By Dana Jacoby and Dr. Douglas Jackson
One of the most common questions from physician groups who are considering a private equity transaction is, “Are we a platform?” There are a number of good reasons for this question, and most physician groups would benefit from being a “platform.” In this first installment of a two part article, the first question concerns why a practice would be concerned about the question of being a platform. In a second article, we explore a number of factors that would play into the determination of the answer of the platform question.
A platform is a term that describes a large group that will serve as a foundation for future growth of the physician practice. Growth will happen in two ways. First the private equity partner will seek organic growth of the practice. This may happen through new services, enhanced economies of scale, marketing, enhanced payor contracting, and the addition of capital projects such as ambulatory surgical centers (ASC’s.) The second way growth will occur is by adding other physician practices to the group. The new practices may be in the same geography, but that isn’t necessary and is less likely the larger the practices grow. Once the first foundation platform is established, the addition of practices after the first transaction is often referred to as a “bolt on.” There is nothing here related to hardware, and there is nothing wrong with being a “bolt on.”
So why would a physician practice want to be the first group to transact with a private equity investor and become a platform? The first answer is because it’s good to be first. In the legal axiom, “They who write, win” meaning the platform practice will have the ability to significantly impact the structure of the entity moving forward. The first platform practice has the opportunity to memorialize the important elements into their contract with the private equity investor.
When a practice is the first platform investment for a private equity group within a specialty, the negotiations over such things as partner benefits, supply chain contracts, leadership structure and other important elements are fresh and the physicians have more ability for input. The physicians may negotiate for additional benefits such as a seat or seats on the board of the new entity. Many of those early commitments will continue throughout the life of the agreement and the later bolt-on practices will have limited opportunity to make significant changes. Such things as vacation time, compensation, call schedules and other culture considerations can be memorialized even for bolt on practices that come to the platform later.
In addition, there will be a greater opportunity to negotiate a stronger equity position during the first private equity transaction. Equity negotiations can become complicated and are beyond the scope of this article. Those negotiations involve concepts such as Pari-Persu, a Latin term meaning “on equal footing.” Later groups shouldn’t be treated unfairly because they are bolt-on’s to a platform, but he value of those later shares may change. All said, the platform position gives the first practice physicians a better opportunity to negotiate a stake in a later “second bite.”
Second bite is another term that is used in private equity transactions and a deeper explanation of the second bite is beyond the scope of this article. In general, however the second bite refers to a situation perhaps three to five years in which a practice is transacted a second time with a larger investor, or a later “bite” when the practice is listed on a stock exchange in a “going public” transaction. In the second bite, the physicians who hold equity in the platform will receive an additional payout of the purchase price of the larger entity. Often, the second bite can be very lucrative to the physician shareholders and is therefore a beneficial opportunity to work toward in the future.
Timing and geography are important elements in the conversation about platform groups. Some medical specialties such as dentistry and dermatology garnered the attention of the private equity investors early. As a result, there are numerous platform groups that have already been established. For example, in dermatology, there are currently over 40 mature platforms. The opportunity to become a new platform is severely limited in a crowded, more mature specialty. In other specialties however, the wave of private equity investment is just beginning and a practice may experience “primary mover advantage” as a result of being early to market. Orthopedics and cardiology are currently on the upswing of private equity investment.
Likewise, geography will impact the opportunity for consideration as a platform. Many larger, urban practices were the obvious candidates for the first private equity investments. The demand has been significant for practices in dense population cities such as on the East or West coasts. Ridiculous as it sounds, the demand has been so high that some private equity companies or investment banks actually began a “fishing trip” by distributing unsolicited “letters of intent” to practices in an effort to hopefully hook an unsuspecting practice with a poorly executed agreement. That said, there are a significant number of very good practices in the U.S. heartland or in rural communities that would serve well as a great platform partner despite existing platforms in their specialty in larger metropolitan, coastal cities.