Could the bottom fall out?
Creating giant groups through consolidation is a main aim for private equity.
Skin and Cancer Associates, founded in 1971, was a large entity, with 25 practices. But for a long time, its leaders had wanted to become a regional or a national player, said Dr. Porges. Those leaders asked Dr. Porges – who helped take his former radiology practice through a private equity purchase – to help them attract investors. In March 2018, Susquehanna Private Capital signed on as a “partner” with Skin and Cancer Associates.
It has since almost doubled in size, with 40 locations and 60 dermatologists, all in Florida, Dr. Porges said. “The only limiting factor for growing it as fast as we want, is really money,” he said.
Consolidation is just an initial step. Most investors have a finite timeline for cashing out. “The ultimate goal is often to realize a profitable secondary sale in three to seven years to another PE investor (or even a publicly traded entity),” Dr. Resneck wrote in the 2018 JAMA Dermatology paper.
Not all private equity companies are the same, said Dr. Wernli, of Forefront. Dermatologists can investigate a company’s “hold period” – how long they keep an investment before trading – and the strength of its capitalization before deciding to sell, she said.
Since 2016, Forefront has been owned by the Ontario Municipal Employee Retirement System (OMERS), a pension fund for the province’s public workers. OMERS bought Forefront from Varsity Healthcare Partners, which had owned the dermatology group for just 2 years.
Dr. Wernli said OMERS is a good, solid investor. “They have unlimited resources to invest so they don’t have to quickly flip a company to satisfy an investment in another company,” she said.
Some investor-backed dermatology practices have gone belly up. In 2012, WestWind Investors bought DermOne, based in Toms River, N.J. But by early 2018, the business had fallen apart, and some practices – in North Carolina, New Jersey, Texas, and Virginia – just shut their doors.
Long Island City, N.Y.–based Schweiger Dermatology Group, backed by private equity, snapped up nine of the New Jersey DermOne practices in March 2018.
Another private equity–backed company, U.S. Dermatology Partners, defaulted on a $377 million loan in January 2020. As reported by Bloomberg, the company had $340 million in revenue in 2018. U.S. Dermatology’s owners are reportedly working out a recapitalization or debt-for-equity swap with the lenders.
Dr. Wernli said that financial problems aren’t unique to investor-owned practices and that doctors could still be out of a job if a private practice goes under.
“A private practice can also default on their loans that they’ve used to fund their own personal practice, leaving employed physicians in the same situation,” she said.
Patients are likely to be in the dark, however, until the doors close.
Pressure on practices
Private equity is changing the shape of practice for both those who work for investor-owned businesses and those still out on their own.
The Alabama dermatologist, for instance, said it has made it harder for him to recruit new doctors, who are offered big signing bonuses and a steady income by the investor-owned practices. “They’re skewing the numbers,” he said, adding that residents are now expecting a big payment and benefits.
Dr. Baumann said that when she was on her own, she had trouble finding and recruiting good dermatologists. But it has become easier since she’d sold to Skin and Cancer Associates, she said, noting that Dr. Porges recently found a qualified candidate for her to interview a week after she put in a request.
Another dermatologist in a Midwestern metropolitan practice – who did not want his name used – said that when it came time for him to increase his equity stake, his older partner, who was near retirement and had explored selling to private equity – wanted four-and-a-half times the price that had been discussed when he joined the practice.
The younger partner believes the private equity offers inflated the practice’s valuation in his partner’s mind. He ended up leaving the practice.
Many dermatologists have been led to believe that their practices are worth more than they might be, according to Dr. Coldiron. “I think a lot of these doctors that sell out are deluded. They think that they’re getting a lot of money and they’re not,” he said.
Typically, investors may offer three or four times earnings before interest, taxes, depreciation and amortization (EBITDA). The money paid out is taxed at the capital gains rate, which provides some savings. “But you have to pay that all back, because when they sign you up, you become an employee,” Dr. Coldiron said.
Doctors often agree to work for 5 years, but during that period, their base salary is decreased while the buyout cash is meted out to them, he added. A chunk of the buyout usually is also given as equity, but that equity is worthless unless the investor sells to another entity.
Pinnacle Dermatology doesn’t want doctors to retire immediately upon an acquisition, said Dr. Vanier of Chicago Pacific Founders. “We want to find physician partners who want to keep working,” he said. “We strongly believe if you don’t have strong physician leadership, experienced physician leadership, that your odds of success go down.”
Chicago Pacific also believes physicians should have an ownership interest, he said. It allows them to share in the eventual financial rewards – whether that’s 5 or 20 years later, said Dr. Vanier.
Dr. Coldiron sees other pressures that skew practice styles and can harm patient care. Clinicians in investor-owned practices are often urged to refer all dermatopathology to labs owned by the practice and often, a Moh’s surgeon is employed to service all the practices – sometimes even being flown in from elsewhere, he claimed.
That takes away the clinician’s autonomy in terms of referring where he or she feels appropriate and also could harm pathologists and Moh’s surgeons that depend on those referral streams, he added.
In their paper, Mr. Gondi and Dr. Song wrote that this practice is concerning because “keeping referrals within the practice may render referral patterns less responsive to patient needs or preference.”