3. Protect the Board and Sponsor!

Right now, boards of directors of middle-market and lower-middle market healthcare companies face challenging decisions as management struggles with the cash constraints resulting from inflation’s effects on debt service, patient demand and staffing costs. Historically, these types of challenging economic factors have created environments ripe for disputes with minority equity holders and lenders. The litigation risk is even greater in light of the continued headlines focused on private equity’s role in healthcare – the most recent of which concerned lawsuits in 33 states alleging violations of corporate practice of medicine (CPOM) laws by management service organizations (MSOs) supporting urgent care clinics.

Board members and PE sponsors would be well-advised to remember that the government has pursued individual claims against private equity investors for healthcare law violations of the portfolio company – a record-setting example was highlighted by Jennifer Weaver and Eric Scalzo.

Will Boards take the initiative to protect their interests by insisting on proactive compliance and oversight? Or will the demand to tighten belts, cut costs and increase revenue put compliance on the backburner? The compliance questions that boards of PE-backed companies should be asking have not changed, but the importance of asking them has only increased.

4. How Can Borrowers Solve their Cash Constraints and Comply with Debt Covenants as Earnouts Mature?

Starting in mid-2020 in response to COVID and continuing in full force through 2022, buyers have repeatedly deployed earnouts as a way to bridge valuation uncertainty resulting from unproven financials. While the use of earnouts in healthcare previously had been less common due to OIG warnings that they would be “suspect” as potential violations of anti-kickback laws, there is little doubt that their use has significantly increased for the legitimate purpose of addressing temporary valuation uncertainty as opposed to incentivizing behavior. 

The problem in 2023 is that none of those buyers anticipated the impact that inflation and supply chain disruption would have on cash availability now, when those earnouts are coming due. And because these earnouts often count as “debt” under credit facilities, healthcare borrowers may be constrained in their ability to close new deals or execute on de novo expansions while the unpaid earnouts remain on the books. We have already fielded calls from clients across multiple sectors assessing their options – options that work from a credit agreement and tax perspective and that are palatable for earnout recipients to the extent their involvement (or acquiescence) is required – but we expect this is only the tip of the iceberg.  Waller’s Steven Connor, Elle McCulty and Rob Harris have thoughts on options to address this liquidity squeeze, which provide relief under a portfolio company’s debt covenants while continuing to honor the commitments to the earn-out holder

5. Sellers and Bankers Beware: The Over-Leveraged Buyer

Buyers increasingly feel liquidity constraints due to inflation, and are doing everything they can to keep potential financing challenges under wraps (for good reason). For years, record levels of dry powder and cheap financing meant sellers paid little attention to a buyer’s balance sheet, relative to the headline purchase price being offered.

2023 is a whole new world, and it may be time for a shift in expectations for what a seller can reasonably expect from a buyer. For example:

6. The Fog of War for Representation & Warranty Insurance (RWI)

This time last year, the RWI market was “white hot”, providing carriers with leverage to cherry pick the deals they wanted to underwrite, and on terms they wanted with little room for negotiation.  That tide has shifted. Ask any RWI broker and they will tell you the same thing: (1) there has never been a better time to buy insurance, at any price point (even for known liabilities and small tuck-ins!); and (2) there is an unprecedented number of claims being filed against policies right now. No one can say with certainty how long those two dynamics will last, especially since increased claims would normally be expected to raise premiums. The healthcare world is still relatively new to representation and warranty insurance, making it even more important for dealmakers who pilot M&A processes in the industry not to fly blind as the market undergoes its next (rapid) evolution.

7. Women in Healthcare and ESG: Talent Seizes Opportunity

Two trends are coming to a head at the same time: (1) the growing success of women in leadership positions in healthcare law firms, private equity shops and corporate management teams, and (2) the robust demand for better healthcare that addresses women’s needs – from the obvious (OB/GYN and fertility) to the less obvious (cardiology). Will women’s issues in healthcare present a unique opportunity for women to highlight their ability to add value and perspective? Will a focus on women’s healthcare become an anchor that limits the business case for women to advance in the industry to only “women’s issues”?  Women are not solely in healthcare to speak on women’s healthcare issues. They are there to bring a new perspective. Studies have shown that the presence of women (and, not just a single token) in Board rooms improves governance even when not speaking about women’s issues.

A related issue will be the ongoing and hotly-contested issue of ESG. Although, the political attention has been focused on environmental factors, ESG can and should also consider diversity, equity and inclusion, including female representation in corporate governance. Because LPs have demanded attention to these issues, access to favorable capital may be better available to companies that actively position themselves either as serving an underserved population or as having significant representation of women and minorities in corporate governance. Will ESG investors and lenders tilt towards companies that aim to serve underrepresented groups, or instead towards companies that, regardless of who they serve, have significant minority representation in the execute suite? There will be no avoiding these issues in 2023 as the business demand for investments in women’s health grows in parallel with burgeoning attendance at well-run conferences such as Kayo and Women in DSO.

8. Skynet is Coming: Chat GPT Brings Attention to Artificial Intelligence

Healthcare technology has emerged in recent years as a dominant area of interest among investors and strategists. And right now, the pubic release of Chat GPT last month has brought a surge of attention to the incredible advances made in artificial intelligence –including talk of a $29 billion tender offer, which would make the research lab behind ChatGPT, one of the most valuable U.S. startups per the Wall Street Journal. The potential application of A.I. to healthcare is deep and wide, from dental treatment to revenue cycle management. It is an area closely watched by our healthcare intellectual property team (including A.J. Bahou, who will be at JPM).

J.P. Morgan Healthcare Conference 2023

As we pack up our rain gear and head to San Francisco, these are some of the top questions that we – and our clients – are thinking about. There are, however, many issues for healthcare companies, investors and advisors to evaluate and address as we begin the new year. Let’s hope the storms in San Francisco aren’t a metaphor for what’s to come.


David Marks
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Morgan Ivey
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