Healthcare startups across the country are working to make specialized care more accessible to patients. As a result, investment groups—from local healthcare-specific investors like Health Wildcatters to general investors—are capitalizing on the recession-resistant industry.
Last week, investors from nationwide groups gathered at the Ritz-Carlton in Dallas to discuss ongoing trends in healthcare investing for Polsinelli’s Healthcare Dealmakers Conference, an annual gathering in Dallas where healthcare providers and their capital sources and advisers come together to discuss the rapidly changing healthcare services marketplace. The conference annually hosts the Health Wildcatters’ Health Innovation Pitch Competition, won this year by Rosy Wellness.
Members of the panel titled A Heart Monitor for Healthcare Investment Views From Private Equity and Family Offices addressed what startups need to do in their quest for funding and how investors evaluate companies. They also took a look at how new technologies are influencing the funding process and the status of funding in the healthcare industry as a whole.
Panelists included Jesse Bland, Heritage Group; Samarth Chandra, Enhanced Healthcare; Matt Jameson, Blue Mountain Capital Management, and Adam Reinmann, Wendel. Here’s what they had to say:
What can companies do better when talking to private equity about their value propositions?
Chandra: “I think oftentimes, especially at middle market and lower middle market, that creating a five- to 10-year game plan for your company can happen when you’re looking for capital.”
“And it can be concurrently done during that process. I think the most beneficial, and the way to best position your business for success, is to begin to harness your internal resources and begin to create that five- to 10-year game plan yourself. And the better prepared entrepreneurs and business owners are to understand their five-year and 10-year long-term value creation plan. It’s better to be able to articulate it when they’re out looking for capital, and the more likely they are, especially in this market with with high valuations, to find the right partner.”
Reinmann: “When I meet people, I ask them to generally describe how the basic business model works. And that sounds really, really simple. But I’ll oftentimes get a sort of glassed-over look. In other words: who the customer is, what exactly are you providing, how does it work?”
“…I think it’s a really good way to start, then think about what makes that model unique in the context of the business or the industry or in how you actually manage the business: What is the business we’re in? Why is it good? And how do we actually manage it?”
“…And then I think the conversation is: how am I really going to create value over the next three, five, seven, 10 years. I genuinely find that for people who can articulate those three or four pretty basic things, it makes for a pretty good introductory conversation, and then you can sort of dig into the details around that.”
How are the private equity and the family offices viewing all of the significant change in the healthcare market?
Jameson: “The only change that that I find really, really difficult to underwrite is the out-of-network to in-network transition, just from a deal perspective. That’s one that we’ve seen many ancillary issues come up with. Otherwise, we look at it and say, ‘Can we get comfortable with what the future is going to be in the sector? …Can we create a structure that aligns interests and that we feel protects us and gives us a posture risk to return?'”
Chandra: “There’s aspects of healthcare that really haven’t changed, and drives stability in the sector. It’s recession-resistant, it’s a six digit GDP. You’re always talking about a growing healthcare year, not a shrinking one. It’s just—how do you slow that growth curve?”
“One area of significant evolution that we’ve been seeing is in consumer-directed healthcare… Patients are now responsible for a bigger part of their healthcare dollar. And that’s only going to increase. We see change in benefit designs, there’s more copays, higher deductible plans. And the way we’re seeing healthcare businesses evolve to respond to those growing consumer trends is something that I think is remarkable. It’s the place for a lot of innovation these days, and it’s put a new lens on many of our multisite healthcare businesses.”
Bland: “Without some kind of regulatory catalyst, you’re not going to see rapid change in healthcare. It’s going to be more evolutionary. So, if you’re in the regulatory catalyst environment, you’ve really got to make sure you understand which side of the bed you’re taking. And our view has always been—be on the on the side that’s taking cost out the system. We think that’s going to be a winning strategy long term. But if you’re in an area where you’re evaluating an investment, an area where there is no clear near term, regulatory catalyst positively or negatively, it’s really about when is this change going to occur that you’re betting on? Because if it’s 10 years from now, you can be right, but you’re still wrong on your investment.”
Is it helpful to have a have a longer timeline outlook? Or is it even better to have a shorter outlook as trends are moving very quickly?
Chandra: “Even for traditional private equity firm structures, if that’s a three- to five-year equation, you want to have a 10-year plan. A prudent private equity investor would be underwriting the sale plan at the time that they’re underwriting the initial investment. Because if there’s a near-term change—of course, there can be circumstances—but if there’s a near-term change, it’s going to affect your exit opportunity.”
Bland: “We offer a structure to solve that problem. We’ll go more senior in the cap stack, do our second-lien—our preferred equity instrument—to try to mitigate those sorts of situations where it’s difficult to say from a private equity perspective to take a full boat, full valuation, and common equity risk. “
Do you see more money moving into healthcare investments right now? Or do you see some of them receding out? Which way is the money flowing on the PE side?
Reinmann: “The good news is for people in the room that are service providers or sellers, there’s no shortage of people to go after. But what that means, by definition, is two things: One is there’s more competition generally for what I would call a big bifurcation between quality businesses performing with good track records, versus for mediocre businesses.”
“And the other thing I would say is—this is kind of unique, and it’s where I started probably got my thesis wrong when I built this business—I would have thought that at this point in the economic cycle, the investing cycle, we would have had an advantage, meaning get our prices relatively high. But if we’re buying the business, we like to we can own it over a long period of time, the ability to weather changes in the market multiple should be less impactful for us, if we do our job properly.”
“What’s happened in practice is traditional private equity is forced to invest through cycles, and their LPs want them to do that. And so it becomes a bit more of a try to pick the right business, the right thesis at the right time at whatever that point in time is. Whereas I think longer term investors family offices are have the ability to do a little bit more patient.”
Bland: “We’ve seen a lot more competition on deals over the last three to four years from generalist firms versus healthcare specific investors than we saw five, seven years ago.
“I think that trend is going to continue… There’s just this massive amount of dry powder sitting out there that people have to park somewhere. Healthcare is a relatively high growth sector. It’s highly regulated, so you’ve got to understand the nuances. But it’s massive; it’s not going anywhere; it’s somewhat recession resistant; and if people are fearing some kind of economic downturn over the next three to four years, this could be a relatively attractive sector to invest. And as a result, we’re seeing increased competition really in every deal.”
What do you like to see in companies, and what frightens you?
Chandra: “Typically, what what we find needs a lot of improvement… is a lack of financial infrastructure. And in healthcare services, specifically, going and collecting. And that is that somewhere where small business owners—if you have a lower middle market company—should really be investing to establish the right infrastructure, the right reporting, and collect your healthcare dollar.”
“It’s not unusual for me to go into situations and meet with companies where, based on our research, they’re collecting 75 cents on the dollar. That should be a lot closer to 90 with proper checks and balances and bad debt reserving methodologies. And so that’s the value creation opportunity for an investor.”
Bland: “Especially on the technology investments that we make and evaluate, it’s always amazing to me how little clarity some companies have on articulating their value proposition. And when we’ve looked back across our portfolio, the most successful investments have been very simple businesses from a value proposition standpoint.”
“And I think you need that. Because if you’re in an enterprise sales environment, and healthcare is long, and it’s painful… And getting in your own way with a murky value prop is, is a big challenge. So we look a lot of that on the technology side, and more broadly at management teams and their experience.”
How does this team feel about sort of the blitz scaling models?
Jameson: “Amazon is an entity that can almost literally enter any business at any point in time. They have the resources to go do that. So I think you have to look at it and say, ‘Does this business exhibit characteristics that someone like Amazon is going to find attractive? Is there an inefficiency that a part of the supply chain is able to exploit that earns disproportionate rewards?'”
“So we look into sectors within healthcare that could be a distribution but maybe just don’t have the margin profile that someone like Amazon or or someone else didn’t want to get into or doesn’t have the population control base like someone like that would be in. I think you have to look at that. And it’s the last section of almost every deck today goes to an IC these days is, you know, what is the Amazon risk for this business?”
Bland: “I think it’s a net positive, frankly, because it’s driving change. And it’s outside the confines of governmental involvement. And at the end of the day, it just brings more visibility and the spirit of innovation to the major stakeholders in healthcare. Now, you’ve got to really understand with respect to your underlying portfolio companies, or potential investments, how and to what extent does a new entrant like this potentially impede growth or create risk.”
Responses have been edited for length and clarity.
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