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An interesting trend is developing in the arena of healthcare investing. Private equity firms are dedicating an increasing amount of capital to the purchase of specialized medical practices.

The aging of America is one of many demographic factors indicating a significant and sustained upside in the healthcare industry. The number of people in the U.S. over 65 years old will double over the next 25 years. Wall Street has taken notice and investment firms are making a conscious effort to identify and invest in promising doctors' groups and private practices.

Opportunities for Growth and Improvement in Care

From the standpoint of private equity groups with business acumen and money to invest, medical practices offer unrivaled opportunity. The most medically skilled doctors are not necessarily savvy businesspeople. Further, the time they have available for running and growing their businesses in a cost-effective and intelligent manner is extremely limited by the delivery of medical services, which is their primary responsibility. Consequently, even the best and most lucrative doctor-owned practices can be fragmented and inefficient.

Doctors who sell to private equities are free to concentrate on providing quality healthcare and can invariably see significantly more patients every workday. Private equity investors who inject cash into these practices can easily increase the value of their investments by making obvious improvements in efficiency and economies-of-scale. Last but not least, patients benefit by having a more attentive doctor and more proficient administrators.

Medical Specialties Are Attractive Investments

When evaluating practices for possible investment, private equity firms favor medical specialists in or near population centers. Dental, dermatological, orthopedic and ophthalmology practices are highly sought after.

The factors that make these particular specialties so enticing to Wall Street is that they offer a highly profitable combination of repeatable, routine care and high margin procedures. Semiannual trips to the dentist's office and once a year visits to the eye doctor provide predictable, reoccurring revenue while expensive procedures, such as orthopedic surgeries and laser vision correction, boost profits whenever they are performed.

The other benefits to specialization are that it provides the advantages of economies-of-scale, and offers excellent prospects for expansion.

A private equity firm that limits its investments to a single specialty — for example, dental practices — can easily implement centralized purchasing of supplies and equipment and receive the corresponding volume discounts. Customer service functions can be concentrated under one roof and banking relationships can be consolidated. Substantial cost savings are also achieved by eliminating management overlap.

Growth of a business is always a concern to investors, but only so much growth can be achieved organically. Expansion due to continued acquisition is a hallmark of private equity, especially those that focus on retail healthcare. Once a firm buys a large medical practice in a population center it becomes easy to add doctor's groups to the fold. All of the infrastructure and administration are already in place, and new practices can be seamlessly integrated into the parent company with little effort or extra expense.

Let the Seller (Doctor) Beware

Well-run doctors' groups are suddenly in great demand and not just by Wall Street. All manner of healthcare investors are acquiring all manner of private medical practices. Suitors today will include publicly traded health insurance companies, practice management companies and hospitals, as well as private equity organizations.

Doctors are likely to be enticed by offers of large upfront payments, generous ongoing salaries, and blessed relief from day-to-day practice management responsibilities. While there are many benefits to selling, doctors should be aware of risks as well.

One of the biggest drawbacks and hardest things for doctors to accept is the loss of overall authority over the practice. Doctors who were bosses may find it difficult to let someone else — usually a businessperson rather than a professional within the industry — be in charge. For this reason, physicians who consider selling, should understand and agree with the business philosophy of the buyer before signing away their independence. Doctors who want to maintain a measure of operational control need to negotiate a management role into the sales agreement.

Laws and Regulation Are Complex

The medical and finance industries are highly regulated. When Wall Street comes calling at the doctor's office, you can bet that a myriad of (State and Federal) laws and a huge amount of complex and daunting regulations will come into play.

Strictly speaking, some states don't even allow private (non-medical) ownership of retail physician's practices. The structure and wording of any deal will be painstakingly scrutinized. Both sides need to secure competent, expert and legal representation.

Because doctors routinely participate in government programs such as Medicare and Medicaid and constantly deal with insurance companies. Investors and regulators will be on the lookout for "red flags" or indications of fraud and abuse. An investor will scour a doctor's books prior to making an offer, and the government will review those books after an offer is accepted. Selling physicians must be able to explain any inconsistencies that might be found.

Retail medical practices have become a target of private equity and the trend promises to continue well into the future. Doctors who sell will be paid handsomely and will be relieved of burdensome administrative duties. However, they will lose some measure of independence and control. The costs and benefits should be carefully weighed.

To learn more contact shibani.faehnle@key.com or visit key.com/healthcare.