Navigating Private Equity in Healthcare

With Rachel V. Rose,  JD, MBA, Principal with Rachel V. Rose, Attorney at Law, PLLC

Private equity has become increasingly entrenched in the healthcare sector, offering various financing options for providers to consider. However, like all types of financing, private equity introduces its own unique set of benefits and drawbacks and carries important legal implications. It’s essential to understand all the factors at play in order to maximize financial impact and preserve operational efficiencies while avoiding sacrificing compliance and quality of care.

Tune in to hear Grace Walsh in conversation with Rachel Rose, JD, MBA, to explore this timely topic. In addition to providing a detailed overview of private equity in healthcare and its various pros and cons, Rachel shares valuable updates on enforcement actions by the U.S. Department of Justice and Congressional inquiries.

Episode transcript available below.

Grace: Hi, Rachel. It’s great to have you back on the show. Thank you so much for joining me today to talk about this timely topic.

Rachel: Hi, Grace, thank you for having me. As always, it’s my pleasure to be a guest for First Healthcare Compliance and to talk about fun healthcare topics.

Grace: Wonderful. So today, we’re talking about private equity. And so, just to get us started, can you give us some background on private equity? Are there different categories of private equity? And if so, what are the differences between them?

Rachel: That’s a great question, Grace. And first, as we delve into our conversation today, I want the listeners to think about healthcare being different than other industries. And the reason is we cannot treat patients the way we can, for example, potato chips or a car. And those are factors that come into play when an entity that is looking to startup, or that is looking to be acquired, starts to ask some very critical due diligence questions of a private equity firm, or a private equity fund.

So, getting to the heart of your question. Although there are different definitions of private equity, basically, it’s an entire asset class of investments that are not quoted on our public stock markets. Now, a private equity fund may be quoted on a publicly traded market, and some examples of firms and funds that are publicly traded are Blackstone, KKR, Carlyle, and Apollo Group. But again, this depends on the phases of capital.

So, I want our listeners to think of private equity as a continuum, and venture capital, which includes angel investing, focuses really on one end of the spectrum, and that is early stage investments, including those that show a promising business model, a promising idea, even or competent leadership through an executive team with experience. Usually, they have a board or an advisory board set up with them, and in exchange for the money for the investment, oftentimes, investors at this stage want a seat at the table in one way or another.

The next phase is what’s known as growth capital. Although it’s similar to venture capital, these companies are already profitable and are really seeking additional capital to continue to fuel growth. Now, continuing to fuel growth is very different than saying at the outset in your business plan that I only need this amount of money to be invested to achieve my objectives. That’s where a lot of startups get into trouble because they didn’t ask for enough money upfront.

You’re always better off asking for more money rather than constantly going to the well. And also making sure that you’ve budgeted and explained to the investors that I’m asking for this amount because these are some unknowns: I don’t know what inflation is. I don’t know if there could be an adverse impact as a result of an election, of a pandemic, of a natural disaster, of a cyber-attack. All of those items are prudent to list as reasons why you need this much capital as well as hard costs that can be established.

So, from this growth capital phase, we really get into the stereotypical private equity phase, and that is making a controlling investment, right? So, having a majority investment in a company, which may or may not be distressed. Now, whenever we hear the term distressed or underperforming, that creates an opportunity for any person, including private equity, to maximize their returns or their Delta from what they paid to what they want to achieve as a return.

Now, private equity firms can do this in various ways. Sometimes they just buy the company outright. Other times, a private equity company or firm takes out a significant amount of debt, often using underlying capital as collateral, and, in turn, the debt is paid via future cash flow from the target company.

There are also different debt equity options, including bonds, and that’s basically in investment, in a security. Typically, people pay per bond, what’s known as a par value for ease. A lot of par values are set at $100 or $1,000 dollars, and in exchange for loaning that money, the investor receives what are known as bond coupon payments over the life of the bond, when, at the end, the bond issuer returns the investor’s initial investment. So, it’s basically incremental interest payments, if you will, known as coupon payments, and then at the end, the bond issuer returns the investor’s money.

For those who are not financially savvy, so to speak—and truthfully, before I obtained my MBA, I was history in pre-med undergrad, I worked in the government, and I worked in pharmaceutical and medical device sales, so I knew when the war of 1812 was, I knew my ilium from my ileum—but once you start learning about finance, my reference was for bonds, always, municipal bonds or government bonds. And there are a lot of privately issued bonds as well. It’s not just a government, including a municipal government that can, in fact, issue those. Additionally, there is something known as a convertible bond, and that is a fixed income debt, security that pays interests, but upon a certain triggering event, can also be converted into either a common stock or a particular type of equity shares.

And given the investment interests in healthcare by private equity funds, I believe in 2021 private equity invested more than 206 billion dollars in US healthcare. This is an area of investment that is not going away, but also should be tempered, both on the PE (private equity) side and by the entities that are being acquired.

Grace, did that answer your question?

Grace: Yes, thank you for that explanation. That’s really fascinating.

You mentioned looking at private equity as a continuum, which kind of leads into my next question, which is: What would you say are some of the pros and cons of utilizing private equity at the various phases of a company’s life cycle?

Rachel: That’s a great question. And the answer—I’ll give you my lawyer answer here—is it depends. And I say that because a company may be well-funded initially by the owners, for example. And they might not need startup costs at that phase. So, if you and your partner, for example—and I’ll just step back for a second. If you are starting a company, make sure that it’s not a handshake deal. Make sure that even if it is your best friend, that you have all of the legal documents, the operating agreement, what happens in the event of a divorce? It’s always safer to have not only a pre-nup upfront, but also, it is something that if you do seek investors down the line, they will appreciate that all of these potential issues have already been addressed in what should be a very unemotional manner, because it’s just business and you’re just memorializing the terms in a contract with both of you represented by separate legal counsel. And that, in turn, leads to a more well-presented package to potential investors.

So, before you even consider whether or not you need money along the different continuum that I just went into, you really want to make sure that you have all of your documents secure, and your exit strategy, including your pre-nup. No handshake deals on that front. It really makes things smoother, again, down the entire lifespan of the corporation. So, if you accept money early on, you’re going to be giving up typically a significant amount of ownership interests.

For those of you who have watched Shark Tank, that is an example of that and Shark Tank sometimes is the angel investor, the idea stage, sometimes it said venture capital stage, which is early stage, where the company’s getting started, but it really needs more guidance and cash in flux, but then it also invests in that growth capital stage. Which is really the middle stage.

So again, you don’t want to over-ask for an obscene amount of money, but you want to make sure that you’re not going back to your investors and asking for additional funds when that could have been accounted for in a breakdown of contingencies: the unknowns, the rate of inflation, disruptions in production because of a cybersecurity incident. Whatever it is, you need to ask what their plans are with the company, especially at the growth phase and that last phase, the stereotypical private equity phase where the firm or a fund comes in to buy out the company, whether through a leveraged buyout, which we just went into, or by paying cash out front, because that’s where you’re really going to give up pretty much all of your control. You may retain some ownership that’s very common, including in healthcare and in practices, but just know what the downstream implications are and make sure that whatever part in the process you’re in, if you are a target for a private equity fund or investors want to invest in your company, make sure a) you’re not giving up more than you have to and b) that you have contingencies in your contracts with the PE entities or funds as to what happens to your share percentage if they sell again, what does that mean? Is there any impact on physicians, for example, in their personal agreements with non-compete?

All of those are items you want to be thinking about at any stage of a private equity continuum.

Grace: I see. Thank you. I’d love to switch for a moment to more of an oversight perspective. As private equity is becoming increasingly prominent in healthcare, have the US Department of Health and Human Services (HHS), Congress, and the Federal Trade Commission placed greater scrutiny on the use of private equity in healthcare and the healthcare sector, and, if so, why are we seeing this trend?

Rachel: Great. That is not only a great question; it’s very important for your audience as a whole. So, let’s step back and focus on the HHS Office of Inspector General (OIG) first.

In November of 2023, they published their annual or quasi-annual compliance guidance. And really, this is a great guiderail, because any person who is in the healthcare industry, or looking to invest in the healthcare industry, can look at this document and say, what areas of enforcement are the government looking at, and how does that impact my due diligence? How does it impact my potential rate of return? Are there additional investments that need to be made? All of these items that should be closely evaluated. And the 2023 guidance was no exception. Basically, it highlighted not only the growing prominence of private equity and other forms of investment, but it also honed in on raising concerns about the impact of ownership incentives, such as the return on investment on the delivery of high quality, efficient healthcare.

And the HHS OIG specifically stated that healthcare entities, including their investors and governing bodies, should carefully scrutinize their operations and incentive structures to ensure compliance with the federal fraud and abuse laws and that they are delivering high-quality, safe care for patients.

And that’s something that really cannot be emphasized enough. Both the Fraud, Waste and Abuse laws, but most importantly, the continuing concern for patients’ care. Because if there’s anything the government homes in on, it will be adverse patient outcomes and deaths, for that matter. So, related to the Federal Trade Commission, I’m going to now pull together recent statements that the Federal Trade Commission, the Department of Justice, and the Department of Health and Human Services launch a cross government inquiry on the impact of corporate greed in healthcare. And really that was a press release that came out in the beginning of March of 2024. So, there’s nothing really new or anything that is really being hidden by the government. They’re telling you. And they’re telling you that it could come from any or all of these potential entities, government entities.

And so, the key areas that they’re focused on are the increasing involvement, the maximization of profit at the expense of quality care, and anti-competitive effect. So, increasing consolidation in order to generate the often touted 20% to 30% return in private equity funds to their own investors at the expense of patients’ health and outcomes, as well as worker safety, quality of care, and affordable healthcare for patients and taxpayers is absolutely not going away.

To that point, we have some recent case law, including the Federal Trade Commission v. U.S. Anesthesia Partners, Inc., and this case was filed in the Southern District of Texas in September of 2023. It’s case number 4:23-cv-03560. And in essence, what the FTC did was to focus on anti-competitive behavior involving a scheme to consolidate anesthesia practices in Texas, drive up the price of anesthesia services provided to Texas patients, and increase their own profits. In turn, providers, whether it was an ambulatory surgery center or hospitals, really didn’t have any other option of going to another anesthesia group because Anesthesia Partners had bought them all up. So that’s where a lot of these issues stem from, so that’s an area to highlight.

Another area to highlight is the Department of Justice and the utilization of the False Claims Act. Not only in relation to the traditional Fraud, Waste and Abuse laws such as the Stark Law and the Federal Anti-Kickback Statute, but also the area of causing to be submitted a false and fraudulent claim. And that’s where, in the example of the United States ex rel. Medrano and Lopez v. Diabetic Care case. This is a case which was filed in the Southern District of Florida. What’s important here is that the settlement involved not only the compounding pharmacy and the Chief Executive Officer; it also involved a private equity firm that colluded to generate referrals of prescriptions for an excessively expensive pain cream, scar cream, and vitamins regardless of the patient need, which were in turn reimbursed by TRICARE, which is the federal health care program for military members and their families, for a total of 21.36 million dollars was the amount of the settlement.

Finally, another example of how the DOJ has named, and I should say, the whistleblower attorneys have named private equity firms. It comes down to ownership and control. If the Government or a relator’s council cannot show ownership and control (you need both), then the private equity company’s likelihood of being dismissed from the case is potentially greater.

I will add the caveat that there is a provision in the False Claims Act for a co-conspirator, and that’s found at 31 U.S.C. § 3729(a)(1)(C). So, their co-conspiracy doesn’t necessarily dovetail with the private equity, ownership and control. So, they still may be named and survive staying in the case as a defendant. But what’s unique about a case that was filed in the Central District of California, United States v. Insys Therapeutics, was that the district court denied the private equity company’s motion to dismiss, and expressly stated that the company could be found liable through its portfolio company, a specialty pharmacy, because the mere use of separate business entities, and the notion that the private equity company itself did not submit the claims, was not persuasive. So, all of those factors are areas to hone in on.

Finally, Congress, and specifically, Senator Warren from Massachusetts and some others, have issued requests to various private equity companies in relation to a specific healthcare system and its private equity firms, because there are a lot of hospitals that are closing, there have been a lot of adverse patient outcomes, and a lot of patient deaths as well. In turn, the private equity company maximized its profits and sold out the real estate and other assets from underneath the hospitals.

So, again, you need to be very conscious of the practices, and if you’re looking to be acquired, or have a majority ownership interest, in particular by a private equity firm, just absolutely make sure that you’re doing your due diligence in asking the questions regarding the adverse impact on patient care. What’s going to be happening with the monies, what is the anticipated rate of return, and is that reasonable in light of legal patient care obligations?

Is that helpful, Grace?

Grace: Yes, very much so. That’s really interesting, particularly the example you brought up that shows that private equity firms may indeed be held liable under the False Claims Act. And the scrutiny on the impact of quality and accessibility of patient care, it seems like an especially important component of private equity in healthcare and the trends that we’re seeing.

Rachel: Absolutely.

Grace: So, I’d love to kind of finish up with the question: What compliance and due diligence suggestions do you have for healthcare providers and facilities considering private equity?

Rachel: That’s an excellent question, Grace. And if I can distill it down into three compliance considerations, first, I would say look at the HHS OIG compliance guidance and use that as a roadmap, because those parameters will give you a good guide as to how your organization needs to comply. From there, and how that translates into due diligence, normally, when I’ve been involved in mergers and acquisitions or I’ve helped startup companies, we have a checklist. And so, helping to create a checklist and questions and answers for due diligence is very important. And some of what we discussed here today, Grace should be included.

And I would specifically, if I could pick three questions under due diligence, I would specifically look at, first and foremost, what cost cutting measures are you proposing? Secondly, how is the anticipated rate of return going to impact, potentially adversely, patient care? And lastly, why do you want to take these steps in order to make our operations more efficient? And those three questions will give an entity a good roadmap there.

Lastly, in terms of compliance, I would suggest looking at what compliance guidance looks like from the Department of Justice. And the reason I say that is, if you are on the defense side of a False Claims Act case, you have the framework as to what the DOJ will consider constitutes an adequate compliance program.

And then, as really, the bow on what I just outlined, I would absolutely keep a pulse on what government agencies are issuing in terms of press releases, in terms of guidance, I would look at what Congress is doing. Take a look, and do a search on congressional hearings and private equity in healthcare. And that will keep you abreast of the areas of potential changes in regulation.

It can also help you, as the acquiring company, sidestep legal land mines, as well as the entity that is being acquired, ask more prudent questions.

Grace: Thank you, Rachel. This has been incredibly insightful, and I appreciate you taking the time to speak on this important topic.

Rachel: Thank you Grace. And if you don’t have any more questions for me, again, it was my pleasure being here with you today and I appreciate your questions and raising awareness on this issue.

Grace: Likewise. And to our listeners, thank you for tuning into 1st Talk Compliance. I hope you learned something new to take with you. If you have any questions about anything you heard today, we’d love to hear from you. You can get in touch by emailing us at or by visiting the First Healthcare Compliance website. Until next time, take care and stay informed.