, there is a significant opportunity for an abrupt change. The recent introduction of weight-loss medications and patient demand for these medications might make plastic surgery practices attractive to private equity investments.

Plastic surgeons in academia are unlikely to have their practice acquired by a private equity firm, given that academic programs are generally affiliated with a hospital system. However, if a surgeon has recently left academia to start a private practice, a private equity group could be interested in acquisition in the right scenario. A larger platform practice would need to be acquired and although a minimum EBITDA has not been established, the practice must demonstrate the potential for profitability. Typically, a private equity firm would look for a practice with established referrals and sustained revenue.

RECOMMENDATIONS FOR PLASTIC SURGEONS CONSIDERING PRIVATE EQUITY ACQUISITION

While the future of private equity in plastic surgery is unclear, continued expansion is likely due to plastic surgery’s lucrative nature.³⁰ As a result, we aim to provide readers who are considering private equity acquisition with recommendations to consider during negotiation.

Our recommendations are as follows:

1. A lawyer should be hired for all contract discussions to ensure private equity firms are not taking advantage of the investing physician.

2. Obtain all financial records for the previous 4 to 5 years, prior to contacting any private equity firms for preliminary evaluation. These should be reviewed by an accountant. A review of the financial records will allow for a baseline understanding of the practice’s EBITDA and its trend from year to year.

3. Recognize the importance of maximizing EBITDA and the valuation multiples in order to maximize the value of the private equity offer.

4. Physicians should focus on the degree of autonomy the private equity firm allows for decisions related to patient care and the day-to-day management of the practice. This should maximize the physician’s autonomy to provide patients with the appropriate care.

5. Clear expectations on the physician’s productivity should be established before acquisition, as firms may not emphasize the expectation for fee-for-service care that can drive patient volume up and compromise patient healthcare quality. This is particularly important as physicians are commonly required to transition to a set, potentially reduced salary.

6. During the contract discussion, ask if there will be a “lock-up” period during which a physician would be unable to sell shares or receive a portion of the initial lump sum payment. Additionally, sellers are encouraged to get and compare competing private equity offers to determine the optimal contract for that practice.

7. Establish and understand upfront who is paid first at the final resale, also known as “waterfall provisions.” Generally, those who get paid first receive a more significant portion of the profit.

8. Be aware that private equity acquisition may compromise future physician hiring. This is because new hires who have not received the initial buyout must still give up a portion of earnings to the private equity fund. Furthermore, inquire if current or newly hired physicians are expected to sign a noncompete agreement, as this may severely limit the number of jobs available in a given region.

9. Recognize that surgeons in varying stages of their careers will have different priorities. Surgeons near retirement may accept a larger investment for less stake in practice autonomy. Conversely, younger physicians may tolerate a higher expectation of value-based productivity.

10. Consider an investment in an MSO to ensure that the initially negotiated contract is upheld after the eventual private equity resale.

11. Appreciate that the ultimate goal of a private equity firm is to make money, not take care of patients.

12. Alternatively, consider the benefits of joining a larger group independently. While there is not an initial lump-sum profit, one can still achieve better terms for debt financing and share resources without forfeiting autonomy.

PREPARING FOR PRIVATE EQUITY BUYOUT

Once a surgeon has decided to join a private equity firm, careful considerations should be made to optimize the final contract. A financial advisor, with a background in investment banking or private equity, should be hired to assist with contract assessment, negotiation, and comparison, in the setting of multiple competing offers. Even surgeons with a financial background can benefit from professional guidance to avoid being taken advantage of and maximizing autonomy. Specific questions to ask a private equity firm include: “what is the fund strategy?”, “what is the firm’s financial performance?”, “what is the quality of the management team?”, “what are other portfolio companies or practices that have been acquired?”, “what are the fees and expenses that are expected of the practice after acquisition?”, and “what is the fund’s exit strategy in 5 to 7 years?”

The answer to these questions, in addition to what is known as due diligence, may help elucidate any red flags that may compromise closing the acquisition. Although due diligence is commonly thought of as the investigation by a private equity firm into the target company, it can also be performed by the private practice to uncover and mitigate potential risks. Again, this should be performed with the assistance of consultants, accountants, and lawyers who are able to reach out to contacts in the financial sector and conduct additional investigations. Potential red flags that may be uncovered include an unrealistic valuation of the practice, lack of transparency, nonaligned values or vision, lack of experience within the healthcare industry, poor communication or lack of clarity, and future plans to overhaul the practice structure.

CONCLUSIONS

The economic landscape of healthcare continues to evolve with declining reimbursements, greater administrative burdens, and, as a result, a shrinking number of independent private practices. As a result, the rise of private equity firms is unprecedented, and this trend is now beginning to influence plastic surgery practices more than ever before. This article aims to shed light on the economic basics of private equity along with its benefits and risks. Based on these findings, recommendations have been outlined to give plastic surgeons interested in private equity acquisition the best possibility of maximizing profit without sacrificing patient care.

Disclosures

The authors declared no potential conflicts of interest with respect to the research, authorship, and publication of this article.

Funding

The authors received no financial support for the research, authorship, and publication of this article.

REFERENCES

Author notes