In New York State, there is a hot market for the purchase and sale of licenses to operate Certified Home Health Agencies (“CHHAs”) and Licensed Home Care Services Agencies (“LHCSAs”) because a moratorium on the issuance of new licenses by the New York State Department of Health (“DOH”).
Deals with LHCSAs and CHHAs are very similar to other M&A transactions, with the main difference being that title cannot actually change hands until final approval of the transfer has been obtained from the DOH. The approval process typically lasts about a year, but can last longer if there are issues with the application for approval. The crux of the matter is that timing is largely outside of the control of the parties. As such, there is a much longer delay between signing and closing than the typical time period for other M&A transactions.
Another distinguishing factor about these deals is that buyers often pay a significant portion of the purchase price upfront – sometimes as much as half, with more paid over time prior to closing – because the market is seller-driven. The combination of the significant upfront investment by the buyer and the long delay between signing and closing creates an interesting dynamic between a buyer that is eager to begin running and growing the business and a seller that is unmotivated to focus on the business, having already realized a large chunk of its return on its investment.
As much as a buyer may want to get into the business in order to revitalize it, protect its investment and start the process of turning a profit as soon as possible, legally, the seller cannot step aside and hand the business to the buyer until the closing has occurred, which requires DOH approval. Therefore, as title and the license remains in the hands of the seller, but the incentive to run the business lies with the buyer, the parties are at an impasse.
Buyers and sellers have contracted around this situation by entering into two consecutive agreements. In order to enable the buyer to start running the business and to free the seller up to move on to other things, the parties enter into a consultative agreement and a management agreement, whereby the seller hires the buyer to run the business during the time between signing and closing.
The consultative agreement is short-term and somewhat limited in the powers that it delegates to the buyer. The parties must provide notice of the consultative agreement to the DOH, which is useful because the unimposing notification requirement allows the agreement to go into effect immediately following the signing. The main purpose of the consultative agreement is to allow the buyer to transition to managing the business while the parties obtain approval of the management agreement.
The management agreement has a longer term than the consultative agreement, and it provides significant management power to the buyer, while reserving ultimate authority and responsibility to the seller. Once approved by the DOH, which usually takes a few months, it remains in effect until the closing is consummated, and title passes to the buyer. Under the management agreement, the seller hires the buyer as a manager, which gives the buyer generous power to run the business while the parties obtain approval of the overall transaction.
Under both agreements, the buyer/manager earns a fair market value management fee, which fee is paid out of the profits of the CHHA or the LHCSA. While any profits above the management fee technically remain the property of the seller prior to the closing, the parties typically provide that any such profits earned on the buyer/manager’s watch are set aside and pass along with the other assets or the equity of the company to the buyer at the closing.
This structure, which is composed of a series of agreements that create relationships between the buyer and the seller, accommodates the fact that there will be a delay between essentially buying the business and owning the business, while respecting the regulatory framework of ownership and management of such entities.
On May 3, 2017, Nixon Peabody LLP hosted a Hot Topics in the Middle Market event entitled Private Equity Investing Outlook: What is Next for Investing in Health Care in its Manchester office. NP partners Andrew Share and Allan Cohen moderated a discussion featuring the following speakers:
- Charles L. Anderson, MD, Co-Founder and Principal, Exaltare Capital Partners
- Gray Chynoweth, Advanced Regenerative Manufacturing Institute
- Troy Dayon, Senior Director, Marketing, Medtronic Advanced Energy
- Daniel Head, Senior Vice President, Corporate Advisory & Banking, Brown Brothers Harriman
A summary of the panelists’ observations on the current state of the health care industry and investment opportunities is as follows:
- Trends and Opportunities: The panelists agreed that, as in many industries, consumers are seeking lower costs and increase transparency in the way services are provided. As a result, services and technologies that drive value for consumers are ripe for investment. Examples of the push for lower cost care are the proliferation of urgent care centers, the number of which increased 10% over 2016. When compared to emergency room visits, urgent care centers can provide services at a lower cost and with quicker access to physicians. Similarly, patients are also turning to ambulatory surgical centers for procedures that once required hospital stays. Advances in technologies have allowed these centers to provide services once only available at hospitals, and at lower costs due to significantly lower overhead expenses.
On the provider side, panelists saw a need for services that decrease waste and the cost of patient care. Services that allow for the sharing of patient data between providers will lead to decreased costs of care. Investment opportunities also exist in companies offering genetic risk profiling, which in many cases allows providers to predict future illnesses, leading to a proactive approach to care.
- Data Sharing: As the value-based healthcare model expands, the need for more accurate patient data increases. Providers will need patient data to report performance metrics to payers in order to demonstrate patient improvement, and payers will require data to justify reimbursements to providers. As a result, data security issues will remain a key issue as data is shared between these parties. Organizations will need to determine the proper allocation of risk in sharing patient data and complying with data security laws. The use of devices and other new (and often unsecure) technologies that collect patient data also complicates things. Working through these issues, however, could lead to lower costs for patients, providers and payers.
- Health Care Reform: The panel agreed that healthcare is often not as patient-centric as it could be. An example provided is the high rate in which patients receive the wrong medication during hospital stays. An anomaly highlighted by the panel is that health care costs per capita in the US are 30% higher than those in Europe, but Americans are no healthier as a result. Bloated costs are often attributed to fraud, abuse and miscoding errors. In light of these issues, the panel agreed that there are a plethora of investment opportunities in patient-centric services in technologies that may lead to reduced costs and waste from a provider perspective.
With the potential for a global slowdown in the near future, PE funds will need to adjust their strategies to sustain their solid returns on investments in healthcare-related assets.
In 2015, PE funds saw a 6% rise in deal volume. Despite a 20% decrease in overall deal value, the number of supersized deals over $1 billion nearly doubled. Funds added onto previously acquired assets, and the number of exits rose 8%. Provider and related services represented more than half of both the year’s deal value and the top ten deals. Healthcare-related information technology, retail health, European laboratories and biopharma were the year’s popular segments. Most of the activity in these sectors occurred in the Asia-Pacific, European and North American regions.
For 2016, the volatility of the markets and threat of global recession has slowed public offering activity. PE participants are finding it difficult to secure financing. As such, experienced PE investors are taking recession scenarios into consideration when making their investment decisions.
In healthcare investing, we can expect the focus to shift to segments that offer cost savings and away from segments that have high cash-pay components or are dependent on consumer demand, such as elective medical procedures. The market leaders who have cut costs by reducing the number of suppliers to manage will be attractive to investors. This appeal and approach may bolster their leadership and improve their financial strength to make investments through a downturn.
In order to prepare for slower economic moments, investors should stay focused on strategy for downturn, the margin for improvement in potential investments as a core driver of value, and the various options for exiting an investment. As always during times of turmoil, healthcare investors should meticulously attend to their current assets and be ready to act quickly on good opportunities emerging in the future.
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The folks at PitchBook have crunched the data for U.S. private equity deal activity in the first quarter of this year and have outlined some very interesting early trends for 2016:
1. Private equity’s “buy-and-build” strategy continues to be a significant portion of the private equity investment activity with add-on investments representing nearly 70% of the private equity investment activities in Q1.
2. Macro-economic uncertainty and a competitive middle-market lending environment continues to reduce the use of debt in private equity deals in Q1.
3. While deals in the lower middle market may require additional effort, funds continue to find attractive valuations in this segment of the middle market with a bit less competition.
4. U.S. PE-backed sales saw a dramatic decrease in Q1 (as compared to the same period in 2015) with only 198 completed sales and not one PE-backed IPO!
5. PE-backed exits remain robust in the healthcare, business-to-consumer, and financial services sectors.
6. Private equity fundraising remains strong. Of the 71 U.S. private equity funds closed in Q1, 98% of all these funds either hit or exceeded their fundraising target. (More info on this trend from PitchBook can be found here.)
7. The median size of U.S. private equity fund vehicles in Q1 were larger relative to prior years.
8. Notwithstanding the increased median size of fund vehicles, limited partners appear to have an increased appetite for smaller fund vehicles (between $250 million to $500 million) with focused and niche investment strategies.
9. There is a higher success rate of private equity fundraising due to increased limited partner demand for established fund managers and for new managers with unique/specialized strategies.
(For additional information from PitchBook, please click here.)
Thus, while private equity deal activity was off to a slow start in Q1, the strong fundraising environment demonstrates limited partners’ continued confidence in private equity as an asset class and in the ability of private equity managers to carefully and creatively execute on their focused strategy in an otherwise uncertain economic time to generate consistent and attractive returns for its LPs.
Nixon Peabody hosted a roundtable discussion on March 9th in its New York City office in which panelists discussed the private equity investing outlook in the health care industry. This discussion was a part of Nixon Peabody’s ongoing Hot Topics in the Middle Market series. Panelists for this discussion included:
• Charles Anderson, MD, Co-Founder and Principal at Exaltare Capital Partners
• Keith Anderson, Managing Director at Piper Jaffray
• Lance Beder, Director, Transaction Advisory Services at Grant Thornton LLP
• Noah Kroloff, Partner at NGN Capital
• Barbara Morrissey, Esq., Legal Director, Office of the CIO at Northwell Health, Inc.
Following are a few takeaways from the various areas discussed by the panel:
- Investors in the healthcare industry are currently focusing on healthcare IT and medical devices as areas that will have strong investment opportunities in the coming year. In addition, investors are focusing on (i) the outsourcing of services, staffing and training with the goal to provide healthcare that does not require hospitalization, (ii) telehealth, and (iii) the mobility of information including secure texting. Healthcare IT is of particular importance to the segment given that the healthcare industry's adoption of technology continues to lags as compared to other industries.
- With respect to how healthcare systems themselves are investing, Barbara Morrissey, (Northwell Heath) reported that Norwell is looking to focus on joint ventures with small and large companies that either provide a product or service to the healthcare industry. One example of this is their partnership with GoHealth where the joint venture established urgent care centers whereby Northwell had the expertise and GoHealth had the infrastructure for such urgent care centers.
- As for the outlook for the deal market in this industry, the panelists thought that it remains a seller’s market. Accordingly, one main area of focus for service providers has been preparing a company to be sold. Associated with that preparation are a variety of tasks to complete to ensure that a company is ready for a sale, one being the conversion from a cash to an accrual based accounting methodology. With respect to legal due diligence, there are various tasks that need to be completed to ensure that a company is ready for a sale, including confirming that the selling company has been complying with all healthcare regulations, including securing all state licenses, obtaining all required insurance and complying with all privacy law issues.
2016 is a seller’s market, according to the panelists at our recent Hot Topics events. Investors, dealmakers and advisors came together in Boston and Los Angeles to discuss what’s on the horizon for private equity in 2016, including the impact of high valuations and rising interest rates on M&A activity, and the regulatory hurdles facing the financial institutions supporting the industry.
In Boston, panelists included:
• Gregory Bondick, Managing Director at Windjammer Capital Investors
• Jason Fennessy, Director at RSM US LLP
• Jay Hernandez, Director at Harris Williams & Co.
• Kevin Jolley, Managing Director at MHT MidSpan
• Matthew Keis, Managing Director at Gemini Investors
• William Nolan, Managing Director at H.I.G. Capital
• Andrew Shiftan, Managing Director at BHC Interim Funding, LP
The panelists had the following observations and predictions for middle market M&A activity:
Recap of 2015 – The past year had a healthy volume of M&A deals, with valuations in many instances at levels not seen since 2007. For many PE funds, fundraising was strong, giving these funds ample capital to deploy in 2016. The credit markets were also friendly to buyers with healthy balance sheets, giving many buyers sufficient cash to deploy on M&A activity. The health care and health care IT sectors were big winners in the past year, as companies and investors became increasingly familiar with the Affordable Care Act and corresponding investment opportunities. Brewery and SaaS-based businesses also drove high multiples.
The Year Ahead – The panelists agreed that while growth may have moderated, it is still a seller’s market. That said, sellers’ expectations may have started to exceed the market reality and valuations are likely plateauing. Despite this realization, the metrics driving deals will hold true. The middle market and lower middle market are a good place for buyers seeking reasonable valuations. Buyers who are flexible in terms of the capital structure of an acquisition and can provide certainty related to the closing of a transaction will continue to be more successful in competitive bid processes.
M&A activity will continue to follow growth sectors. The panel agreed that the natural and organics, outdoors, pet product and business services industries would remain hot. The pet products industry, for example, is growing faster than GDP and appears not to be affected by market cycles. The industrial sector will likely not fare as well, and finding growth here may be challenging. The revenue of companies in this sector is often tied to the oil and gas industry, which is hurting, and the U.S. dollar, the strength of which hurts companies who have operations offshore.
From a lender’s perspective, 2016 will continue to present challenges as banks, business development companies (BDCs), SBICs and insurance companies compete to deploy capital. Uneasiness will remain in the high yield market related to macroeconomic conditions such as the price of oil and China’s economy. At the upper end of the credit market, there is a lack of liquidity. Larger institutions are holding debt in industries like oil and gas that are not faring particularly well. Lenders are also facing regulatory pressure related to balance sheet requirements. The panelists agreed that only time would tell whether this uncertainty would trickle down to the middle market.
Speakers at our Los Angeles event included:
• Brad Meadow of SPK Capital LLC
• Andrew J. Howard of Shamrock Capital Advisors, LLC
• Naeem Arastu of Solace Capital Partners
• Saif Mansour of Breakwater Investment Management, LLC
• Brad Holtmeier of CriticalPoint Partners, LLC
• Yem T. Mai of Marsh Risk & Insurance
• Tracy Washburn Bradley of Fortis Advisors LLC
• Margaret Shanley of CohnReznick LLP
• Vince R. Lawler of Bernstein Private Wealth Management
Here are some of the key takeaways from the discussion:
Deal Environment – In general, 2015 was a sellers’ market with buyers competing for fewer quality assets and generally buyers paying top dollar in the process. With relatively modest economic growth forecasted in the U.S. for 2016, the consensus at the event was that corporate strategics would continue their strong pace of M&A activity in 2016 in an effort to acquire revenue streams to bolster their profits. Private equity funds would also deploy their abundance of “dry powder” in this environment on the buy-side (platform, add-ons, and growth investments), but would continue to do so only in a very selective and careful manner. Entrepreneurs and private equity funds will likely continue to seek opportunities to sell their companies, but should be aware that the high valuation environment may be showing signs of compression.
Valuations – Valuations remained high throughout much of 2015 and, in general, the increasingly elusive high-quality assets should continue to demand higher valuations in 2016. With that said, portions of the middle market (especially the lower middle market) showed signs of valuation misalignment between buyers and sellers during the latter part of 2015, and the general consensus is that this disconnect would likely continue in 2016. As a result, this misalignment has resulted in the increased use of earn-outs in the latter part of 2015 and will likely continue in 2016, especially in the life sciences and biotech sectors.
M&A in a Rising Interest Rate Environment – The general consensus is that the Federal Reserve’s anticipated gradual increase of interest rates should not dampen M&A activity in the U.S. in the short term, and that debt should remain generally available notwithstanding the volatility in the debt markets over the past few months. In the long term, however, there was some concern as to whether a higher interest rate environment in the near future might impact a private equity fund’s internal rate of return on companies bought today but sold in a higher interest rate environment in the future.
Preparing to Buy and Sell – Notwithstanding the competitive environment for desirable companies, the general view was that it is essential for companies approaching a sale today to engage in a thorough sell-side diligence process before engaging with prospective buyers. Such a process allows the seller to identify any issues that may impact the value of the business or the ability of the seller to close the transaction quickly. As noted during the discussion, the failure to identify and address issues before engaging with prospective buyers could result in a broken deal process, which could negatively impact the company’s business and valuation. On the buy-side, it was suggested that it is equally important for buyers to be patient throughout the process and invest the time to thoroughly understand the seller’s business and build stronger relationships with the seller’s management team – an evaluation and building process that may, at times, last more than a year. Spending that investment time, however, allows a buyer to fully understand the challenges and opportunities facing a company and gives the buyer the opportunity to be transparent with the buyer’s lending sources.
2016 Forecast – There was a cautious optimism that the M&A environment will continue to remain strong in 2016. Corporate strategics will remain active on the buy-side, who will likely do more “carve-out” transactions in 2016. PE firms will keep deploying capital, but they’ll continue to be patient and disciplined in their buy-side activities. Firms will also address the perennial issue of the “portfolio company overhang” and, in doing so, will continue to sell companies into a market with so many willing buyers. The new norm of rep & warranty insurance will continue in 2016 as more and more buyers obtain these policies in an effort to remain competitive for quality assets.
Nixon Peabody continued its interactive Hot Topics in the Middle Market series last week by hosting a roundtable discussion in its Chicago office. The discussion focused on investment trends, opportunities and challenges in health care given the recent impact of the Affordable Care Act. Nixon Peabody attorneys Gary Levenstein (Private Equity and Mergers and Acquisitions) and Lynn Gordon (Health Care) moderated the discussion, posing engaging and challenging questions to each of the following speakers:
• Patrick Flavin, Executive Director at MATTER
• Lisa Giles, CEO & President at Giles & Associates Consultancy
• David Reitzel, Healthcare Advisory Service Partner at Grant Thornton
• Jason Shafer, Partner at HCP & Company
• Puneet Singh, Vice President at Chicago Pacific Founders
The speakers touched on several hot-button issues in the hour-long discussion, where common themes included the shift from fee-for-service towards value-based payment for care, as well as the various gaps in population health management technologies that investors are looking to help fill with new health care innovation opportunities.
• Patient Engagement Tools. As part of the larger discussion surrounding the shift to value-based care, many of the panelists brought up the pressure faced by providers to provide higher-quality care at increasingly lower costs, while at the same time dealing with the influx of patient data now available to aid providers in this pursuit. The panelists highlighted investment trends in efficient tools for post-clinic visit follow-ups by providers, as well as tools to help increase patient education, giving patients a newer, more integral role in the success of their care.
• Pharmaceutical Shift. The rate at which price of pharmaceuticals in today’s market are increasing also was addressed. The panelists discussed seeing pharmaceutical companies shift away from focus on developing new drugs, to developing specified technology that can make existing devices and drugs more effective for today’s health care needs. The panelists also identified the business opportunity available in the specialty and orphan drug sectors, citing the potential returns of successful treatment for highly specified needs. Global consolidation will also continue across the pharmaceutical and medical device manufacturers which face cost pressures and the need to rationalize their operations across all markets.
In concluding the event, each speaker shared their predictions for what the health care sector will look like 5, and even 10 years from now given today’s investment trends. The main takeaway was that while the provider/patient model of care as we know it is undergoing radical changes prompted by the Affordable Care Act, many of these changes are more complicated and slower than predicted, and it may be more than 5 or 10 years before the industry reflects and embraces true value-based, high quality care models. However, transitioning care models will create opportunities for disruptive technology to improve efficient high-quality care, and the speakers agreed that we should at least expect to enjoy a healthier population, along with a more globalized health care market in the next 5 to 10 years.
On September 30, as part of its Hot Topics in the Middle Market series, Nixon Peabody hosted a roundtable discussion entitled “What is Now and Next for Investing in Technology and Delivery Solutions in Health Care”. Nixon Peabody Partners David Martland and Michele Masucci moderated the hour-long discussion, which also included the following speakers:
· Daniel Head, Senior Vice President at Brown Brothers Harriman & Co.
· Chris LeLonde, Partner at Century Capital Partners
· Rhea Heath, Manager, Healthcare Advisory Services at Grant Thornton LLP
· Charles Larkin, General Partner at Webster Capital
The following are some takeaways from the many topics touched on by the panel:
1. Mobile medicine. The proliferation of technology is transforming this industry. Mobile applications, wearable health monitoring devices, and at-home testing kits are becoming more mainstream, allowing providers to review and use data from patients’ phones in their diagnoses. Telemedicine is also increasingly commonplace, used to serve rural patients and non-urgent care issues. If used properly, these advances may contribute to better patient care and increased access at lower costs.
2. How much data is too much? While allowing a doctor to remotely monitor patients’ heart rates 24/7 may sound great to patients, doctors may disagree. The abundance of patient data may actually complicate doctors’ diagnoses, forcing them to sort through mounds of irrelevant data in order to determine what may be relevant to patients’ care. Also, with the expanded use of electronic medical records and integration between providers, doctors are expected to be more familiar with patients’ long-term health history. This “analysis paralysis” may strain providers, who are generally constricted in terms of how much time they can allow per patient visit.
3. Data risks. The US government, retailers, credit card companies, insurers – everyone is susceptible to a data breach. The consequences are harsher when the leak involves patients’ private health information. Patients want to share their data with providers; payors want to review their insureds’ data in order to spot trends; researchers want to store data that has no current purpose but may be useful in the future. At the same time, everyone expects their data to be secure. Providers and payors must navigate the inherent regulatory and economic risks involved sharing and storing patient data.
Law360 reports that global M&A activity hit $3 trillion last Wednesday. Deal activity is moving faster than in 2014, when the $3 trillion mark wasn't hit until November. Megamergers - most recently, Carlyle's $8 billion bid for Symantec's data storage business - are driving the fast pace.
According to Law360, here are 5 reasons why M&A activity has already hit $3 trillion:
1) Pressure from activist investors, or fear of such pressure, is compelling companies to put capital to work.
2) Inexpensive financing.
3) Low oil and gas prices are leading to consolidation in energy business.
4) The strength of the stock market has given buyers money to spend.
5) Several multibillion dollar deals in the hot health care sector.
In light of President Obama’s historic announcement in December to revisit and revise the U.S.-Cuba relationship, U.S. firms interested in this emerging market will need to understand the current landscape and keep abreast of changes as the new U.S.-Cuba relationship evolves. Although many believe that U.S. firms will not be investing in the region for many years to come (see the recent article in Pensions & Investments entitled “No Gold Rush for Cuba Despite Diplomatic Thaw” found here), the private equity community is (or should be) closely following developments in the region in light of the number of potential opportunities in Cuba, which, according to one commentator, such opportunities could be anything “because Cuba needs everything.” In that regard, my colleagues in our Washington, D.C. office (Douglas Dziak, Alexandra Lopez-Casero and Lindsey Nelson) recently held a fantastic webinar that provides an extremely helpful overview of the existing U.S.-Cuba relations, the policy changes proposed by President Obama (and the new business opportunities coming from the President’s actions), and the political hurdles facing the new U.S.-Cuba paradigm. You can access the webinar where we answer your questions about investing in Cuba here. As noted in the webinar and referenced article, there are a host of issues that will obviously need to be addressed before U.S. firms start investing in Cuba, including, among others, the U.S. Congress’ removal of the existing embargo, convertible and non-convertible currency in Cuba, and legislative and other changes in Cuba with respect to foreign investment.
It has been said that “Rome wasn’t built in a day,” and the same is true for Havana with respect to U.S. investment in that country. But, notwithstanding the time and challenges ahead, U.S. firms interested in this emerging market would do well to start their preparations now by keeping close attention to the evolving regulatory, financial and political landscape impacting the U.S.-Cuba relationship.