The Private Equity Deal in Ophthalmology: A Generational Approach

A payout now—and perhaps another one later—is one reason physicians might consider a private equity sale. But those payouts take many forms, and it’s important to know what you’re getting. During the private equity bubble of the 1990s, many purchases were all stock (high risk), and when the bubble burst, both the investors and physician partners were left with little if any return on their investment.

Today, some private equity sales are all cash, some are a combination of cash and deferred payment (a note), and others also include stock. Deals vary widely, but PE firms will most often offer a significant percentage of the purchase price in cash, while the remainder will be some form of deferred payment. There is always going to be a piece of the purchase price held back, so “you have to go into this knowing [the amount of] capital you want,” says attorney Caroline Patterson, who spoke about private equity at AAO 2017.

The risk tolerance of the physician partners is also an issue, and you need to balance risk and return, notes Gary Markowitz, MD, another AAO presenter. All cash is no risk, while all stock is 100 percent risk and no liquidity, but also a higher potential for reward, he explains. Flippers tend to offer the largest proportion of stock, adds attorney Mark Abruzzo, who presented alongside Patterson. “To my knowledge everyone is offering a lot of cash,” he notes. “If you’re going to do this kind of deal, be very happy with the cash,” advises Patterson. “Consider any stock ‘cream’.”

As a physician stock holder, you should expect to see 3-5 times return on equity, according to Markowitz.

Cash and Compensation: What’s the Connection?

Don’t forget: there is interplay between the practice’s purchase price and physician compensation. Yes, you’ll get a chunk of cash upon sale, but your yearly compensation is reduced in return. For a senior partner nearing retirement, the cash they’d get at closing might well be more than what they would have received from their original buy/sell agreement. But for a younger physician, there’s more at stake and you need to consider the value of the payout versus potential future earnings.

Does the purchase price justify reduced compensation, and if so, at what point?  You’ll get money on the front end, but you’ll earn less in the years to follow, says Abruzzo. The break-even point in many PE deals is 10-14 years, he notes, and that timeframe is a much bigger deal for the younger physicians than for the older ones. On the other hand, there’s the time value of money. Is it better to take a big payout now and invest it? The loss in annual income could be replaced by the opportunity the transaction provides. Would you have invested your original compensation—the portion that would be reduced—or have simply spent it? The only way to answer these questions is to do your due diligence, including a thorough financial analysis of how the PE deal would impact each physician at the practice.

Private Equity: Is It an Age Thing?

A private equity deal won’t affect all physicians in a practice equally. PE is usually a great deal for older physicians. It gives them an exit strategy, allowing them to cash out on their investment in the practice. They could even continue to work part-time, at a reduced productivity. Physicians nearing retirement may also be less worried about the practice’s long-term prospects and more willing to give up operational control.

Reasons to Consider PE. Or Not.

• Eliminate practice debt.
• Access to services that the PE firm can provide.
• Management and resources
• Safe harbor:

But there are reasons to be wary of a private equity deal—especially for young ophthalmologists just now buying into practices. PE is often less popular with the younger shareholders of the practice, says Abruzzo. Because the reentrance of PE into ophthalmology is still in its infancy, “we don’t know how these deals are going to work out,” says Patterson. The “if” is bigger for younger physicians than for older ones. And when young shareholders speak up, you need to listen to them, says Abruzzo. Clauses like dissenter shareholder’s rights could kill a PE deal, he notes.

First, there’s the expectations. Younger physicians who have recently bought in to their practice were likely expecting long-term ownership. After the private equity deal, they’ll be minority shareholders, or even employees and that could require some mental gymnastics to get used to. There will also be reduced flexibility should they want to leave the practice due to the sale non-compete restrictions. There is usually a required length of employment for selling physicians—five-year terms are most common. However, the cash payout at closing could go a long way to assuage some of those concerns.

In contrast, associates who haven’t yet bought in won’t be receiving any payout, which could make a private equity deal a bit harder to swallow. They may balk at spending their prime career-building years growing a practice that they’ll never get to buy into. A PE investor is going to approach employed physicians and want them to stay on after the private equity deal, says Abruzzo, so they actually have more leverage than they think. Even so, Abruzzo doesn’t see the buy-and-flip model as one that will ultimately benefit most young shareholders, even though that’s the selling point flippers are making, he points out.