HLTH22: Private equity rebuffs critics, says it brings rigor, scale and necessary change to healthcare

LAS VEGAS—With its focus on profitable exits and increasing presence on the boards of startups and provider organizations alike, it’s little surprise that private equity’s role in healthcare is facing scrutiny.

Policy researchers, nonprofit watchdogs and healthcare industry groups have alleged that PE investments can be tied to strategic decisions that ultimately harm patients or the industry, whether by limiting clinician staffing, price gouging or reducing necessary services in favor of higher margin offerings.

To some extent their cries are being answered by the Biden administration.

Health and Human Services recently released ownership data on roughly 15,000 Medicare-certified nursing homes in a bid to increase transparency and accountability for PE owners trading quality for profits. Alongside a push against corporate consolidation, both the Department of Justice and the Federal Trade Commission have promised to tighten their oversight of PE deals in healthcare.

Despite the negative attention, a panel of PE representatives speaking this week at the HLTH 2022 conference argued that big-money investors are necessary to help scale promising companies and bring tighter rigor to those that need it.

But healthcare is no simple beast and, more so than other industries, can have severe stakes when organizations fall down on the job, Adaeze Enekwechi, operating partner at Welsh, Carson, Anderson & Stowe and formerly the head of health programs for the Obama administration’s Office of Management and Budget, said at HLTH.

While failures can and do occur among PE-backed or PE-owned companies, repeated cases of negligence or "Gordon Gekko-like" focus on stripping businesses for immediate profit are quickly brought to light and, if repeated, would spell the end of any firm of “solid reputation,” she said.

“With the harsh spotlight on PE, any instance of [failure] tends to get magnified,” Enekwechi said. “That’s not to say there are some bad actors, if you will, on the investment side. I think we need to own that.

“However, we’re not sitting in our respective roles looking for businesses we can tear apart,” she continued. “A lot of that, I think, is coming from people who don’t really have a deep understanding of the motivations, the incentives, how we think about assets [during] identification and ultimately an investment.”

Even prior to investing, PE firms need to win over limited partners (LPs) such as public pensions or endowments to back their funds, the panelists explained. These groups expect PE firms and fund managers to be able to explain their vetting and investment strategies upfront, meaning that establishing demonstrable structures of operating responsibility has become “table stakes” for PE firms of scale and renown, said Chris McFadden, managing director of the healthcare finance practice at Kohlberg Kravis Roberts.

More recent years have seen LPs turn up the heat with their expectations regarding social issues and responsibilities, the panelists said. The result has been an increased focus from both sides on ESG (environmental, social and governance) goals, which Ron Williams, operating advisor at Clayton, Dubilier & Rice and the former president, CEO and chairman of Aetna, said often dominate his conversations with LPs.

“Tomorrow, I have a meeting with potential LPs,” Williams said. “They all want to talk to me about things like the culture that we create in the portfolio companies, the kind of time I spend coaching and mentoring the CEO and the senior management team. Or, how do we make decisions that we have the right CEO, and what is the criteria, is it performance based or is it arbitrary? LPs really want to know that—given that other people have given them half a billion [dollars]—that they’re placing that capital with people that they think have good values and are focused on really creating long-term sustainable growth.”

McFadden cited recent Bain & Company data indicating that 75% of all surveyed LPs have embedded formal ESG criteria in how they select managers for new commitments. Half of those LPs said they believed doing so also increased the monetary performance of their investments, per the data, while 93% said they would walk away from a fund investment opportunity if it posed any ESG concerns.

The speakers did acknowledge a “heterogeneity” across PE firms’ ESG platforms, investment goals, structures and other internal priorities. While each insisted their firms and those of other major players promote ESG values and growth among their portfolio companies, McFadden advised those doing business or looking to join a firm “to look really carefully [at] what they do, how they do it, who leads it, who stays, who goes in—get some sense of what the organizational ethos is.”

“We’ve got to strike the right balance”

Beyond the discussion of PE’s investment philosophies, the panelists also came ready to defend the “scary” organizational changes that come with a change in ownership—in some cases, cuts and layoffs.

When the goal is to expand a company from, say, $500 million to $1.5 billion, “it’s foolish to think that you can basically retain 100% of what you have when you make an investment and expect to see a completely new set of results,” Enekwechi said.

It’s common that a founder or other leader had the skills to lift a company to its current size but doesn’t have the right experience “for the next iteration,” in which case a change to new leadership “is not a bad thing” for the broader organization, she said. Other decisions around cutting an inefficient team or an unfocused portion of the business can also come with new leadership but are hardly superfluous, she noted.

“Some of what you have will need to stay, absolutely,” Enekwechi said. “We don’t think of it as ‘this will be my company … and everyone has to go.’ … But you have to be a truth-teller to yourself in case you don’t have Bain or McKinsey money. You have to at least be able to look at your farm and understand where should we make resource allocation decisions, again, that is consistent with our value maximization plan.”  

The other panelists similarly described organizational changes as a necessary evil but highlighted the role of a responsible PE firm to shepherd any upheavals appropriately and with dignity for those affected.

“None of us like change. I don’t like to change. But the market tells you ‘change, or else’—and the ‘or else’ isn’t always pleasant,” Williams said. “The leader has to make the difficult decision to execute that choice in the most humane way possible, to say to people ‘Look, it doesn’t make you a bad human being, but this isn’t a good fit for you and we’re going to find a way to help you get on with your life while replacing you with someone who is a better fit.”

“I agree with Ron fully, humanity is always critical to that,” McFadden said. “It speaks to how we want to approach all of our responsibilities—but we also have a responsibility to those who provide us capital to return on that capital. We’ve got to strike the right balance, that goes with the job.”