Our special guest on this week’s episode of the M&A Masters Podcast is Grant Jackson. Grant is the Managing General Partner of Council Capital, a middle market private equity firm based in Nashville, Tennessee. Their mission is to be the best healthcare private equity firm, with their focus on investing in the right side of healthcare change.
We chat about the underlying goal of improving the healthcare system, as well as:
Patrick Stroth: Hello there. I’m Patrick Stroth, President of Rubicon M&A Insurance Services. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today I’m joined by Grant Jackson, managing general partner of Council Capital. Council Capital is a middle market private equity firm based in Nashville, Tennessee. Their mission is to be the best healthcare private equity firm, with their focus on investing in the right side of healthcare change. Grant, great to have you. Welcome to the podcast.
Grant Jackson: Thank you, Patrick. Great to be here.
Patrick: Now, before we get into Council Capital, on your specialty in focusing on being on the right side of healthcare change, we’ll start with you. How did you get to this point in your career?
Grant: I grew up in in of all places, Africa, under a dictator came here and really started from scratch from scratch. A lot of people helped me along the way and generally without there being anything in it for them. And really think America’s unique in that regard. Started in M&A consulting and post merger integration. But quickly realized that I wanted to be partnering with great entrepreneurs and supporting them in growing really valuable businesses, which meant getting into private equity, I hadn’t had any kind of draw towards healthcare that came later. And so to get the private equity at the time, that really meant you had to get an MBA, that’s not true anymore. But it was back then.
So I went to Northwestern’s Kellogg School, graduated, during of all times the.com bust, and got fortunate that there was at least one company, one firm that was willing to hire me into private equity, but literally one. And so I quickly took that job, and got into private equity. The surprise to me was then how quickly I developed a passion for healthcare. And I knew that I needed to make my career around investing in companies that improve the healthcare system. I’d always felt that advances in science and disease were important. But they always were held up as the most important things. Whereas I felt like we were only capitalizing on 10% of the potential of all of the technological advances we’ve made in healthcare, and that the other 90% really comes from improving the healthcare system.
And that’s really what I’m passionate about supporting and doing. So, my career has been about following that dream, which has ultimately led me to, to Nashville and to Council Capital, which at the time was a very small fund. But one that had what I felt was a really strong approach. That I felt I could scale as, as the firm’s leader. And I have been at Council for 12 years now, we’ve just launched our fourth fund, with an investment that we closed just a month ago.
Patrick: Well, going into Council Capital specifically, and I like to ask this of my guests, because we get a feel for the culture of an organization when you drill down and figure out unlike law firms and insurance firms that essentially name their companies after the founders’ last name. Tell me about Council Capital by beginning with how did you come up with the name, and then give me a quick profile of your organization, and we’ll get into strategies and so forth after.
Grant: Yes, happy to. So the name I get no credit for the name, the name was, was created by the founders of Council Capital, who had a vision for improving healthcare, by investing in companies and they felt that the best way to do that was to find real experts, get them to invest their own money into our fund have real skin in the game, and where their money goes, then you will have their hearts. And so we put together the original CEO Council, which was a council of people who had been there done that in house in in healthcare. And that formed the CEO Council, hence the name Council Capital.
Patrick: Then with your focus, because you’re not focusing on upper middle market or middle market, you’re looking at the lower middle market. And I kind of think about with health care, a lot of people that aren’t familiar with health care think they think of it just on these institutions, side. Hospitals and large physician groups have large health plans. That’s not it. There’s a universe of smaller organizations within within the business of healthcare. Talk about your direction because you’re focused on the lower middle market.
Grant: Yes, what we do is we make buyout investments of healthcare companies. We can grow fast, we don’t use that much leverage. And we’re able to achieve those fast growth rates partially because of our council model. But also, because we’ve used our CEO counsel, that group of 34 people who’ve really built really valuable healthcare companies, to help us figure out where healthcare is going, and thus, where growth will be the highest. And so that has led us to focus focus on important or in today’s world, essential services, that are usually providing access to vulnerable populations or under managed high cost populations, and at the lowest cost point of care.
And so these are naturally, companies that move care away from high cost settings, often with people don’t want to be particularly in COVID, in places such as hospitals, inpatient behavioral health units, and toward caring for people where they live. And that’s why we have, for example, investments supporting medically fragile kids, which is one of our ideals, autism, those with intellectual developmental disabilities. And so, you know, think of us as investing in any company that improves the healthcare system, we can do that by investing in a company that actually provides care itself. Or it could be a to a services provider or a technology provider to those care providers, or it could be anywhere else in the support ecosystem around healthcare. So there are just a tremendous amount of different ways you can support the growth of building great healthcare companies.
Patrick: Well, I think what’s great about what where your focus is, with the lower middle market is, you know, my belief is that there are so many of these lower middle market companies under under 30 million under $50 million in transaction value that they don’t know where to go, when they reach some inflection point, and they’re too, too small to be big, but too big to be small. Where do they go next. And if they don’t know about organizations like Council Capital, then they will default and look to a financial institution. Or even worse, they could just surrender and capitulate to a strategic that doesn’t necessarily have their best interests in mind.
And so the more people can understand and learn about Council Capital, and all the resources you bring to bear for that specific class of business, I think is is fantastic. The issue though, when we look into health care, which is different from any other business, because you’re dealing with people’s lives, people’s health, okay, and so there’s a different standard that they have. And you’ve mentioned it a couple times already, but talk about the paradox out there of, you know, making an investment in healthcare that is efficient and profitable, without sacrificing quality of care. How do you balance that?
Grant: I don’t look at it as necessarily a balance, the way we look at it, is that we start by saying, where is healthcare going in 10 years? We then back away from that and say, what does that mean about the best starting place for us today? What kind of company should we be investing in. And then we look for companies with several attributes, it starts with, they have to be if they’re a care provider, they have to be providing great care if they’re a service provider, they need to be providing great support services. And if they’re a technology provider, they have to provide great technology. Once we understand that they are doing what they are meant to be doing great, then we look at the unit economic model and their ability to scale. And it’s an end rather than an or it has to be that they have both.
Once we have that, we look at it and we say what the entrepreneur printer has done is the most difficult part we believe, and that is to start something up and create something with great quality, a good unit economic model and limited compliance risk. And then the way we’ve built Council Capital is to be able to support them in scaling it from there, which oftentimes because they’ve built their capabilities around that first part of building a company, what we’ve done is we’ve said, what do we need to do to one identify those kinds of companies and then support them in their growth. And so the way that we’ve built the council model has been to specifically help support those companies, wherever they need it within growing from there up to a company with more scale, and so that includes several elements. One part of that is the CEO Council.
Which, just going into that a little bit more deeply, we’ve got 34 of them. These are people who have generally built very large successful valuable healthcare companies, billion dollar healthcare companies, the who’s who of their respective industries. In in healthcare, a lot of people have said, well, you’ve got the LeBron James and the Michael Jordan’s of, and then they named their individual sub specialty. And what we do with them is they have invested more than $140 million of their personal capital into counsel into our funds. So they are directly investing into, you know, the entrepreneurs business. So if you think about that, relative to having an advisory board or something, you know, where somebody doesn’t really have skin in the game, the CEO councilmembers have real skin in the game. And then they’re motivated to help that entrepreneur that company to scale.
So there are a variety of ways in which they help us with that, whether it be strategy on the board, helping with connections, relationships, basically helping the company punch above their weight class, so that you can take something with great capabilities, but enable them to behave as if they were a billion dollar business get the credibility of as if they were a much larger business. So we’ve done that with the CEO Council. And then, you know, we are we’re always evolving our business. And so what we said is, what else can we do, as it relates to building capabilities to help support these these businesses in their growth. So we built a value creation function that, in addition to the CEO Council, also builds brings a whole lot of other capabilities. So it, it helps people scale their human resource function, their finance function, their technology function, etc.
And we have a lot of very simple case studies to be able to demonstrate to people the kind of value that that has, in terms of helping a company really grow and scale in the right way. So, you know, a lot of times, small companies, as they scale, they lose their quality, quality of care, etc. And what I find when I speak to entrepreneurs, is they’re often worried about partnering with somebody, because they don’t want to see a dilution of the quality. Whereas what I think we can demonstrate to them is that we will help them to solidify that quality, and ensure they don’t lose it as they scale. And that, to me is the beauty of building a great, valuable, scalable company is that you want to hang on to what was special, when the company was small, great clinical quality, great service quality, great technology quality, and figure out how you scale that which is, is different than what you do when the company is small.
Patrick: I think one of the things that you cannot understate the value of what your bringing with with that counsel model is that and again, we’re dealing in healthcare, as you’re growing, you’re dealing with institutions out there as prospective clients or opportunities or whatever, who better to get access to those institutions, than members of your council who they’ve got credibility, because they put their own money behind these ventures, they’re not just speaking it up. And that eliminates a lot of obstacles. So if anyone out there listening today is considering, you know, making a move, I’ll tell you that a resource that Council Capital brings to the table that is literally unmatched out there. And I think that’s just terrific.
Grant: Patrick, to that point. Healthcare is an enormous industry, but in some ways, it’s quite small. And so just to help people understand what that CEO council really represents, those 34 CEO council members plus our strategic investors, so all of those are investors in our funds. They directly represent over 60% of the managed care lives in America. And over 60% of the for profit hospital beds in America, similar statistics in behavioral health, a range of other sub sectors within healthcare.
But what that really means is that if there’s a relationship that the company needs, we are going to be able to access them directly through our investor network. And our investor network is really leaning on our credibility. They’re looking at us to be the stamp of approval for the company we invest in because their reputations on the line, and because we haven’t violated that trust that we have with them are investors, it means that that credibility goes a long way, when they stick their neck out their own reputations on the line to go to bat for a small company.
Patrick: Let’s underline one other thing about this. And this is just an undeniable fact. Let’s talk about the importance of Nashville, Tennessee, in the healthcare world.
Grant: Yes, Nashville really is the biggest healthcare market in the United States. I always thought that it was big when I lived elsewhere. And then I came to Nashville, and I realized that was much bigger than I’ve previously understood. It’s also well organized, which means that you have a path to navigate the system. So what we found is that we can invest in companies around the United States, and then give them access into Nashville and what that gives you access to is not only the biggest market within healthcare in the United States, but Nashville companies often have the benefit of working with each other, which means that you can avoid mistakes, figure out what the right approaches to doing things are often. And so you really get access to a lot of that, you know, that thought capital
Patrick: Well then, tell us Grant, give me a profile of your ideal target. What are you looking for?
Grant: Well, we really want a business that is great at what it does. So whether that’s great clinically great service, great technology, that they have a good unit economic model, they have to be going in the direction that we believe healthcare is going. So I often look at people ask me, what’s the difference between venture capital and private equity, for example, and the what what I respond with is, oftentimes venture capital is looking at the right side of change in healthcare, but they are looking for things that might work in 10 years. And not all of those things are going to work now. So the success rates going to be be lower, which is fine, because that’s part of their business model, the way we look at it, in terms of what does right side of change, mean for a private equity fund investing in the lower end of the the middle market in healthcare is that we want to invest in things that represent the future of healthcare, but they have to have business models that actually work today.
And therefore, you’ve got a company that has products that they’re selling today, solutions that they’re selling today. And they can be profitable, and they can grow it today. But as the winds of change pick up, then they’re just going to have more and more wind at their back. And so it’s going to accelerate their growth over time. But it’s a very important distinction, in terms of what we look at, relative to what a lot of other great healthcare funds might be looking at, it’s just a different focus. While markets, clinical quality, etc, are important and table stakes. What really enables us to be successful with these businesses, is having great leadership that we trust. So the quality of the management team is really important.
We’re not looking at people through necessarily a traditional resume based approach, we’re really looking at them as what capabilities do they have to take this company from, where they are now, going forward, and we need to be able to trust them with that. And so increasingly, what we found is that we can back people up, they may not have been there, done that on every single element of what we need them to do in the future. But as long as we feel that they are really capable individuals, then we can support them in a lot of the ways that they want support going forward. You know, we never want to run companies, but we can create that a toolbox that we give them access to. So that they can help themselves to the toolbox to really help them scale their own business. So, you know, great leadership and having a great relationship with that leadership is critically important for us in a deal.
Patrick: When you’re looking at investments and acquisitions in in healthcare, you know, everything can fit everything can look right. But you know, these deals don’t happen in a vacuum. And so there’s always risk involved. And a lot of the, your counterparties are probably first timers in the M&A world. And so they get the experience very new experience of learning about that risk and how it applies to them personally, they can’t hide behind the corporate veil. They are financially at risk to a prospective buyer. In the event something blows up post closing that even the best diligence just didn’t pick up. And you’ll have your seller target, arguing, hey, I can’t tell you something or be held responsible for something I don’t know, I told you all I know.
And contrary, buyers gonna look and say yes, but we’re investing 10s of millions of dollars, that you have a perfect memory. And so, you know, there is going to be indemnification agreements, there are going to be these tools out there to transfer risk, and so forth. And that can introduce a bit of stress and tension between the parties where it didn’t exist before. Because of that, and it’s just the the issue of fear of you know, those types of losses. I’m very proud that the insurance industry has come in with a product to transfer that risk away from the parties. And it’s called rep and warranty insurance, where the insurance company essentially looks at the seller reps, compares the seller reps with the buyers diligence of those reps for accuracy, and then makes a decision says, hey, for a couple bucks, I’ll tell you what, we will take that risk that indemnification obligation away from the seller.
And we will take it so that if something does explode post closing buyer, you have peace of mind that you will recover, we will pay the pay the loss for you seller, you get a clean exit, it’s been a rapidly moving product that has now come down to the lower middle market transactions, which is very welcome news. I’m curious grant because this only became available for sub hundred million deals in the last 16 to 18 months. Good better and different. What experience have you and Council Capital had with rep and warranty insurance?
Grant: We’re not as experienced as a lot of our much bigger private equity brethren, with respect to rep and warranty insurance, but that’s really because it was serving a much larger market. We’ve since been paying attention to it because we’ve realized that it is suitable to the small you know, the smaller end of the market, which is where we play. And so we we look at it as as something to consider on whatever deal we are looking at. And it really is just going to depend on the facts and circumstances of the deal. But it does give you the ability to be able to both close on the deal in the manner that we need to and give the seller the ability to take more money off the table up front. And without us really giving up much in the process. So I think it can be can be a great way to navigate a potentially significant issue between a buyer and a seller.
Patrick: Yeah, I think it’s a case by case it’s maybe not a fit for every single deal out there. The one thing is welcome news is healthcare was one of the sectors that the rep and warranty industry did not like to deal with. It’s heavily regulated. And there were a lot of other exposures that the underwriters just didn’t know what I’d get their hands around. And I think that over time with great experience and a little bit more understanding, particularly getting the right brokering to negotiate with the underwriters and show them that there are exposures that aren’t really relevant to every healthcare company.
There are ways that your solutions can be found. And this is, you know, consistent with one of the things that you came up with where you don’t have the dilemma of, you know, profitability versus quality of care, you can have both. And I think that’s one thing that’s encouraging about this sector with with insurances. things continue to develop in favor of the policyholders out there. So we’re very, very, very happy about that. Grant, as we’re getting into, you know, the first half of 2021, now times flying, I think it’s safe to say we’re looking at the beginning of the end of the pandemic. Give us give us perspective, from what you see, what trends do you see in M&A either for Council, Capital, healthcare, the economy at all. What do you see out there for the rest of the year?
Grant: Well the market, in healthcare for deals that really are in these sectors that we view as right side of change in healthcare is very hot. So there, I think what the pandemic did was it highlighted the vulnerabilities in healthcare, you know, what kinds of companies could have issues and people focused on you the areas that that had strength. A lot of those are markets that we’ve already been invested in, and will continue to be invested in. So it just means there are more funds out there looking for investments in those markets, which leads to more competition. I think the key for us, is making sure that we find ways to adequately communicate what we are like as a partner, you know what we bring to bear and let the entrepreneur then, you know, determine how they would compare us against any other alternatives which we which we welcome.
Patrick: Grant, how can our audience members find you and Council Capital?
Grant: Best way is through the website and really through our leader of business development, Jon L’Heureux, who’s also his contact information is is on the web on the website. And we’d love to meet entrepreneurs who are growing great healthcare businesses.
Patrick: Yeah. And I’d say you’re yours is one of the better websites out there. I just looked at websites from private equity firms from five, six years ago where it was, it was almost password protected, and they had so little information on there. Now your organization is easy to find easy to navigate, easy to reach out. So I think that’s user friendly is good because you do not want to be the best kept secret in private equity, particularly for healthcare. Grant Jackson, been an absolute pleasure. Thanks again for joining me today. You have a great day.
Grant: Thank you, Patrick. Thoroughly enjoyed it. Have a great day, too.
The politics of healthcare is a mess in this country, as you know.
But Matthew Hanis, executive producer and host of the Business of Healthcare, is more interested in practical measures for incrementally improving a system that is the most expensive in the world and doesn’t offer a great quality of care in exchange.
We also talk about the M&A landscape in healthcare, including the trend towards increasing vertical integration, as well as…
Mentioned in This Episode: www.bohseries.com
Patrick Stroth: Hello there, I’m Patrick Stroth. Welcome to M&A Masters, where I speak with the leading experts in mergers and acquisition. We’re all about one thing here, that’s a clean exit for owners, founders, and their investors. Healthcare is literally a force of nature in our economy. It’s been in the news quite a bit lately and like it or not, as time goes on, everyone will be consuming more, not less of it.
Today we’ll discuss the future of healthcare from a business perspective, and how mergers and acquisitions will factor into the inevitable changes coming to healthcare. I’m pleased to be joined by Matthew Hanis, Executive Producer and host of Business of Healthcare. Now in his 13th season, BOH is an online platform where Matt interviews senior leaders in healthcare. BOH estimates that 118,000 decision-makers are responsible of 80% or more of the buy and sell sides of US healthcare. Just about 20,000 of these very decision-makers participate in BOH’s audience. That’s about one in six, which is a respectable share of any market. It is for this audience that BOH was purpose-built to identify and help propagate proven innovations, elevating mission and margin more rapidly. Wow, one in six, that’s nothing to sneeze at. Matt, thanks for joining me, and welcome to the program.
Matthew Hanis: Patrick, thank you so much for inviting me on.
Patrick Stroth: Now, we’ll get into Business of Health in a moment. First, tell us how’d you get to this point in your career?
Matthew Hanis: Well, I tried to make as many mistakes as possible, and this is the culmination. I’d spent about 25 years in healthcare, most of that time I’ve either worked on the vendor side, selling data solutions to health systems, larger payers of health plans, or working within a health system, Mercy in St. Louis, to have the experience of actually doing the work of healthcare. Ultimately, all of those experiences culminated in a passion for entrepreneurship and for finding the innovations that I felt could really transform our healthcare delivery system in the United States.
Patrick Stroth: When we see BOH’s core statement, which is mission and margin, with mission, we get that because healthcare and doing good and providing care to people, there’s a passion, the mission. It’s the margin that people start looking at real quick. Why don’t you explain what you mean by mission and margin in the Business of Healthcare.
Matthew Hanis: Healthcare makes up about a fifth of the US economy, and every sector of the economy is important, but healthcare one of our challenges though is the cost of healthcare has continued to rise at a rate faster than pretty much any other aspect of our economy. But when you look at the quality of healthcare as measured by access, patient satisfaction, survival, life expectancy, all the broad measures of healthcare, we don’t do very well in this country. We have a major portion of our economy, which is getting progressively more expensive, and on most measures of quality, it’s not very good.
I believe that this is unsustainable. Now, the laws of physics tell us that all systems come back into balance. There’s a couple of different ways that we can see the US healthcare system coming back into a healthy balance in terms of cost and quality. One of the ways though, which tends to be the primary focus right now is trying to cut payments to physicians, and try to manage healthcare by managing how consumers consume it and managing how it’s provided. Our belief is that these approaches are unsustainable and that there are at the same time, very, very sustainable ways to improve the effectiveness and efficiency of our healthcare system. That’s what we try to bring to bear.
Mission is really about all the things you and I can agree on, quality, access, patient satisfaction, physician and other provider satisfaction. Margin is recognizing that like any other part of the economy, the providers who deliver healthcare must be able to make a profit in order to make it a sustainable business. We just need to figure out how to balance that with the cost to the consumer.
Patrick Stroth: The problem that you mention out there which is making a challenge for us is that cost of healthcare continues to go up, quality continues to go down. I would think that a lot of people would think well, the more it’s intuitive almost that if you spend more you should get better quality. Are there any specific reasons why the cost goes up and yet we’re not getting the value, the benefit?
Matthew Hanis: Yes. There’s a couple of different reasons. One issue which is very microeconomics, is pricing. We know that one of the biggest drivers of the cost of healthcare is the price that’s charged for healthcare. There’s an enormous set of problems around understanding price. God forbid you should have to go to the hospital for surgery. It’s extremely difficult to understand what that’s going to cost you, and what the costs would be for you to go get that exact same procedure in other settings.
Why is it so complicated to understand price and the cost of healthcare? Well, I believe that a big part of that is we’ve got a lot of intermediaries in our delivery system. Too many intermediaries can cause such a separation between the consumer of healthcare, the provider of healthcare and the payer of healthcare, that we create a whole myriad of complexity. I think a big aspect that we can look at is, why do we have so many intermediaries, so many people that handle healthcare transactions multiple times? Why is it so hard to get that data to be meaningful to the consumer?
I think another cause that we face in our system is regulatory constraints. I’m not suggesting that healthcare should become an unregulated industry. I think we can all agree that just about any industry in the US, we want to have good regulation over healthcare to protect the consumer and protect the providers of healthcare. The problem that we face today though is that the regulatory environment that healthcare providers face is so confusing and so complex that it’s almost impossible to comply. I’ll give you a concrete example. A typical health system reports somewhere in the order of 4,000 different quality metrics each year. Most of those quality metrics, most of those 4,000 are actually redundant metrics that are being reported to different organizations in slightly different ways.
Another issue in the regulatory side are the constraints of the Stark Laws. The Stark Laws were created to prevent or to discourage physicians from referring patients to treatment from which the physician would profit. The problem with that is if we ask a physician to take accountability for a patient’s total spend, and for that patient’s quality of care and their overall quality of life, which is the concept of fee-for-value, if we were to ask physicians to do that, unlock their ability to make those decisions and to be able to refer patients to the providers that they most want to work with and potentially refer them to themselves, for things like imaging, and other services that are adjacent or ancillary to the primary purpose of care, these issues of so many intermediaries and the regulatory constraints that are so confusing, create an enormous part of the enormous waste of our delivery system. Today we spend about a third of our healthcare dollar on waste, things that do not provide value. A decent chunk of that waste is directly related to too many intermediaries and enormous regulatory constraints.
Patrick Stroth: Wow. I think when people look at healthcare, the only way you address this is, either you have the universal care, care for all, unlimited, which a lot of people would say, well that means care for nobody because the system would be overrun. Or, the other extreme is fear there would be extreme rationing out there, where some arbitrary person will dole out allocation healthcare by some abstract basis. You’ve got fear on both sides, but it’s really a false choice. It’s not all of one, all this or nothing. There are models that are being set up and there are ways that are being tried to go forward. Why don’t you talk about those types of models.
Matthew Hanis: One of the fundamental trends in healthcare is the shift from fee-for-service to fee-for-value. The basic idea is that today, when a physician bills for a service they provide, or a hospital bills for a surgery that was performed in one of their operating rooms, they essentially are billing for units of work performed. They’re not charging for a knee replacement, they’re charging for all of the components that go into a knee replacement. The concept of fee-for-value is that you charge, or pay provider for the outcome that they’re delivering. The knee was replaced, no infection occurred, the patient came out of the procedure with a responsible period of recovery. Those concepts around fee-for-value create far better aligned incentives between the providers of healthcare and the payers of healthcare.
I just want to touch on your point about, I think you touched on the Medicare for all concept. It’s important to recognize three things about our current US delivery system. First, we cost per capita somewhere between 30% more and 200% more than the rest of the delivery systems in the world, like that in Britain, Canada, Sweden or Switzerland. Before we toss those systems out as being un-American, or undesirable, consider the fact that they generally provide much better access to care. More people can get to care faster. They cost on a per capita basis, far less than our system does, and in general their consumers of healthcare report being better satisfied with the care that they received.
Now, I’m not arguing that those systems are perfect, and I’m certainly not arguing the idea that Medicare for all is a particularly good solution. But I would want to differentiate between the concept of a single payer system versus the concept of universal healthcare. A single payer system essential says, we’re all going to agree that one entity is going to pay for healthcare. Doesn’t say what the rules are about that. It’s just saying that each of us that pays money into healthcare is going to pay it to one place, and that entity is going to be the entity that pays the providers of healthcare. That’s how most of the delivery systems in the industrialized world operate.
In the United States we kind of have that, because 70% of healthcare provided in the United States is paid for by the government. Most people forget that it’s a relatively small portion of healthcare that’s paid for by the consumer and large employers. A single payer system does not necessarily mean universal healthcare. Universal healthcare takes it a step further and says, everybody gets healthcare and the government’s going to pay for it. Two really different ideas, but related.
Patrick Stroth: Well, let’s focus on M&A on the physician side of the industry, because we’ve got the large health systems, and we’ve got the large institutions and then you’ve got the pharmacy development, medical devices and everything like that. Let’s just look at the physician provider side of the industry. What do you see for the future of physicians in healthcare as we try to change into this fee-for-value emphasis?
Matthew Hanis: I think physician practices for the next 5 to 10 years are in a race for lives. What I mean by that is, if you take the concept of fee-for-value, which has generally pretty solid evidence to indicate that it produces better healthcare value for the consumer and the payer and the provider. If you agree with that premise, then that means that physicians are in a race to find ways to be in contractual arrangements where they have accountability. If I’m a primary care practice, it behooves me to try to enter into contracts where I take on the risk of a Medicaid population, a Medicare population, but I go directly to employers and contract with those employers to serve their employees and the employees families.
Those sorts of arrangements, manage care contracting if you will, are the strongest position for a physician to be in to get a market. If I as a physician practice hold contracts, either for the bundles of healthcare, like I’m a surgical practice, and the bundle for doing orthopedic surgery for a large employer, or I’m in the primary care space and I’m going to contract for the quality of care for an entire population, I’m guaranteed to be sitting at the bird’s eye view of how the money moves in healthcare. If I don’t have the contract for lives, that means that I’m going be subcontracted to somebody else.
I believe the essence of the M&A space for the physician world will be the race for lives. Those physician practices that have built the infrastructure and the capacity to take on population risk of various sorts, that can demonstrate their value in measurable ways, those organizations will continue to expand contractual relationships and exclusive network relationships with payers and ensure the flow of patients to their doors. That requires an enormous amount of work in infrastructure. Frankly, many physician practices are not spending those dollars. I think from an M&A perspective, I don’t think we’re going to see much more acquisition of physician practices by health systems. We’ve seen that market cool significantly. In fact, there’s signs of a number of physician practices unwinding their relationships with health systems.
What I do think we’ll see is acquisition and merger between physician practices, specialty groups merging into multi-specialty. I would expect that when you look at the 4,000 largest physician practices in the country, those organizations will likely consolidate. In 10 years from now I would predict that we’ll have half of those practices that occupy the largest group of physicians.
Patrick Stroth: You spoke awhile earlier about where we’ve got a big layer of intermediaries involved between provider and patient. If there was a way that if we had the physician practices moving toward this fee-for-value model than physician groups are going to be consolidating and one group will buy another, and so forth. Does that translate also to possibly them buying other facilities, imaging centers, surgery centers, physical therapy? Is there room for vertical integration and how would that look?
Matthew Hanis: Yeah. I think you’re spot-on. I feel like the trend there is a combination for the race for lives. If I’m a physician practice, I can provide a much better Population Health solution if I’ve got pretty good control over lab, pharmacy, imagining, rehab, physical therapy, those sets of services that are ancillary to the work of a physician, but are critical to achieving a particular outcome for a patient. That vertical integration trend, I think is very likely. I think that trend comes in two different flavors. One flavor is the vertical integration of healthcare service, like I just described. But the other is vertical integration in a manner to dis-intermediate many of the non-value producing participants in the healthcare ecosystem.
I’ll give you an example. If a physician practice had the ability to manage the total, all the healthcare transactions for one of their patients and they’re in a Population Health contractual arrangement, they probably are going have a much better understanding of the spend of that patient and be able to manage that spend more effectively. I can imagine, or I can see physician practices getting better at being able to do the data of Population Health and perhaps dis-intermediating stakeholders by directly contracting with employers, or contracting with employers in a manner that takes advantage of less brand name sorts of health plans, and more health plans that are designed to serve physician practice needs as much as they’re designed to serve large employer needs.
Patrick Stroth: Is there going to be need for some regulatory reform in order to do this?
Matthew Hanis: I think there is. We’ve already seen the Center for Medicare and Medicaid Services signaling that they want to soften or weaken the Stark regulations that prevent self-referral. We’re seeing several rulings that have come out of the Federal Trade Commission that solidify the ability for independent physician to contract together with health plans and other payers, without getting into anti-trust problems. I feel like from a regulatory perspective the three big things to be watch are Stark Laws, anti-trust law, and then a third area which is CON, certificate of need. Certificate of need constrains in about 20 states of the 50 states in the Union, about 20 states use CON laws to constrain the ability to create new imaging centers or add new surgery suites. Those constraints on the surface, make enormous amount of sense because they prevent the addition of unnecessary healthcare services, which often lead to an increase in utilization.
The problem with CON laws is they often get in the way of a physician practice being able to add imaging and other services to their capabilities of achieving that vertical integration. From an M&A perspective, the loosening of those laws would suggest an acceleration in the merger of physician practices and the expansion of practices to this vertical integration process.
Patrick Stroth: Could you see owners of medical facilities, I don’t know if they’re exclusively physicians as opposed to medical groups and physician practices by law, have to be owned by and run by a physician. But when you’ve got things like kidney dialysis centers, or labs, those don’t have to be owned by physicians. Could there be a situation in M&A where you could see a multi-state network of labs buying physician groups? Could that happen?
Matthew Hanis: I don’t know that I’m aware of that particular example occurring, but I’m 100% sure that there’s strange bedfellows in the outcome of these acquisitions. For example, United Healthcare acquiring DaVita, the largest dialysis business. Well, turns out United Healthcare is currently the largest employer of physicians in the United States. That’s kind of a surprising number because we all think of them as a health insurer, but in fact, they’re a provider of healthcare.
We also see retail pharmacy businesses moving aggressively into the providing of healthcare services. Being able to walk into a clinic at a Walgreens, to get your care taken care of. In those cases it’s not actually in most cases the entity, like the pharmacy is not necessarily employing the physician, but they’re contractually enabling the physician to practice care, and there’s movement of money. I would argue that, if it isn’t a merger on in fact, in many cases, it’s a merger in reality.
Patrick Stroth: The great interviews you have and they’re in HD quality videos and so forth, on Business of Healthcare. Matt, how can our listeners find you?
Matthew Hanis: Absolutely. They can find us on our website at BOHseries.com, or they can search for us on the web. Search on Business of Healthcare and our red logo, you’ll see us pop-up pretty high on the list, both our website, our podcast channels, or LinkedIn and our Twitter as well.
Patrick Stroth: Matt, thank you again for joining us, and we’ll talk again soon.
Matthew Hanis: Thanks so much Patrick. Thank you for having me.
This episode was originally published on May 23, 2018.
M&A activity has been heating up in the last few years… and 2019 is no exception. At the same time there has been a lot of movement in the healthcare sector, but due to its unique nature, special care has to be taken when dealing with acquisitions in this industry.
Patrick Krause, a director at investment bank MHT Partners focused on healthcare, has shepherded a lot of deals in this sector. He shares how he helps turn M&A transactions into win-win-win deals, where both Buyers and Sellers are happy – and patients benefit, too.
Tune in to find out…
Mentioned in This Episode: mhtpartners.com
Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters, where I speak with the top experts in mergers and acquisitions, and we’re all about one thing here, that’s a clean exit for owners and founders. This week, I’m joined by Patrick Krause. Patrick is a director of MHT Partners and also the co-head of their healthcare services. MHT Partners is an investment banking firm with offices in San Francisco, Dallas, and Boston. Patrick has advised on numerous transactions during his career, including sell-side and buy-side advisory work, as well as various strategic advisory assignments. Again, this is all exclusively within the healthcare sector. Patrick, welcome aboard today.
Patrick Krause: Well, thank you, Patrick. It’s a pleasure to sit down and chat with you a little bit here today. Hopefully, we can make it fun and informative for our listeners.
Patrick Stroth: I don’t think that’s going to be a problem. Tell me now, how did you get started in investment banking in general, but then also specifically where you focused on one sector as an expertise, which is healthcare? Walk us through how you got there.
Patrick Krause: Happy to. So, I’ve spent the bulk of my career working at the confluence of healthcare, finance, and technology. Upon graduating from the University of Michigan, which seems like a million years ago, I came out to the Bay Area and really cut my teeth as a consultant working for Deloitte. I worked across a number of their different groups, but almost exclusively serving their large global healthcare clients, ranging from integrated models like Kaiser to large biotech companies like Gentech, Roche, and really everywhere in between on the healthcare value chain, hospitals, provider groups. It really gave me an opportunity to deepen my skillset there. The range of my assignments varied from technology implementations, to the development of financial controls, to audit work, so between the operational exposure and the ability to build a deep skillset, and then move to investment banking was a straight forward one.
I worked at a number of post-merger acquisition deals, diligence deals for private equity businesses, all related to healthcare, knew that I’d been bitten by the deal bug. At the time there was not an opportunity to do more transaction oriented work at Deloitte, so I went back to business school and got my MBA with the intent of getting more hands-on deal experience, either at a bank or as a corporate development officer at a business, and have been fortunate to have the opportunity to do both. Prior to joining MHT Partners, I had a quick stop at Novartis’ Molecular Diagnostics Group doing some business development, corporate development work. Then, linked up with the founders of MHT Partners, as they were leaving their respective prior firms, to come onboard and help build-out our healthcare practice, which is what I do today. I lead our practice, and again, focus on serving founders, owners, entrepreneurs, private equity groups, as they seek to craft and execute healthcare strategies designed to maximize outcomes for the party.
Patrick Stroth: Well, I like how you went and characterized it, you got bit by the deal bug. I think that’s something that’s kind of common in this industry right now. As an investment banker, now your expertise is, not on the diagnostic side, but it’s helping owners and founders sell their businesses faster, and for a greater return, and making it overall smoother. Now, healthcare is very, very different from other sectors like tech or consumer products, okay? Both based on their ownership structure and then also operationally, there’s a lot less outsourcing that can be in done in healthcare. Why don’t you describe the differences between the healthcare sector versus pretty much any other sector out there?
Patrick Krause: Yeah. It’s certainly an interesting place to play as a banker. I think the realization that folks need to come to is, first and foremost it is, it’s a people driven business, whether they’re relying on providers to deliver great care or taking great care of your patients, it’s really driven by the interactions between different folks. Being able to speak the language of medicine and business helps bridge the gap. It helps to be more effective when you’re crafting the deal. Investing and healthcare is obviously a process which requires some thoughtfulness, just to ensure that you’re compliant with the rules and regulations that are in place in our country, generally speaking, with good reason. That is such that business concerns don’t necessarily drive medical decisions or outcomes.
We talked a little about this in prior conversations, to buy a healthcare company that actually is responsible for delivering care, a couple extra steps are involved. It’s not like, you know, a sales force going out and acquiring Realsoft, which just happened, or you negotiate a deal and you’re done, you can directly buy the company. Physicians and physician practices in this country are required to be owned by physicians, to be compliant with corporate practice of medicine. I’m not a lawyer, I’ll say that. I just play one on TV. A good transaction attorney can help you through all this, as well. But, in order for someone to directly invest in a private practice, there’s typically an interim step, whereby, we create a management service organization, or anther legal entity that that private equity group can invest in, that group does the administrative work and kind of back office work that physicians tend to loath, while the physician retains ownership of their business, and then signs an agreement to share revenue with the MSO, enabling the private equity group or other non-physician to invest in the brackets.
It’s a little more convoluted than a traditional sale. But, we found over the years, that it’s an effective way to get these deals done, appropriately align incentives, and really capitalize on the value proposition that we all believe in on these deals, which is, you free doctors up to focus on the delivery of high quality patient care, you hand-off some of the administrative tasks, and as you become a bigger organization, not only can you see more patients, make healthcare more accessible, hopefully, you make it more efficient and more cost effective for folks.
Patrick Stroth: Yeah. That’s something that, you know, you can only outsource so much of the admin work and the file keeping, and so forth. It’s the actually delivery of care, it’s impossible to outsource, but as you get larger groups, if groups come together, and organizations get bigger, there’s a lot more sharing, and it improves, like you said, the accessibility. That’s a real key point that is a big differentiator. The other thing we could get into a little later on, that you mentioned, is the regulatory burden is unavoidable in this sector. Now, my experience in the healthcare sector in the last 20 years is largely on the insurance side, doing the directors and the officers, and the regulatory, and cyber coverage, things like that. When I first got into the sector, I thought of two things. There were doctors and there were hospitals. That’s what every person sees on the street and everything. I didn’t realize that there’s this entire universe of other businesses like the MSOs that are established just to support, and facilitate, and supply the delivery of care.
Now, when we’ve spoken before, you have a real neat, clean way of dissecting that huge diverse universe into really simple to understand, I would say, buckets, for lack of a better word. Tell me about these buckets. What’s the differentiation between each, and then how are they exposed or not exposed or what are their big concerns facing an M&A transaction?
Patrick Krause: Yeah. I don’t think there’s a lot of original thought in this. This is how we at MHT have elected to kind of segment the healthcare universe.
Patrick Stroth: Oh, no. You take credit for it. You made a very user friendly way. So, go ahead and take credit for it.
Patrick Krause: Well, we have a fairly broad mandate in terms of where we like to play. That translates into four industries, sub-vertical. I’ll start with the first. It’s really been the cornerstone of our healthcare practice, and that’s specialty physician groups, whether it’s hospital-based specialties like anesthesiology, radiology, cardiology, or it’s more consumer-facing medical fields like dermatology, ophthalmology, dental, and physical therapy. We’ve seen a lot of activity in the space. I’ve done a number of deals in this space.
Key challenges there are, obviously, making sure that all the partners incentives are appropriately aligned, risk and compliance is appropriately addressed, and then making sure that you’re delivering high quality care. At the end of the day, as a physician, you’re only product is a satisfied customer, meaning, is a well patient or is a better patient, and really having that high touch, and focusing on people is important, and that drives the culture and the business. Making sure you get a group of physicians aligned with the same mindset is a big part of the battle.
But, certainly, an important part of healthcare system in this country, it’s the folks that are on the battle lines every day, taking good care of people. Gosh, it’s been a pretty exciting place to be an investor the last five or six years. I cannot think of a more active period of investment in that space in a long time.
The second industry vertical that we spend a lot of time on is post-acute care. It’s kind of a catchall for us. But what that means is, the treatment of folks outside of a hospital or clinical setting. It could be home health, it could be hospice, it could be behavioral health.
Patrick Stroth: Physical therapy too?
Patrick Krause: That’s more reliant on providers.
Patrick Stroth: Okay.
Patrick Krause: We tend to keep that in the first group, but point well taken. I suppose it could be in that bucket, as well. But, the element here, the interesting thing for investors has been a lot of the dynamic that we see in our country. For better or worse, we are a graying nation. Folks are getting older. Folks are needing to consume more healthcare services. A hospital is not always the best setting for that. It’s not your home. It’s expensive. It could be a risk of infection, just by being around people that are sick. Taking care of people in their home is a compassionate, cost effective way to deliver care. We see that as a pretty exciting area of growth in the coming years. It’s not without its challenges, as well. Reimbursements have stabilized over the past several years. But, a business that has yet to find a model where you can scale over larger regions, just because it’s so focused on the provision of care by a local population and skilled nurses, or physicians assistants to take care of people.
As you’re thinking about how to allocate risk, whether on a deal or after a deal has been identified, and you’re thinking about how to translate that allocation of risk into your purchase agreement, you need to make sure you’ve got a good handle on providers, credentialing, their past record, make sure that incentives are appropriately aligned, so that those providers stick around. Turn can be kind of a scary component in this industry.
Again, it all comes down to taking good care of the patients. I think culture is an important thing to look at when you’re evaluating any opportunity to doing a deal in this space, as well, it’s a good thing to take a look at. And, throwing a bone to Patrick, it’s one where insurance is your friend, and you have to make sure you have the right product in place, and risk appropriately identified, allocated, mitigated.
Patrick Stroth: Gotcha.
Patrick Krause: Last big bucket for us is technology driven products and services. That could be true healthcare IT point solutions or products geared towards serving commercial payers like revenue cycle management, billing, coding, scribing, things like that. Or, you could have a different risk profile. It’s more product driven and technology driven, so you want to make sure that there’s no infringement of IP, there’s kind of a uniqueness or a dependability to that technology. And, you want to make sure that you’ve got an exciting, addressable market to go after.
Last bucket, a smaller one, but one that’s important to us, as well, is other healthcare services. You’re familiar working in that space too. That could be pharma services, like CROs. It could be the delivery of goods and products to a hospital or a clinic, it could be some of those products themselves. It’s another area that we like. Again, just different risk profile in that it is not driven by people or providers per se, but by products and services. There a more traditional business risk profile exists around customer concentration, products, cost of acquiring or creating products, cost of selling products, all those good things.
But, it’s a broad mandate for us. It’s a great big world out there from a healthcare perspective. It continues to be an exciting place to play from and M&A perspective, from a strategy perspective. Gosh, we have a ways to go, but if we can take some of the other business principles from other industries and apply them to healthcare, hopefully, we can get better outcomes, make it more affordable, more accessible for everybody.
Patrick Stroth: Well, I think great item that you pointed out there, that a lot of people overlook, it’s more of a millennium-type of term is called culture. And, particularly in a post-acute care, where we’ve got nursing homes or assisted living facilities, and everybody can recall those terrible news stories about elder abuse and everything, and these disconnections within the system that doesn’t bring the care that should have been brought, a lot of that is cultural, and it’s just having that culture of wanting to deliver the best care, the best services, and stand behind it. You see the physicians are pressing that because it’s literally their name on the door or their name on the practice. As you get to these other things, I can’t tell you how you can possibly understate the importance in culture with the post-acute care because that’s where you’ve got behavioral health, you’ve got a lot of these other things that are the softer-type, longer term issues that you’ve got to keep that great sense of excellence. That’s great that you pointed that out with these.
As you look, because you’re dealing with the founders and owners, many of them are physicians, some of them aren’t, they’re in the medical tech area, what’s the difference, where some founders, they succeed in getting what they want out of their deal? They get it set up, they get what they want, and then their peers will struggle. Maybe you can differentiate it between a physician owned practices or physician owned companies and non-physician owned companies, but where’s the drop-off, where some struggle and others seem to get right to go, right to where they need to be?
Patrick Krause: Well, being ready, it’s kind of the biggest thing that you can do to be success in a transaction. I mean that in multiple ways. One, obviously, it’s important to have your house in order, to make sure that you’ve got processes documented, that you’ve got your financials cleaned up and on an accrual basis, if possible. But, I also mean, you need to be ready emotionally. In some instances, seek control of a business that you’ve built for 30 years. Be able to bring on a partner that is going to have thoughts on how you run your business, and be ready to let go on something that you’ve spent a career building. Some folks are ready to do that, others are less so. But, being able to really understand why you want to do a transaction, why it’s the right time, and being able to let go, so to speak, can help a lot.
A good advisor will be able to talk you through that. At the risk of seeming shamelessly self-serving, it’s very important to pick the right advisors to guide you through this process, accounting, financial, deal related. They’ll be a sounding board. They can help depersonalize a lot of the issues that come up on a transaction. Just like a good lawyer would not choose to represent themselves in a deal, a good advisor can kind of take you out of some of the more contentious conversations.
Patrick Stroth: I don’t want to interrupt you too much there, but I do want to really highlight this because I think it’s a real big point, of having somebody as a third party, intermediary there that can be diplomatic, can listen to the various players, and give honest feedback without being emotionally tied or defensive with the other sides, I think that’s a great role that experts like you play in this. This is a very emotional time, you may have different objectives on the seller’s side, and being able to negotiate within that selling team before going off to the buyer, I think is critical with what you do.
Patrick Krause: I couldn’t agree more. Just depersonalizing it, and knowing that somebody there’s to be your arms and legs will make all the difference in a transaction. There’s no secret to it. It’s hard work. Maybe that is the secret. It’s just like anything else, stay organized, be fair in your puts and your takes, and you’ll get through it. A lot of folks, it ends up being a great experience. It’s a chance for folks to realize some liquidity. It’s a chance for folks to effect a generational shift in their business, such that it survives beyond the first generation of the founders, or to find a partner to help grow and achieve the growth that you see for the business.
Patrick Stroth: I think another real big benefit of having someone like you involved is, for a lot of these, especially physicians, but a lot of these owner and founders, with some exceptions, this is their one deal. This is their one time. You’ve been involved in hundreds of these deals. I think, not only have you seen these processes work, you know who the real good buyers are, as opposed to the other buyers that may not have the best intentions in the world, and may make a perspective seller spin their wheels only to grind them down, where you’ve got others that they may not offer the best price outright, but they’re going to be a lot easier to deal with, and you know their buying habits.
Patrick Krause: That’s right. You make a great point there, Patrick. A good advisor, particularly one that focused on an industry, will have been down the road a few times with a few of the buyers that you’d be reaching out to in that process, give you insights into how to negotiate, what’s important to them. That in turn allows you to position a seller’s business to get the most of what’s important to you, the seller. A good banker or advisor will be able to help you do just that.
Another key consideration is whether you want to sell all of it, all your business, so to speak, or if you want to find a partner and continue to work with them to grow it. That can certainly influence your buyer choice, as well, whether you sell out entirely or you identify a partner to move forward with, can give you unique opportunities, different in several regards. But, I think the key point is a process, well-designed, will create options for you, such that you can evaluate buyers, you can match price points to roles going forward, such that you can get most of what you want. It might not be everything, but if you have a couple options to pick from, you can usually get what’s more important to you.
Patrick Stroth: Is there a particular size practice or metric for people that are listening that want to get ahold of you? What size practice or maybe value is an area that you fall in with your clients?
Patrick Krause: That’s a good question. I think there’s a degree or flexibility on our end in terms of the mandates that we take on, but I think if you were looking at averages for MHT Partners as a firm, we typically represent companies with around five million dollars in EBT, earnings before income, tax, and depreciation. That’s not to say that we wouldn’t work with bigger companies or smaller companies, just on average that’s where we tend to shake out. That’s more of a function of the lifecycle that the companies that we represent are in, right? They tend to be a little bit older and more established. The owners might be looking for an exit or a liquidity event and it just happens to be where they are. But, no hard and fast rules. The only real criteria for us is to work with great companies, niche market leaders in their states, and usually uniquely differentiated from their peers.
Patrick Stroth: The best way then for listeners then to decide whether MHT would be a fit for them is, they need to reach out to you directly. How can our listeners find you?
Patrick Krause: They can certainly find us on the internet, mhtpartners.com. You could always reach out to me directly. I’d welcome the conversation. You can call me in the office, that’s 415-446-9511 or email me at firstname.lastname@example.org. Would love to be helpful however I can be.
Patrick Stroth: Well, fantastic. Well, this is diverse, very technical, very specific type of area to get into. I’m sure a lot of people listening are going to have further questions for you. And so, I encourage everybody to reach out the Patrick. He’s going to be absolutely responsive and maybe there’s a fit, maybe not, but the thing is having a conversation with these experts, really enhances your chance of having a clean exit. I want to thank Patrick for helping us and sharing his knowledge with a very, very highly regulated technical industry that is enormous. We wish you all the best of luck, Patrick. Thanks again for joining us.
Patrick Krause: My pleasure.
In our conversation, Patrick Krause explains the unique balance healthcare companies must make between quality of care and profitability, as well how the healthcare sector is unique to any other business today.