The Healthcare Breakdown No. 022 - Breaking down financial engineering and what it means in healthcare

Ben H.

Hatched by Ben H.

Sep 01, 2023

3 min read


The Healthcare Breakdown No. 022 - Breaking down financial engineering and what it means in healthcare

In the complex world of healthcare, where regulations, reimbursement issues, and the need for efficient care delivery collide, financial engineering has emerged as a strategic tool for private equity (PE) firms. These firms are increasingly targeting specialty clinics, and there are a few key reasons behind this trend.

Firstly, delivering care in today's highly regulated environment is no easy task. Specialty clinics face numerous challenges, from individual and population dynamics to figuring out how to get paid through value-based contracts. Reimbursement is a particularly sore point for these clinics, with CMS (Centers for Medicare and Medicaid Services) not paying doctors enough. This issue is further compounded by commercial plans that often do not care if a physician practice is out of network, leading to significant cuts in payments. For doctors, a PE buyout offers relief from these headaches, although new challenges are sure to arise.

One of the main goals for private equity firms in these acquisitions is to maximize EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for a future sale at a higher multiple. However, there is a legal hurdle that PE firms face when buying physician practices. They cannot directly employ the doctors, as doing so would violate Corporate Practice of Medicine laws. While hospitals often bypass this restriction, PE firms must find an alternative solution.

This is where the concept of a management service organization (MSO) comes into play. PE firms set up an MSO that has a master service agreement (MSA) with the acquired physician practice. The MSO then takes care of various operational aspects, while still allowing the doctors to retain control over how they practice medicine, to some extent. This arrangement allows for greater efficiency and streamlining of processes.

However, the real strategy lies in the consolidation of practices within the same specialty onto a single platform. By acquiring multiple practices and bringing them together, PE firms can achieve economies of scale and significantly increase their EBITDA. This, in turn, drives up the multiple for a potential future sale and provides the firm with greater leverage in all its contracts.

While the financial engineering aspect of PE buyouts in healthcare is intriguing, it is also important to explore other innovative companies that have emerged in this space. One such company is Kalderos, which initially focused on the 340B program but has since pivoted to create the world's first Drug Discount Management platform.

Kalderos aims to improve collaboration among drug discount stakeholders by providing better data, transparency, and trust. Their platform, known as Grappa, was launched as a prototype in July and enables covered entities to easily review claims. This innovative approach addresses the challenges faced by various participants in the drug discount ecosystem and offers a promising solution.

In conclusion, financial engineering plays a significant role in the healthcare industry, particularly in the realm of PE buyouts of specialty clinics. The goal is to maximize EBITDA and achieve a higher multiple for future sales. This strategy involves setting up an MSO to handle operational aspects while allowing doctors to retain control over their practice. Additionally, the consolidation of practices within the same specialty on a single platform provides economies of scale and increased leverage. Alongside this trend, innovative companies like Kalderos are revolutionizing the industry by creating platforms that improve collaboration and transparency among drug discount stakeholders.

Actionable Advice:

  • 1. For specialty clinics facing reimbursement challenges, consider exploring partnerships with PE firms to alleviate financial burdens and enhance operational efficiency.
  • 2. To navigate the complexities of financial engineering, seek legal and financial expertise to ensure compliance with regulations and optimize outcomes.
  • 3. Stay updated on emerging companies like Kalderos that offer innovative solutions in the healthcare space, as these advancements can potentially improve collaboration and transparency within the industry.

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