Pulling back the curtain on private equity

By Emily Margosian, content specialist

“From a physician’s perspective, it’s just harder and harder to make a go of it alone,” says Betsy J. Wernli, MD, president of Forefront Dermatology. “There are the increased constraints that the government has put on us — increased regulations on how to chart and code and bill — that have just made practicing medicine as a doctor much harder. To be quite honest, all the extra requirements in addition to providing quality care become so overwhelming that it’s really hard for a single practitioner to do it alone.”

Data seems to back up Dr. Wernli’s observation. According to the AAD’s 2017 Member Profile Report, the number of dermatologists in group settings has continued to grow, having now become the dominant practice model at 52%. This trend extends beyond just the specialty, having ramped up considerably over the past several years. According to a recent Health Affairs report, the proportion of physicians in groups of nine providers or less had shrunk by 5% over the span of two years (2013-2015), whereas much larger groups of 100 providers or more, had increased by 6% within the same span of time (2016;35(9):1638-1642).

As dermatology has begun to consolidate, however, the specialty has become of increased interest to outside financial forces. Seven private equity transactions in which financial terms were disclosed added up to nearly $1.5 billion; numerous other investments have been made without such disclosure. They have created a growing number of very large, cross-national dermatology practices with private equity backing. What does this mean for the future of the specialty? Dermatology World studies the trend, breaking down:

• What factors spur dermatologists to consolidate

• Tips for navigating a practice sale or merger

• Pros and cons of joining an equity-backed group

• Whether or not private equity’s growth in dermatology is sustainable

Grouping up: what drives consolidation?

“I love dermatology,” explains Manfred Rothstein, MD. “But the non-dermatology part was getting more onerous, cumbersome, time-consuming, and frustrating.” In September 2015, Dr. Rothstein closed his Fayetteville, North Carolina solo practice (much to the dismay of long-standing patients accustomed to the sight of his record-breaking collection of backscratchers: staging.aad.org/dw/monthly/2017/august/scratch-that-itch), a decision, he says, that was largely caused by the administrative burden of running a small practice. “Having to worry about whether the secretary’s kid was sick and she wasn’t coming in, taxes, payroll — none of which we were trained for — they just weren’t worth it anymore,” he explains.

Dr. Rothstein is certainly not alone. Many dermatologists opting into group practice have identified burnout with non-medical, administrative duties as a major part of their decision. “I no longer wanted to manage all of the aspects of the practice including the employees, their health insurance, benefits and human resources, the billing and collections, the requirements for PQRS and now MIPS,” says Risa Jampel, MD, who sold her Maryland-based practice to join equity-backed Anne Arundel Dermatology in March of 2016. “It was overwhelming. I had not yet invested in EHR and knew that a good system would be costly as well as time consuming to implement and maintain.”

Likewise, as the future of health care remains increasingly uncertain, many dermatologists are also looking toward group practice as a way to access resources that can help them navigate an ever-changing legislative climate. “We’re seeing more and more requirements, whether it be MIPS, MACRA, HIPAA, or OSHA, and it’s much easier for a group of 100 dermatologists to have a compliance department or a contracting department with professional contracting and credentialing employees,” says Colby Evans, MD, a dermatologist in group practice in Austin, Texas who recently sold his practice. “That would be impossible for a three- or four doctor-practice to afford.”

The move toward group practice may also have a generational slant, as younger physicians entering the field are either unwilling or unable to overcome the financial hurdles associated with opening a solo practice. “We have more now than just a general trend of physicians who are coming out of their residencies choosing to join groups of one kind or another,” says Dr. Wernli. “There are always rumors of a millennial generation shift, and I can’t say that in and of itself is something we give a lot of credence to, but certainly when it comes to the financial burdens of starting a practice and paying off med school debt, it makes sense why young physicians are looking more toward groups as an attractive practice model.”

BIGGEST DEALS IN DERMATOLOGY

$600 million: Advanced Dermatology & Cosmetic Surgery (ADCS) by Harvest Partners, LP
$450 million: Forefront Dermatology by OMERS Private equity
$300 million: US Dermatology Partners by ABRY Partners
$58 million: Dermatology Solutions Group by Cressey & Company
$35 million: Schweiger Dermatology group by LLR Partners and SV Health Investors
$33 million: Riverchase Dermatology and Cosmetic Surgery (Riverchase DCS) by GTCR LLC
$31.8 million: QualDerm Partners, LLC by Cressey & Company and Apple Tree Partners

*This list includes transactions whose financial terms were disclosed. Other transactions may have been larger; see “The main players” sidebar.

NAVIGATING THE SALE

While the majority of dermatologists retain outside legal or business counsel to help them navigate potential practice sales or mergers, Dr. Evans instead relied on some in-house help during his sale to Dallas-based US Dermatology Partners (backed by ABRY Partners private equity). “There are certainly a variety of third parties that will help you for some cost,” says Dr. Evans. “I did it myself, and I’m fortunate because my wife has an MBA and extensive business experience.” Although ultimately the appraisal process varies from practice to practice, Dr. Evans generally advises that physicians consider the worth of their practice beyond that of just the initial payout. “You’re giving up the long-term control of your practice and the long-term revenue of your practice. So you have to get an amount that justifies that to you,” he explains. “So we looked at both the hard numbers — the revenue of our practice and the growth of our practice, that sort of thing — but also what we would be giving up in a more philosophical way, and used that to negotiate the deal.” Dr. Evans notes that at the time of the sale, his practice was being courted by a variety of groups, before settling on USDP.

Like Dr. Evans, Dr. Jampel says she approached the sale of her practice cautiously. “I was not in a rush. I spent about four years looking at various options until I found the one that was right for me. I got appraisals from different organizations so that I knew what was fair and what the market offered,” she explains.

For Dr. Rothstein, however, joining a group owned by a fellow physician was important. Ultimately (and conveniently), his new multispecialty practice is owned by his own family practice doctor. “His office does all the billing and takes care of all the staffing,” Dr. Rothstein explains. “I can pretty much practice dermatology like I always have, like I want to. I know of a few dermatology practices who have sold out either to the hospital or to management groups, but then you don’t have nearly the same control. As far as the hiring and firing I’m happy for someone else to have it, but I’m too old for someone to tell me how to practice medicine. Either I’m doing it right by now, or I’m not.”

SELLING OUT: PROS AND CONS OF PRIVATE EQUITY

While the benefits of group practice may be clear to some, the financial forces feeding some of dermatology’s largest groups remain more opaque. “In the past two years, there have been over 200 [private equity] deals involving physician practices, with about 30 of those transactions in dermatology,” reports a 2016 Business Insider article. Likewise, while dermatologists only account for about 1% of U.S. physicians, 15% of recent practice acquisitions by private equity firms have been dermatology related (JAMA Dermatol. 2017 Nov 21. doi:10.1001/jamadermatol.2017.5558).

And as reports of multi-million dollar deals in dermatology continue to roll in, more and more physicians may find themselves part of a group with capital backing. However, venture capitalism is synonymous with big wins — and losses. For this reason, there are some pros and cons that dermatologists should be aware of when considering either selling to private equity or considering joining a private equity-owned dermatology group.

Pro 1: Immediate payout if your practice is valued favorably

While acknowledging that dermatologists join large groups for practice management benefits, Dr. Evans says that financial considerations also play into the calculation. “A major reason is, of course, the money. In my opinion, the market is hot right now, and a number of practices have sold,” he says. “The demand for practices, at least presently, seems to remain high, so the prices being paid for these practices have correspondingly gone up.”

Pro 2: Relief of administrative duties

Private equity money can often bring in the capital to secure access to a wider breadth of staff and management services. “There are other offices that are close by, and we are able to share employees when someone is sick or on vacation,” says Dr. Jampel. “My office manager also has more resources to help her with questions, and the IT and HR departments are easily accessible.”

“Personally, it has made my life easier,” says Dr. Evans. “My wife, who was our practice manager for 10 years, has retired. I no longer do any kind of work on payroll or taxes or compliance or any of that. That’s not to say my practice couldn’t sell or change — because it could — but in the current state, it’s been nothing but positive.”

Pro 3: Financial backing for ambitious expansion

For entrepreneurial physicians, investors can hold the door open and secure the talent needed to expand a practice on a national level. “If you have a vision that you want to do something bigger, you have the financial resources to do things, like building a new office, or acquiring expensive technologies like lasers,” says W. Patrick Davey, MD, MBA, former chair of the AAD Practice Management Committee. “You have the financial strength to do that in a larger group.”

Dr. Wernli echoes that private equity backing has the potential to benefit both average dermatologists and physicians with wider business aspirations. “You might have some risk-taking entrepreneurial dermatologists who really push things as far as they can with their own investments, taking out debt, and putting together a decent-sized group before realizing that to get to the next level they need additional resources. That’s where private equity can really step in. Similarly, for a practice where it’s just a board-certified dermatologist or two, they can take advantage of the centralized resources, and the increased bargaining power that comes from strength in numbers.”

Con 1: Loss of control

For private equity groups, dermatology is an investment, and one that is ultimately expected to turn a profit. Future exits by investors can create uncertainty for doctors as in some cases the physician group has less control over later transitions. “These groups are business ventures, and they’re designed to one day either be managed or sold,” says Dr. Evans. “Even if the group you go to work with is fantastic, if six months, a year, or five years down the road they sell to someone else, you may not have a say in that, and the new group may not be similar in style to your old group. You have to be in a position where you can accept that, because even if you have some ownership, you are not going to have control the way you do when you own your own practice.”

Jack Resneck Jr., MD, professor of dermatology at University of California San Francisco School of Medicine, echoes these concerns in a recent JAMA Dermatology article, noting that if an investor’s push for profit goes badly, dermatologists and their patients can also suffer. “Practice acquisitions at inflated prices in a competitive quest to quickly consolidate fragmented markets and sell practices at a profit to future investors may eventually lead to bankruptcies, leaving dermatologists without practices and patients without services,” he says (doi:10.1001/jamadermatol.2017.5558).

Likewise, private equity-controlled practices may make staffing decisions — without the consultation of dermatologists — that do not put the best interests of patients first. “Dermatologists working for PE firms reported concerns that their initial or subsequent investors sought to increase profitability by extensively hiring physician assistants to work in unsupervised satellite settings,” says Dr. Resneck. “Some clinicians anecdotally report receiving productivity reports that purportedly include data on biopsies performed per patient or cosmetic procedure upsell rates.”

Con 2: Conflict of interest

Another potential consideration for dermatologists involves the insertion of a third party’s financial interest into the physician-patient relationship, says Louis Kuchnir, MD, a dermatologist in private practice in Marlborough, Massachusetts. “Dermatologists who used to refer to the best Mohs surgeon or pathologist, solely based on the patient’s best interests, may find themselves employed by somebody who has a financial interest in their decisions and recommendations,” he says. “While we as dermatologists have to admit that we have our own financial interests — which are hopefully not prioritized over the best interests of the patient — in this scenario there’s now a third party, and there may be the appearance that we make decisions, or even are part of contractual relationships, that require us to take into account their financial interests. That can be a little scary for doctors.”

Beyond any potential ethical dilemmas, dermatologists in equity-acquired practices may potentially face legal and regulatory compliance issues as well. “The primary methods that some PE firms use to improve profitability (changing ancillary referral patterns, encouraging additional procedures, and expanding use of unsupervised physician assistants) may ultimately carry risks of Stark law noncompliance, False Claims Act exposure, and malpractice litigation,” says Dr. Resneck (doi:10.1001/jamadermatol.2017.5558).

WHY IS DERMATOLOGY ATTRACTIVE TO PRIVATE EQUITY?

As more investors turn their eye toward dermatology, their interest can be attributed to a variety of factors, including:

More instances of skin cancer (Morb Mortal Wkly Rep. 2015;64(21):591-596)

An aging population with greater skin care needs (J Am Acad Dermatol. 2017;76(5):958-972)

A historically fragmented specialty ripe for consolidation

Physician scarcity — demand for dermatologists outweighs their distribution (J Am Acad Dermatol. 2017;76(5):958-972)

Profitability of the specialty — At the 2015 AAD Annual Meeting, David Wagener, MBA, CPA, commented, “Dermatology is thought to be sufficiently diversified to have upside potential even in difficult times. We have the ability to provide both medically necessary services that are covered by third-party payers — which are always at risk of payment reductions — and non-covered elective services that are cash on delivery.”

Profitability of specialized services such as Mohs and dermatopathology — According to 2015 data from QuintilesIMS (formerly IMS Health), there are approximately 9,600 office-based dermatologists at 7,800 dermatology practices in the United States, with an estimated 15 to 20% operating a full-service histology lab. This makes the specialty particularly attractive to outside investors, due to the profit generated by practices that operate their own pathology labs. By QuintilesIMS’s calculation, a five-physician practice in 2015 could generate an estimated total of $733,100 of annual pathology revenue.

Likewise, the Mohs surgeons found within larger groups have made those groups more attractive to investors, according to AAD 2016 group practice data, which found that specialized dermatologic services (such as Mohs surgery and dermatopathology) were more likely to be offered by larger group practices, which in turn, were more likely to be private equity or corporate-owned.

The desirability of individual practices for acquisition by equity-backed groups is often determined by whether or not a practice:

Offers a mix of medical and cosmetic dermatology
Performs Mohs surgery
Does in-house pathology
Employs nurse practitioners or physician assistants
Has a desirable geographic location

WEIGHING THE PROS AND CONS

How can dermatologists reap the rewards of private equity partnership while avoiding the pitfalls? Do your due diligence, suggests Dr. Evans. “While obviously the amount of money being offered is important, just as critically so are the terms of the offer itself. Things like non-compete clauses, how long you’re going to continue to work for them, whether you’re going to invest in the mother company, et cetera. The second thing to look at is the reputation of the group. USDP is what I would consider a mature group; they have a lot of doctors; they’re experienced at bringing practices into the fold. Other groups are just private equity looking for a platform to get started in the business, but they may not have a lot of experience in dermatology or even in medicine.”

Dr. Jampel agrees that it is important to consider reputation before committing to any partnerships. “I happened to do my residency with the owners of the group I joined,” she says. “I respected their integrity and primary concern for patient care; I would not have joined unless I had a high level of confidence. I also had a knowledgeable attorney who had worked on other similar transitions.”

Despite presiding over an equity-backed dermatology group, Dr. Wernli cautions that dermatologists should understand that not all private equity partnerships are created equal. “Not every group has the same intentions, and you have to choose the right partner,” she says. “Our physician leadership team was at the table in our transactions with Varsity Healthcare Partners and OMERS. In both cases, our physician leaders vetted the private equity groups and were unwavering about selecting a partner that was aligned with our physician-centric operating model and shared our desire for increasing patient access to board-certified dermatology care. Our goal was to identify a long-term financial partner that was committed to supporting our practice expansion plans and creating a best-in-class support organization to enable our physicians to focus their attention on our patients.”

“I think physician leadership that prioritizes patient needs could potentially be maintained in these new arrangements,” says Dr. Kuchnir. “I want to be hopeful about it, because it strikes me as the kind of thing that can be done right. I’m sure it can be done wrong.”

INVESTING IN THE FUTURE

Where is the private equity trend in dermatology headed? From Dr. Evans’s point of view, while private equity’s acquisition of dermatology practices shows no signs of immediately slowing, eventually the market will be forced to level out. “Since I sold my practice I haven’t been shopping around, but I know that our group continues to acquire practices, and I know that other groups have continued to expand. Certainly at some point you’d expect the market to calm down since it’s been so hot. That day is likely coming, whether it’s here today or a year or two or more from now.”

According to Dr. Davey, despite the current uncertainties in health care, the market remains an attractive platform for investors. “They want to get into the health care market because it’s continuing to grow. What’s happening with the Affordable Care Act is throwing a wrench in that a little bit, so the insurance side is a little bit scary for them, but of course dermatologists have the cosmetic side as well to provide cash flow to these groups.” (See sidebar for more on dermatology’s appeal to investors.)

Overall, while profits are undeniably part of private equity’s interest in the specialty, capital backers also have a vested interest in keeping the needs of physicians and their patients in mind. “My group is overall responsive to physician needs, and wants us to be productive and happy, otherwise it doesn’t work for anyone,” says Dr. Jampel.

More so than good or bad, change in the way the specialty operates is inevitable, says Dr. Evans. “You can certainly argue both sides of the coin, but these groups are a huge part of dermatology now, and they are going to be a bigger part of dermatology in the future. So even if you don’t like it, you still have to be thoughtful about how the specialty is going to change and how we as dermatologists are going to approach it.”

As dermatology consolidates, private equity expands its reach. What does it mean for the specialty's future?

Pulling back the curtain on private equity

As dermatology consolidates, private equity expands its reach. What does it mean for the specialty's future?

Grouping up: what drives consolidation?

Private equity investment by region

NAVIGATING THE SALE

SELLING OUT: PROS AND CONS OF PRIVATE EQUITY

Pro 1: Immediate payout if your practice is valued favorably

Pro 2: Relief of administrative duties

Pro 3: Financial backing for ambitious expansion

Con 1: Loss of control

Con 2: Conflict of interest

The main players: Private equity ownership in dermatology

Anne Arundel Dermatology Management (ADM)

Forefront Dermatology (formerly Dermatology Associates of Wisconsin)

DermOne (formerly Accredited Dermatology)

Riverchase Dermatology and Cosmetic Surgery (Riverchase DCS)

Dermatology Solutions Group (formerly Gulf Coast Dermatology)

Schweiger Dermatology Group

US Dermatology Partners (formerly Dermatology Associates/Dermatology Associates of Tyler)

Advanced Dermatology & Cosmetic Surgery (ADCS)

Integrated Dermatology Group*

United Skin Specialists

Epiphany Dermatology

Platinum Dermatology

The Dermatology Group, P.C.

West Dermatology

California Skin Institute

QualDerm Partners, LLC

WEIGHING THE PROS AND CONS

INVESTING IN THE FUTURE