Private Equity (PE) throws a lifeline to healthcare practices that are treading water. The thing is, while it’s great being pulled to safety, you might find yourself caught in the occasional riptide.
Basically, PE has its pros and cons, which you should consider before you make a final decision about letting investors into your life.
The Growing Role of Private Equity in Healthcare
The US healthcare sector still hasn’t recovered from the impact of Covid-19, leaving specialty practices like dermatology, cardiology, and anesthesia ripe for private investment. PE has grabbed the opportunity and is forging ahead, making inroads into behavioral healthcare and primary care.
PE makes it possible for practices to extend their reach by opening additional practices, while increasing their capacity and efficiency by purchasing the latest medical technology, implementing digital systems, and increasing their staff complement.
Investment enables small and medium-sized healthcare practices, and underperforming entities to keep up with industry trends, which currently include consolidation and upscaling. PE firms often use a “platform and add-on” approach; the primary practice is the platform. Several smaller acquisitions are add-ons to increase market share and ROI.
Some firms play an active role in the practice’s daily operations, while others are content with a macro-management approach. Whatever the level of involvement, PE firms typically ensure they get a couple of board seats. They stay in the loop and have a say when decisions are made.
On the surface, accounting processes between owner-run practices and PE firms appear similar. They both comply with the Financial Accounting Standards Board (FASB) and Generally Accepted Accounting Principles (GAAP). The difference is that PE firms aren’t absolutely required to follow the standards, provided they deliver institutional-level accounting.
This means switching from cash basis to accrual basis and adjusting to differences in consolidation and reporting processes. For instance, there is no standardization in financial statements, they must follow the overarching accounting standard.
How Private Equity Reshapes Financial Reporting
Change is inevitable when new investors come aboard, so if you’re going the PE route, make sure all your staff are prepared for different systems, policies, and operations. The bad news for healthcare practices is that accounting becomes significantly more complex as systems must be adapted to align with the investor’s accounting framework. The good news is that healthcare-specific accounting software with AI and automation can help you survive teething processes.
In fact, advanced accounting software is particularly important as a reporting tool because it uses data, including real-time data, to provide insights into your practice’s financial status and guide investors as they aim to improve overall functioning.
EBITDA comes into the picture as a measure of your practice’s financial performance. EBITDA – Earnings Before Interest, Taxes, and Amortization – tracks and compares your practice’s profitability (and cash flow) in a way that facilitates the transfer of ownership. It provides investors with a clear idea of your practice’s potential profitability, which is a key factor in their final decision.
Private equity investors have one primary aim: Boost value (ROI) quickly. This can be good for practices because it streamlines and enhances operations and introduces the latest in technology. However, the focus on profits can compromise the quality of care.
Standardization in cost management is another benefit for healthcare practices. Standardized financial and reporting procedures ease the adjustment to new accounting systems. Everyone speaks the same financial language, so there is more cohesion and understanding. Consistent billing helps insurers settle claims quickly and sharing real-time data is great for decision making, especially when it comes to identifying risks, opportunities, resource allocation, and ROI.
Balancing Growth and Cost Management
PE investors want to increase ROI, preferably without increasing costs. That’s obviously impossible. You can’t grow if you don’t invest time and money. However, costs must still be minimized.
There’s pressure to stretch budgets to get maximum value from every cent spent. Meanwhile, practices must ensure the quality of patient care isn’t affected, not if they want to keep their reputation.
Investors usually start by identifying cost inefficiencies. They plug cash leaks quickly with short-term solutions that must be developed to provide long-term leak protection. They find areas where costs aren’t optimally managed and likely take over until they’re satisfied with the results.
This includes balancing workforce expenses with profitability goals. Workforce expenses are all those related to employees, from recruitment and training to salaries and benefits. The Total Cost of Workforce is divided into three categories:
- Total rewards: All compensation – salaries, overtime, bonuses, medical and insurance benefits, retirement savings, and paid leave. Investors can cut expenses to increase profits, but eliminating overtime and cutting back on medical benefits won’t win friends.
- Employer costs for labor: Workforce management expenses – taxes, employer insurance, workers’ compensation, and contractors, consultants, and temps. Investors can cut costs by keeping tasks in-house, but they risk over-worked and disgruntled staff.
- Workforce overhead: Indirect costs related to product/service creation and delivery – recruitment, training, onboarding, and facilities. Investors can cut costs by limiting recruitment and training opportunities, but they risk skills shortages and under-trained staff.
Fortunately, technology saves the day. Software automation and AI manage most admin tasks, and bookkeeping and accounting functions, like accounts receivable and financial reporting and analysis. PE investors can save costs by outsourcing tasks to healthcare accounting specialists.
Healthcare is governed by strict regulations and compliance requirements, including licensing, patient privacy, price transparency, and medical waste disposal. Related costs include implementing new technology and staff training to ensure everyone understands compliance rules. There is absolutely no cost cutting here, not unless investors want to face stiff penalties that could include high fines and prison sentences.
Challenges for Accounting Teams in PE-Owned Practices
Being taken over by a PE investor is a bit like getting a step-dad. You know they’re going to change things in your home and you’re not particularly happy about it. They mess up your routines and you have to adjust accordingly. So, one of the biggest challenges accounting teams face when investors enter the scene is adapting their systems and processes to fit in with the new financial reporting requirements and priorities.
The best thing you can do is prepare all your teams for change. You can even get a change management consultant if there is resistance. Sometimes, investors bring their own accountants or financial managers to oversee the transition from your comfortable old systems to the shiny new processes. Advanced accounting software, like Sage Intacct ERP, integrates with existing programmes so there is little disruption to business operations.
The new processes often demand more from your team than they’re used to. For instance, PE investors are all about ROI and the best way to drive revenue is to make savvy financial decisions. These are based on real-time data, so your team might have to deliver reports more often or meet stricter deadlines.
Your entire practice might feel the pressure as investors demand improved performance. It’s not an unreasonable expectation if you agreed to the deal because your practice wasn’t functioning as well as it should. PE investors want to turn that around and that means you and your staff must pull yourselves up the boot straps and get to work with enhanced performance in mind.
Long-Term Financial Impacts on Specialty Practices
Private equity has the potential to boost ROI significantly. However, practices must buy into the new accounting culture, learn to allocate resources productively and take advantage of capital to carry out projects that were always just a little out of budget’s reach. The focus on operational efficiency to drive returns can organically lead to new opportunities that increase revenue and contribute to your long-term financial goals.
An increase in revenue is great, but it mustn’t come at the cost of patients’ care. Use the cash injection to upgrade equipment, or, depending on the size of the needle, buy hi-tech equipment that will revolutionize patient care and attract hordes to your doors.
Tax is a whole other kettle of fish. It’s two kettles of fish – and a teapot. Tax laws are evolving to adjust to the new financial landscape carved out by private equity firms. You need to stay on your toes so that you don’t accidentally contravene legislation. Tax considerations include:
- Multi-state tax rates
- Multi-state reporting and compliance
- Deal structuring (acquisition or debt vs. equity financing)
- The type of partnership: General partners or limited partners
- Unique exit strategies
- Tax-loss harvesting
Your priority is your practice. Investors’ priority is financial growth. They don’t have to be at odds with one another. You can collaborate to develop financial and operational strategies that enhance performance and efficiency over the long-term. The sustained growth is mutually beneficial and that’s great for ROI.
Will You or Won’t You?
Private equity is transforming healthcare accounting and it’s doing it lickety-split. That doesn’t mean the only way your practice will thrive is by joining a private equity firm. Your practice is unique and you need to make the decision that’s right for you. And, if you need some guidance there are always consultants that specialize in healthcare accounting who will be happy to help.
