Constructing an ethical framework for strategic leaders in healthcare private equity
When the triple aim of private equity value creation converges with the triple aim of healthcare, who stands to benefit?
Despite the disruption of the COVID-19 pandemic, private equity healthcare deal volumes jumped above the record 2018 and 2019 levels. While overall deal value was down 17% from $80B in 2019, this number is considered robust given the pandemic’s impact on patient volume and provider margins. In the wake of the COVID-19 pandemic, we have a healthcare system in the U.S. that is financially fragile, with hospitals losing close to $120 billion in 2020. And in the starkest of juxtapositions, we have an overheated market for healthcare investing with the rise of the SPACs and multiple billion dollar liquidity events for virtual-first healthcare companies. Growing healthcare costs across the U.S. population paired with the financially enfeebled healthcare system create a perfect storm of opportunity for private equity.
In the coming years, I predict that we will continue to see strong growth in healthcare private equity. Weakened provider and practice networks will benefit from the capital and operational rigor offered by private equity firms. To invest and closely manage a company in the healthcare system is to have patient contact. The Hippocratic Oath serves as a moral compass for clinicians and those that directly come in contact with patients, but where does that leave investors? In the post-COVID era, the U.S. population has a more acute understanding of the structural gaps that exist in health access and how that impacts community spread. If private equity firms are going to be part of investing in the future of care delivery, their management teams and portfolio company boards should play a role in equitable access to high-quality care. There needs to be some convergence between the “triple aims” of healthcare and private equity.
In healthcare, the “triple aims” of improving the patient experience of care, improving the health of populations, and reducing the cost of care per capita are seen as guiding principles. Private equity’s equivalent to the “triple aim” are the three primary tools for value creation they offer: financial engineering, governance engineering, and operational engineering. Roughly $200 billion of annual healthcare spending in the U.S. is estimated to be waste, and about one third of total spend consists of administrative costs. Healthcare spend is also dominated by healthcare services (80% of total spend) versus medical devices and drugs. Given the salient spend, inefficiencies, and low barriers of entry to healthcare services, many private equity firms see healthcare services businesses as ideal targets for financial, governance, and operational engineering.
While I believe that private equity has the potential to be a driving force for care delivery innovation and access in a fragile and exorbitantly costly healthcare ecosystem, I think there are strong gaps between the goals of healthcare institutions and the goals of private equity investors. To remediate this gap, the triple aim of healthcare should be core to investors’ diligence efforts and scope of work after purchase. While many private equity firms will hire a medical doctor for expertise, the entire deal team should be well-versed in the healthcare industry and in the culture of medicine. Strategic leaders of private equity firms and private equity-owned healthcare companies should actively codify patient primacy over shareholder primacy in the realm of clinical decision-making and patient outcomes. But how?
I propose a framework for advancing the goals of equitable and affordable healthcare in private equity.
This set of questions and recommendations is meant to address the complexity of healthcare and the flawed mental models we often have about how healthcare works as business people rather than clinicians. An example of a flawed mental model is that more healthcare is always better. In a fee-for-service world, more healthcare might be more profitable, but the patient outcomes are more likely than not, suboptimal. The proposed ethical framework attempts to bucket the work of private equity firms into due diligence, their core turnaround efforts that involve financial and operational engineering, and the governance structures employed in their portfolio companies. By applying a healthcare impact screening assessment to due diligence, private equity firms can ensure that they are investing in care delivery companies that drive the triple aims of healthcare. The questions and recommendations for scope of work and governance are geared at ensuring that patient safety and outcomes are core to operational improvements and firm decision-making.
To provide an explicit instance of how this might work, we can evaluate the application of corporate governance procedures to protect patients. Corporate governance design can play a role in ensuring that private equity management does not sacrifice access, cost, or quality. Healthcare organizations should have a governance architecture that has the Chief Medical Officer reporting to the Chief Executive Officer and also independently to the Board of Directors. This structure can serve as an important counterbalance to the profit motive. Additionally, the structure should reinforce that clinical decisions must be made by officers that can knowledgeably balance business imperatives with clinical imperatives. Conscious leadership design is important as there is currently a trend whereby Chief Medical Officers report into Chief Financial Officers.
Strategic leaders of private equity firms and their healthcare portfolio companies are focused on making operational and capital structure improvements that enhance the financial attractiveness of a company in a 3 to 5 year period. Increasingly, the financial viability of healthcare firms is linked to their ability to adjust to the world of value-based care, which the triple aim of healthcare is designed to support. In applying the ethical framework proposed, strategic leaders can ensure that they are investing in and supporting companies that will successfully transition to value-based care and will support equitable and quality care for patients across the U.S.
