Making the Leap to Private Equity

Of recent trends in retina, the entry of private equity (PE) investment is perhaps the most impactful, generating intense interest among retina practices and angst among young retina specialists and fellows. PE firms use capital raised from investors to buy companies, with the goal of eventually selling those companies for a profit.

Make no mistake, the goal of the PE firm is to make money. However, the perception that PE firms routinely make decisions that are detrimental to practices to maximize profits is not so. Such actions would be antithetical to the profit motive. Profits are best generated by working constructively with the company’s management to improve operations. Such an approach is currently the rule, not the exception and is in the best interest of all stakeholders.

Our group in Minnesota, VitreoRetinal Surgery (VRS), completed a transaction with a PE firm in September 2020. We had declined previous opportunities to partner with PE but unanimously agreed to join Retina Consultants of America (RCA), a PE-backed national horizontal aggregation of retina practices. Horizontal, in this context, refers to the all-retina nature of the consortium, as opposed to the more typical vertical grouping of optometry, general ophthalmology, and subspecialties.

We chose this path because we believe that RCA will become an impactful organization of retina specialists, with initiatives that will benefit members in terms of education, patient care, clinical research, contract negotiations, operations, finances, and practice growth. We believe that this national organization including more than 100 retina specialists will lead to greater future success for our practices and for each of us individually.

Negative perceptions of PE include the potential for:

• loss of clinical and personal autonomy,
• adverse effects on quality of care,
• constraints on future personal income, and
• the uncertainty of future transactions.

My partners and I at VRS share these concerns, but we found comfort and optimism as we researched the opportunity with RCA. I have no insights about other PE-backed platforms, but let me explain why my partners and I chose to align with RCA.

AUTONOMY

Most retina specialists, particularly those in private practice, value and jealously guard their autonomy. With RCA, the principals at the PE firm understand that they are engaging with retina practices that are successful because of the characteristics of the physicians and that interfering with their autonomy would be counterproductive and harmful to the value of the investment.

Thus, personal and clinical autonomy are enshrined in our legal agreements, and so far no one from RCA or the PE firm has joined our offices; in fact, we continue to operate as we did prior to the transaction.

A carefully constructed legal agreement is critical for any retina group considering a partnership with PE. You must negotiate detailed protections into the contract to safeguard important aspects of your personal and practice autonomy. VRS has control over schedules, personnel, hiring, and growth decisions. Costly decisions warrant justification and discussion, but there are no barriers if we are operating consistent with past business practice; plus, new initiatives are good for VRS.

QUALITY OF CARE

Commitment to high-quality patient care is a measure of the character of each physician, with or without a PE partnership, and this remains a priority for VRS physicians, partner physicians at other RCA practices, and our PE partner. Our success depends on our service to patients and referring doctors. A decline in the quality of care would be bad for our patients, reputations, practices, business, and the PE investment.

At VRS, in our first few months under RCA, we have not seen a decline in our commitment to quality, nor do we anticipate one.

FINANCIAL CONSIDERATIONS

A practice must have financial characteristics that are both acceptable to a PE firm and sufficient to structure a deal that provides attractive upfront and ongoing compensation to the physicians. The basic structure of a PE merger is to calculate the practice’s earnings before interest, taxes, depreciation, and amortization (EBITDA) and then to sell a portion of that EBITDA to the PE firm at a market multiple. The residual EBITDA is retained by the physicians as initial compensation.

Ongoing physician compensation can still grow as practice profitability increases over time, which is a major goal. This structure necessarily results in a decrease in initial annual income after the deal, which for us was more than offset by the upfront financial consideration (including cash and equity).

This trade-off may be perceived differently by early-, mid-, and late-career physicians and especially by retina fellows considering job placement options. The simplistic—and incorrect—interpretation is that seasoned physicians are getting their money upfront and will retire soon, leaving the younger physicians in the practice to deal with the aftermath of the PE deal, saddling them with lower annual incomes in the future. However, this ignores important factors, including the time value of money, the characteristics of an organization such as RCA, and the increasing risk to traditional private retina practice.

Because of the effects of compounding interest, young physician partners who invest their transaction proceeds wisely have an opportunity to be financially wealthier than their more seasoned physician partners when they approach the same age. With smart investment over the long term, given the average equity market return over the last 100 years, one can expect assets to double every 10 years, ad infinitum. Investors must maintain a long-term perspective, as returns over 1 year, or even 10, are highly unpredictable. However, over 10- to 20-year rolling periods, equity market returns have historically been very good.

Older physicians’ financial wealth has typically been painstakingly accumulated over a long period of time. They don’t have the same amount of time for their PE transaction proceeds to compound as do their younger partners.

Nonpartner physicians are in a different position. They don’t own equity in the practice, but they also haven’t spent decades investing in the practice. However, they can negotiate favorable considerations that can place them in a beneficial financial position, and, again, they can take advantage of the time value of money.

Future physician hires in RCA practices will generally start at higher incomes and will become full partners in their RCA-affiliated practices sooner than those who are hired at non-RCA practices. They will also benefit from the economies of scale and the greater career stability we expect RCA to provide.

Finally, all physicians in a practice (both current and future) can have equity in the PE-backed entity, which has the potential to be quite valuable over time and has the possibility to make up for, or exceed, whatever speculative future income is forgone.

CHANGE IS IN THE AIR

Some of the risks and benefits associated with partnering with PE are based on whether and how much the practice of retina will change over the next 30 years. Unfortunately, the future is not likely to be as favorable for the field of retina as the past. Significant and unfavorable changes in practice, and especially in reimbursement structures, are likely.

Retina has been lucky, but over the past 20 years we have seen one high-powered medical specialty after another brought to heel by a changing health care system. For example, in our region of Minnesota there are few independent physicians in specialties other than ophthalmology and cosmetic surgery; most are employed by large health care systems. Perhaps retina can avoid this fate for a while, but at some point trends against independent retina practices are likely to become overwhelming.

For me, the horizontal nature of RCA, as a pure aggregation of retina specialists, gives us an edge over vertical aggregations that include optometry, ophthalmology, and subspecialties. My personal interests are more closely aligned with fellow retina specialists than they are with a more diverse collection of eye care providers. I am confident that our uniform, committed, and cohesive group of physicians will be able to preserve and protect our prerogatives and our success in future relationships.

After long days at professional conferences in years past, I remember talking over dinner and drinks with my friends and colleagues from around the country, each of us extolling the attributes of our independent, successful retina practices. It occurred to many of us then that if we could combine into a national retina “supergroup” we would be able to respond more effectively to the growing challenges that face all of us. During those times, we couldn’t conceive of a mechanism or structure to accomplish that goal, and we all went home to our individual silos.

Now, RCA has provided us with an opportunity to create some form of that retina supergroup. I am proud to be a part of this new concept, and I’m incredibly optimistic about my own future and the future of all of my colleagues around the country who choose to join us.