Why we should be wary of private equity’s presence in healthcare
September 27, 2024
Business Affairs
By Mary Bugbee
Healthcare has historically been one of private equity’s preferred industries for investment. Many consider it “recession-resistant” because there is permanent demand for healthcare services, amplified by an aging population with a chronic disease burden. And many subsectors within healthcare are fragmented and ripe for consolidation, which is a favored quality of private equity investment targets. Private equity has invested over $1 trillion in the US health sector over the last decade.
But what exactly is private equity? Private equity is a type of investment class that buys private companies by pooling investors’ capital together, often in conjunction with substantial debt, in order to restructure them and sell them for a profit four to seven years down the road. Private equity-owned companies depart from other types of for-profit healthcare ownership in three key ways:
1. Lack of transparency: Private equity-owned companies are less regulated than publicly traded companies. They do not need to make the same disclosures to the Securities and Exchange Commission (SEC) or to their investors. As such, critical financial information about private equity investments often remains in the shadows.
2. Use of debt: Private equity investment strategies involve using much more debt than is typical in other types of investments. Firms use debt to buy companies in leveraged buyouts, and the company – not the private equity firm and its investors – will be on the hook for the debt. Portfolio companies can also be directed by their PE owners to take on more debt during the ownership period in order to finance add-on acquisitions or pay dividends to investors.
3. The moral hazard of limited liability: A private equity firm can generate returns on an investment even if the company ends up in financial distress or bankruptcy. This is because private equity firms are not liable for the debt secured by their portfolio companies, and so they cannot lose more money than the amount they invested, which is often not much. In other words, private equity firms take on little risk but get to make outsized returns.
Private equity’s reliance on high debt leaves companies more vulnerable to changing market conditions, including high interest rates and rising labor costs.
Healthcare has historically been one of private equity’s preferred industries for investment. Many consider it “recession-resistant” because there is permanent demand for healthcare services, amplified by an aging population with a chronic disease burden. And many subsectors within healthcare are fragmented and ripe for consolidation, which is a favored quality of private equity investment targets. Private equity has invested over $1 trillion in the US health sector over the last decade.
But what exactly is private equity? Private equity is a type of investment class that buys private companies by pooling investors’ capital together, often in conjunction with substantial debt, in order to restructure them and sell them for a profit four to seven years down the road. Private equity-owned companies depart from other types of for-profit healthcare ownership in three key ways:
1. Lack of transparency: Private equity-owned companies are less regulated than publicly traded companies. They do not need to make the same disclosures to the Securities and Exchange Commission (SEC) or to their investors. As such, critical financial information about private equity investments often remains in the shadows.
2. Use of debt: Private equity investment strategies involve using much more debt than is typical in other types of investments. Firms use debt to buy companies in leveraged buyouts, and the company – not the private equity firm and its investors – will be on the hook for the debt. Portfolio companies can also be directed by their PE owners to take on more debt during the ownership period in order to finance add-on acquisitions or pay dividends to investors.
3. The moral hazard of limited liability: A private equity firm can generate returns on an investment even if the company ends up in financial distress or bankruptcy. This is because private equity firms are not liable for the debt secured by their portfolio companies, and so they cannot lose more money than the amount they invested, which is often not much. In other words, private equity firms take on little risk but get to make outsized returns.
Private equity’s reliance on high debt leaves companies more vulnerable to changing market conditions, including high interest rates and rising labor costs.
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