After more than two years of the pandemic, competition for private equity healthcare services deals has come back dramatically. Ari Markenson, a partner in Venable's Healthcare and Corporate Practice Groups, moderated a panel discussion with investors to learn how they are assessing risk in this competitive and frenzied marketplace for healthcare services transactions.
Ari was joined by Pete Tedesco of Health Enterprise Partners, a lower-middle-market private equity firm focused on investments in healthcare services and healthcare technology businesses; Nick Coleman of Excellere Partners, a middle-market private equity firm that specializes in partnering with founders and management teams within healthcare, business services, and industrial growth; and Michael Vaupen of Vestar Capital Partners, a middle-market private equity firm specializing in buyouts and growth capital investments, with a focus on the healthcare, consumer, and business and technology services sectors.
The Landscape
Despite an initial adverse effect, the COVID-19 pandemic has served as an accelerant, heating up the competition for private equity investment in healthcare. The healthcare space has experienced an influx of interest and capital. Given the competition for both timing and valuation, private equity investors have adjusted their processes and approach to deal making and have become even more selective about where they play.
Firms are focusing on broad investment themes and certain areas within healthcare in which they already have familiarity. They are working to understand these themes and their key players in order to be able to aggressively pursue opportunities where they have a lot of conviction. At the same time, they are also pulling back from deals in areas in which they do not have such faith.
If an investor is going into a situation without an angle or an understanding of the market, they are already a few steps behind other firms that are spending time upfront doing the research they need to understand key trends and what is driving the business from a macro perspective. Firms are also leveraging prior relationships and bringing industry experts and executives in earlier than before, which they find helps build credibility with management teams.
Investors are identifying a few key areas where they have confidence in the growth and tailwinds; then they spend time actually mapping out these spaces and getting to know the companies within them. Before the process actually starts, they try to develop a point of view or an angle, because in order to win in a competitive process, investors need to come in offering more than just valuation.
Due Diligence
In response to current market conditions, firms have tightened up the timeline of their due diligence processes. Sellers, companies, and advisors are also trying to find ways to make the diligence processes more streamlined for investors. When a company makes the investment up front to do some diligence work and data organization on the sell side, it helps make the process more efficient and effective for investors and their advisors.
That being said, sell-side diligence work is never going to be a perfect substitute, but it means that at least attentive companies have been through the process, considered some of the most logical questions, and understand the data, which allows investors to move more quickly.
Advisor Availability
With competition for deals comes competition for advisors. Potential lead times for some third-party advisors have increased, which is something investors need to plan for as they think about their diligence process. Investors are now reaching out to secure their first-choice advisors more than a month in advance of when they actually need them to be engaged on a full-time basis to get a report completed in the time frame when they need it.
Leveraging existing relationships was especially vital toward the end of last year, when there was a flurry of investment across the whole industry. Most acutely felt among those doing commercial diligence and market diligence, capacity was not able to serve the market and processes were delayed. This busy time underscored the importance of relationships, and investors became more creative in expanding relationships to grow their networks and close deals. While things have settled down slightly since 2021, finding enough resources to actually do the work is still a challenge.
Lenders are feeling similar pressures. Although many seemed less willing to be aggressive at the height of the pandemic in 2020, the healthcare industry bounced back very quickly and has continued to hold up relatively well.
Addressing Multiples and Assessing Valuations
To win in the current marketplace for healthcare deals, investors really need to believe that they can do something with an opportunity that others are unwilling or unable to do.
Firms have become more selective in choosing deals and try to find areas where they can bring a differentiated angle or perspective that would allow them to underwrite a higher level of growth. Is there an angle for growth that justifies their valuation? Is the company already on that trajectory, or are there things that investors can or need to do to be able to accelerate it?
At the same time, investors are allocating more time to assessing risks and downsides. They need to prioritize both, in order to successfully win a deal in this hectic marketplace. It has become more important than ever to understand the range of potential outcomes.
Investing in healthcare comes with a certain degree of headline risk. It's impossible to completely avoid, but it raises the bar, from a compliance and risk standpoint, when investors do their homework and thoroughly assess the quality of organizations to ensure there are no significant gaps that can't be mitigated.
The healthcare industry is not much different from other sectors in terms of competition, speed, and approach to diligence, but what sets it apart is its regulatory oversight. The regulatory intersection is a major challenge, but also an opportunity in healthcare.
Investors have adjusted their approach to deal-making as the healthcare market has shifted. While there is no one-size-fits-all solution in this competitive marketplace, our attorneys are closely monitoring the landscape and will continue to provide updates. We encourage you to watch the full webinar and reach out to our Healthcare Group with any questions.