Private Equity Funds + Hospitals = Joint Venture Opportunities

March 18, 2021

Joint venture relationships between private equity funds and hospitals present great opportunities for successful expansion for both parties. These relationships develop out of the distinct but complementary business objectives of private equity funds and hospital systems. While certain risks are attendant to the joint ventures, a number of business lines and strategic models have developed as ripe for joint venture investment.

What is the hospital seeking from the joint venture relationship?

  1. Readily available cash. Hospitals can benefit from the capital availability a private equity firm can provide. Hospitals often have access to larger facility-based capital (often supported by bond sales), but have less access to operational expansion capital.
  2. Expertise. Private equity funds can provide specialized knowledge and business and management resources that are beneficial to the success of a joint venture. A joint venture (particularly one the private equity fund invests in repeatedly), can benefit substantially from a fund’s existing management and administrative resources.
  3. Retaining patients within the hospital orbit. One risk for a health system is when the patient enters a different, unaffiliated point of service (e.g., an immediate care center) where the patient could be referred to specialists or care outside the hospital system. Through a joint venture, the hospital could expand into venues of care it otherwise would have difficulty accessing effectively or quickly.
  4. Speed and ability to be nimble. Left to its own, more deliberate and bureaucratic process, a health system might be unable to quickly enter a market, even to fulfill an immediate business need. A private equity fund works with speed and efficiency, making it the natural partner for a hospital looking to expand its service offerings.
  5. Defense of territory. Whether or not a hospital partner is available, private equity funds often plan to enter the market anyway. The fund can do so on its own or with another, more competitive partner. The hospital can choose to allow the fund to enter the market without it and usurp hospital business, or it can consider a joint venture and take part in the business opportunity. Hospitals also may use a joint venture relationship to defend territory (or deploy into new territories) faster than a competing health system,

What is the private equity fund seeking from the joint venture relationship?

  1. Branding. Hospitals have established recognized and trusted brands that attract patients. Private equity funds can leverage this established branding to enter a market under a hospital flag and take advantage of the hospital’s goodwill to increase patient growth and accelerate return on investment.
  2. Ready-made referral source. Hospitals are a reliable and voluminous source of referrals with access to patients on a scale that a private equity fund could not achieve alone. By partnering with a hospital, a private equity fund can tap into this patient base at the commencement of the joint venture and continue to utilize this referral source throughout the life of the joint venture.
  3. Leverage in payor contracting. The large size of a hospital system also means the system has significant leverage in payor contracting, something private equity funds may lack. Hospitals are in a strong negotiating position because of their sheer size and because of increased reimbursement rates given to hospitals, as compared to other providers, simply due to the status of being a hospital. Preferred reimbursement rates make joint ventures with hospitals an attractive investment opportunity to private equity funds.
  4. Single, larger splash in a market. A single joint venture with a large hospital system can make a significantly larger impact than a number of small acquisitions could achieve. Traditionally, private equity funds enter markets through a series of add-on acquisitions aimed at growing an organization that can benefit from efficiencies of scale. Partnering with a hospital allows a fund to make a much bigger impact through a single investment.

What risks are inherent in partnerships between private equity funds and hospital systems?

  1. Referral risk. Referrals between the hospital and joint venture must be evaluated and monitored for regulatory compliance.
  2. Loss of preferential payor contracting. While the goal is to take advantage of a hospital’s leverage in payor contracting, there is risk that the hospital’s minority position in a joint venture would result in a loss of preferential reimbursement rates a hospital can obtain in areas such as urgent care.
  3. Barriers to entry. Startup costs for a hospital and private equity joint venture are high, and executing on such a joint venture takes much longer than a traditional private equity acquisition. There is also a risk that the partnership may need to be unwound, thereby undercutting the investment and resulting in sizeable sunk costs.
  4. Exclusivity could preclude other partner relationships. Either a hospital or a private equity fund may demand exclusivity in the business relationship. While locking a partner into an exclusive relationship can reap benefits for the partner demanding exclusivity, being subjected to one narrows a hospital or fund’s ability to partner with other possible joint venturers.
  5. Restrictions on potential buyers. Hospital joint ventures introduce additional layers of business and regulatory risk that not all buyers are interested in or equipped to handle. Further, while a private equity fund will be dealing with one hospital throughout the relationship, the hospital participating in the joint venture may have to work with more than one partner throughout the joint venture, which raises two specific concerns. First, hospitals are incentivized to participate in a joint venture to expand the hospital’s footprint in the community. As expansion continues, hospitals will not want additional competitors to enter that market, which limits the fund’s ability to exit the investment. Second, potential buyers are limited, even if a hospital partner is open to additional market investment. As an example, a hospital will not be willing to enter into a joint venture with another hospital, and a hospital will not want to sell its interests in a joint venture to another hospital, as the brick-and-mortar locations are likely on or very close to the seller hospital’s campus.
  6. Expansion. Hospitals are likely to be less interested in expanding the joint venture to new markets than private equity funds are. Both parties need to consider and accommodate the other’s business model and objectives when establishing the business relationship.
  7. Sale event. Planning for an exit event is a necessary process when establishing the joint venture, but the fund’s desire to exit the investment presents risks for each party to the relationship. Hospitals will necessarily want to hedge against changes to a successful relationship in the future, and may request a right of first refusal to buy out the private equity fund at the time of the sale event. The joint venture itself may be an attractive portion of a portfolio company’s business, and a hospital exercising a right of first refusal may significantly limit a company’s attractiveness in the market.

Given these objectives and risks, what types of businesses lend themselves to hospital joint ventures?

  1. Urgent care. Urgent care is an attractive investment opportunity for hospitals considering joint ventures, as urgent care facilities offer an opportunity for a hospital to expand its footprint and increase name recognition throughout a geographic area.
  2. High-end specialties. Additional specialties that create attractive investment opportunities are those that heavily refer to hospitals, such as fertility and oncology. A joint venture that keeps patients within the hospital system is likely to result in attractive returns for the investing hospital.
  3. Physical therapy. Like urgent care, this is an area where private equity funds have been very successful and can assist with rapid deploying and efficient management, sometimes at a lower cost than a health system can deliver.
  4. Ambulatory surgery centers. Here, private equity-backed platforms often seek to joint venture ambulatory surgery centers with physicians or health systems or both. In these scenarios, the private equity-backed platform often manages the joint venture, while the health system is afforded a low-cost, high-quality venue for outpatient surgery.

What types of forms do these joint ventures take?

  1. Extension of core business. The practice of the joint venture, such as urgent care, may be the core business of the private equity platform. In these cases, joint ventures are an opportunity for a fund to grow its platform presence in a particular market and in new markets.
  2. Complementary business line. Another common model for a joint venture between a hospital and private equity fund is a structure where the joint venture’s practice is a complementary segment of the private equity-backed practice, such as a joint venture imaging center where the private equity fund platform is in the radiology business. Subject to regulatory compliance, both the fund and the hospital can benefit from referrals to the joint venture imaging center.

Hospital joint ventures will likely continue to grow in prevalence in the years to come. The opportunities for scale, the advantages in value-based contracting as well as the increasing willingness of health systems to entertain the relationships are too transformational for any other answer.