In a recent article titled "Private Equity In Healthcare: Where Do We Go From Here? A Balanced Look At The Good And Bad Of PE In Healthcare," former healthcare consultant Blake Madden takes a thorough look at the relationship between private equity (PE) and healthcare. Bringing together deep research and experience-based observations, he outlines issues and compromises necessary to create better outcomes for investors, founders, healthcare leaders, and patients.
The article covers a lot of ground, but one section stood out to me. Quoting from the article (bold emphasis his):
Making profits in healthcare is not a bad thing, even though it's popular to bemoan profits publicly. I strongly believe provider organizations, vendors, and anyone doing the right work in healthcare deserve to get rewarded for the work they're doing to support patients in communities across the U.S. The reward for that care provision or service offering is financial margin generation. And initiatives like value-based care, while far from perfect, are working to align those financial & clinical incentives.
However, with that belief in mind, the core problem with capitalism in healthcare is this: there's a lack of differentiation financially between 'good' healthcare firms focused on the right objectives versus the 'bad' healthcare firms focused on maximizing profits. In fact, oftentimes the 'bad' ones have optimized for gaming the system and generate higher margins and higher returns, providing negative reinforcement and incentivizing bad behavior. This dynamic extends far beyond private equity.
He's absolutely right—this issue is not limited to private equity. It's also not just a healthcare tech problem. This is a capital allocation issue. I will explain this issue from the private capital perspective, but aside from the hold durations, you can pretty much extrapolate the challenges to any capital structure where capital is tied up—including the public markets.
In fact, time horizon issues are often just as prevalent in public market companies. Publicly traded businesses typically manage to their next earnings call and forecasts at all costs because executive compensation is tied to near-term financial and stock price performance. That abbreviated measurement period leads to strategy and planning that optimizes results for the defined measurement period without much consideration for long-term impact. Like many things in life, the short-term and long-term are often at odds. Buying the new iPhone (short-term) is at odds with saving for a down payment on a first home (mid-term). This friction is just as true when building a company.
The typical early stage private capital-funded startup grows inside a portfolio for about seven years. Many of them start their journey with limited revenue, so that 'gestation' period includes finding product-market fit, determining proper GTM motions, market traction, and scale. For many, it also includes exit planning. That's a lot to accomplish in such a short amount of time.
On the LP (limited partners) side, though, the conversation can tend to center around the timing of liquidity because any time an LP makes an allocation to a fund, they are forgoing other opportunities until the capital is returned. In a traditional fund, investors' capital is locked up during that period. LPs understand that illiquidity is part of the agreement and that the more patient they are willing to be with a relatively illiquid asset, the more return they can ultimately demand. But even though they know that a longer runway could offer the potential for benchmark-beating returns, most LPs don't want their money locked up for too long.
For investors sitting at the nexus between optimizing long-term value creation of an investment/company and managing investor returns, it's a delicate balancing act. The demand for returns makes sense. The private market is a critical element of many investors’ total portfolios. But considering that it takes around 18 months to prepare a company for an exit, even a seven-year holding period is tight. Enforcing overly compressed timelines forces the company to optimize equity value by a certain date rather than over an extended period.
You can see why this issue is not a healthcare tech problem. It's a self-imposed challenge that private capital providers created. At some point—probably in response to LPs demanding a return on capital—the five-to-seven-year line was drawn in the sand. And it has persisted for decades despite proof that it's not optimal for any of the stakeholders (LPs, GPs, or the companies they invest in).
In his article, Madden offers a solution:
Instead of 5-7 years (which is around the typical holding period for PE) either require a longer holding period, or when it comes time to exit the investment, introduce a phase-out approach: limit how much of a company a private equity firm can sell at a time to keep skin in the game over a longer time horizon
This is a good idea, but there are others.
Throughout the history of BIP Ventures, we've pushed back against setting arbitrary, time-fenced exit windows as a standard practice. While we have large, healthy anchor funds, we also create funding vehicles that allow high-potential companies to exist in the portfolio as long as needed to generate optimal value—for the company and the LPs invested in it. Those vehicles include annex funds, SPVs, and an innovative evergreen BDC structure.
To keep from tying up capital, we institute carefully controlled liquidity windows along the way. To ensure our fiduciary commitment, we provide full transparency about performance and timelines. To address the desire for liquidity, we provide investors with transparent, fair, and partnership-oriented tender offers at reasonable, optimal points in time. Those events give them the option to stay in the Fund or liquidate some or all their ownership, even as we continue to provide capital and support to a company in the portfolio. For LPs, those events 'restart' their investment clock, and the building continues. Since 2007, we've seen time and again that removing the line in the sand solves many problems because it creates space for healthier growth, more enduring businesses, and the possibility of compounding returns for investors. Win, win, win.
Circling back to Madden's examination of the relationship between private equity capital and healthcare tech, a couple of points are worth noting. Almost every healthcare company will attest that they are in business to provide quality care. At the very least, as the Hippocratic oath promises, they are committed to 'do no harm.' Today, most physician practices and healthcare systems are also trying to focus on jobs and operating efficiencies that free them to attend more to patient needs than business imperatives. Many are using disruptive technologies to accomplish those efforts.
Introducing change in healthcare is typically very expensive and time-consuming. More often than not, it requires more than a five-to-seven-year investment horizon to see change take hold and create genuine value across the startup/investor/patient ecosystem. Take the shift to Value-Based Care (VBC), which is sweeping across many healthcare systems. The transition requires front-loading the cost of care and recognizing that the benefit will not likely be recognized for years. Once it is, of course, it's a better model for everyone, but time, support, and patience are critical components of success.
A longer time horizon allows vital relationships to take hold throughout that care ecosystem. Collaboration between the healthcare companies and their private capital sponsors gets more productive as the investor holds the business longer. The alliance with committed investors has more time to produce mutual benefits. And, perhaps most importantly, the doctor-patient relationship strengthens.
Madden's observations about PE and healthcare are relevant for considering how investments drive or inhibit progress in the sector. At the end of the day, this issue is bigger than the healthcare sector. It is about allowing the appropriate amount of time for relationships and startups to mature. When they do, the positive results tend to be more impressive and enduring.
