State of Orthopedic Private Equity - Physician Growth Partners

State of Orthopedic Private Equity – White Paper

Winter 2024

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Introduction

Private equity investment in the physician practice management (PPM) space has continued to accelerate and expand in scope over recent years. After beginning with specialties like anesthesiology, radiology, pathology, and multi-specialty groups in the early 2000’s (Private Equity 1.0), private equity began investing in specialties like dermatology and eye care in the early to mid-2010’s (Private Equity 2.0). Today, there are very few specialties that haven’t been touched by private equity, whether directly or indirectly. That said, while their scope has expanded significantly, there has also been a clear evolution in approach and strategy, (Private Equity 3.0) that some of the more recently consolidating specialties, like orthopedics, are benefitting from. 

We will dive into the specifics of the “Private Equity 3.0” model being employed in the orthopedic space at the conclusion of this paper, but first it is important to understand the trends driving the uptick in private equity activity that has been occurring over the last couple of years – activity that shows no signs of slowing down in the near future.

Consolidation Drivers for Orthopedics

Attractive Demographics

Like most of the specialty medicine verticals, private equity interest from a demographic perspective in the orthopedic space is being driven by an aging population that is, in turn, leading to increased prevalence of musculoskeletal conditions. This is being further supplemented by a sharp rise in adult obesity rates that will further increase the demand for MSK services. For example, by 2030, it’s estimated that total knee replacement surgeries in the U.S. will increase by 673% to 2.48 million procedures, while total hip replacements are expected to increase by 174% to 572,000 procedures1. PE firms see this growing patient base as a stable, predictable revenue source, and in turn an attractive area to evaluate investment opportunities.

A Shift Towards Outpatient and Ambulatory Care Settings

The specialty of orthopedic medicine has traditionally been dominated by an in-patient care setting. From a private equity perspective this fact would greatly inhibit the investment opportunity within the space, but there has been a recent and ongoing, substantial shift away from inpatient care in orthopedics. Simultaneously, this has led to a scenario where providers are much less reliant on health system interaction. The shift from inpatient hospital surgeries to outpatient and ambulatory surgical centers (ASCs) for most orthopedic procedures is having a substantial impact on go-forward growth within the market. The ambulatory surgery center (ASC) market for orthopedic procedures is projected to grow by 6.02% annually through 20302. PE firms are investing in these outpatient models, which offer cost-effective solutions and shorter recovery times, leading to higher patient satisfaction and profit margins. This trend aligns with the broader healthcare shift toward value-based care, which has acute implications within orthopedics that, along with the shift in care setting, have made it very attractive.

Technology and Innovation Driving Growth

The integration of advanced technology, such as robotic surgery, AI-based diagnostics, and 3D printing for customized implants, among others, are transforming orthopedic care. These innovations increase the precision and effectiveness of surgeries, improving patient outcomes and reducing recovery times. The global orthopedic device market is projected to grow at a CAGR of 4.3%, from $60.4 billion in 2023 to $80.8 billion by 20303, fueled by advancements in medical devices and implants. Private equity backing removes the burden of independent groups needing to make this capital investment themselves. With capital constraints removed, practices aligned with PE that are already ahead of their peers from a scale and reimbursement perspective can further widen the gap by implementing the latest and greatest technology as it becomes available to the market. 

Current Orthopedic Landscape

Network of orthopedic partner locations in the USA.

Why Now?

Private Equity 3.0

As mentioned in the introduction, the most noticeable difference within orthopedics compared to other specialties experiencing consolidation is the strategy – private equity 3.0. This model enables a plethora of advantages that make the contemplation of private equity much more attractive than it has been historically from a control, compensation structure, provider alignment, and growth strategy perspective.

With regard to control, the model in orthopedics allows decision-making to be maintained at the practice, or local level. This is in stark contrast to earlier iterations of the PE strategy in PPM where physicians maintained little or minimal control at the local level. This fact directly impacts the opportunity and difference from a go-forward compensation perspective as well. Where specialties like Dental, Dermatology, and Eye Care continue to utilize a percentage of collections compensation model that only pays providers on their personal productivity, the 3.0 model follows a profit share model that keeps the old shareholder compensation formula in-place, while simultaneously allowing for “income repair,” or the return of income to pre-transaction levels, by allowing shareholders to participate in the growth of local level profits. This local level control and participation in profits also allows a much clearer path to partnership for current and future employed associates. The ease of access to practice ownership is integral in aligning with physicians for the long term. All of these benefits culminate in a much larger voice, along with much more significant participation, in the go-forward growth strategy. Physicians continue to drive growth at the local level, but no longer have the resource, capital, or bandwidth constraints that existed prior to the partnership. 

Compete Stronger

As the orthopedic landscape continues to evolve, it is becoming significantly more challenging for smaller practices to compete with larger, consolidated platforms. As a result, independent physicians are heavily motivated to transact in an effort to control their own destiny and raise their compete-level in their local markets. In addition to maintaining a level of ownership in the new entity they sign on with, many groups will ensure clinical autonomy stays 100% controlled by the physicians.

Optionality & Succession Planning

Outside consolidators such as United Healthcare’s Optum Health, Walgreens, large health systems and other “payvider” insurance conglomerates are becoming more acquisitive of independent physician practices. Optum, for example, is the largest employer of physicians in the U.S., with 90,000 physicians employed or affiliated with the organization. Following that trend, it is imperative that independent orthopedic group owners get educated on long term strategic options and exploring a private equity partnership has become an increasingly popular option. Even if a group doesn’t end up doing a deal, getting educated and exploring a competitive transaction process helps practice owners zoom out, helping them look at the bigger picture; allowing them to think about what the next 3, 5, and 10 years could look like if they maintain the status quo, were to partner with private equity, and/or sell to a health system or retail giant.

Key Considerations For Practice Owners

When evaluating a potential partner, it is extremely important to find the right fit to ensure a strong go-forward partnership. PGP advises that four critical factors are considered when evaluating whether a partner is right for your practice

  • Maximize Economics and Achieve Most Favorable Deal Terms
    • Negotiating favorable economic deal terms (equity share price, timing of payment, etc.) 
    • Strike appropriate balance between total EBITDA credit vs the EBITDA multiple
    • Receiving credit for various tangible growth initiatives in the business (new locations, new providers, new service lines, etc.)
  • Achieve Clinical Autonomy
    • Ensure there is a strong level of go-forward governance control at the local level
    • The practice maintains directional control at the company, including work schedules, vacation days, work location, and retention of staff
    • Maintained control of provider recruitment and retention
  • Ensuring potential partners have the resources to execute against the strategy
    • Access to capital and economies of scale 
    • Adequate level of administrative and operational resources provided (Accounting / Finance, IT, RCM, Marketing, HR & Recruiting, Business Development, Legal, etc.)
  • Track Record of Success
    • Partnering with experienced healthcare / PPM ‘Operating Partners’ with a history of adding significant value and operational guidance in the PPM space
    • Proven ability to align with young and newly recruited providers
    • Exceptional key performance metrics (recruitment, attrition, location growth, service line expansion)

What Happens After the Transaction?

One of the biggest questions practice owners have is “what happens after the transaction is consummated?” If you are doing a transaction with a reputable private equity platform, physicians will largely continue to operate “business as usual”. The private equity partner will look to implement certain growth initiatives, but these initiatives will all be items that were discussed at great length in advance of consummating the transaction. On the clinical front, physicians will practice medicine the way they always have. Clinical autonomy is maintained, and an advisory firm like PGP negotiates this on the physician group’s behalf. As for infrastructure capabilities, groups that lack back-office sophistication will typically integrate into the “platform” practice’s EMR, Accounting and PM systems. Outside of day-to-day operations and clinical delivery, the most notable change is the holding of rollover equity in the new partnership by selling physicians. Due to the fact a substantial liquidity event is experienced, shareholders are required to utilize a percentage of their proceeds in the form of equity in the new enterprise. This is desired by the private equity firms as they want to maintain alignment with the physicians that they have invested in, creating a shared goal of growing the platform and creating a “second bite of the apple” opportunity 3–7 years down the road.

What to Look For in a Partner and Why an Advisor is Important

Every private equity sponsor views the world through a different lens when it comes to their motivations, growth plan and relevant experience within the space. When seeking a partner, it is imperative for practices to be diligent in ensuring alignment for the future. The partnership is not permanent, but the years following a transaction will need close collaboration from each party for it to be successful. 

Physician Growth Partners (PGP) works on behalf of independent physicians to ensure their goals and succession planning needs are met through a transaction. Our process is tailored around maximizing value, while identifying and engaging investors that will be a strong cultural fit with experience in the healthcare space to ensure a successful go-forward partnership. It is essential that you partner with a healthcare private equity group that has a similar vision.

A seasoned healthcare transaction advisory team can ensure that the most attractive outcome is achieved. Through a formalized competitive marketing process, an advisor can ensure the practice maximizes the economic value of the practice. A transaction process also allows the practice to interview multiple private equity partners, in what we call reverse diligence, allowing you to choose the group that presents the best ‘fit’.

Conclusion      

With notable consolidation occurring across the country, orthopedic practice owners should continue viewing private equity as an attractive option and we foresee heightened orthopedic M&A activity heading into 2025, with expected add-ons and a few new platforms created by larger groups.

For those that choose to go down the path, it is imperative that culture and alignment, not simply economics, is the first goal. The role of an advisor like PGP can be the difference maker not only in knowing who can be trusted and who has a track record of success, but in ensuring an economic outcome that is satisfactory when transferring the ownership structure of your practice.

If interested in pursuing a transaction, learning about private equity, the private equity strategy, or activity in your market, please utilize the information below to schedule a discussion with the PGP team.

1Journal of Bone and Joint Surgery 2007: Projections of primary and revision hip and knee arthroplasty in the United States from 2005 to 2030

2 Grand View Research 2018 – 2022: U.S Ambulatory Surgery Center Market Size, Share & Trends Analysis Report By Specialty, By Ownership, By Center Type, By Device Type, By Region, And Segment Forecasts, 2024 – 2030

3 Grand View Research: Global orthopedic devices market, 2018 – 2030

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