The Evolving Landscape of Healthcare Bankruptcies and Private Equity’s Impact

The healthcare sector has witnessed a significant surge in bankruptcies, positioning it among the top three industries for filings in 2023, as reported by S&P Global.

With the healthcare landscape rapidly evolving, driven by private equity involvement, and shifting deal dynamics, it is crucial to understand the factors behind this distressed market. 

In this article, we explore the insights shared by Andrea Cunha, a partner in the health care and FDA practice group at K&L Gates, as she provides a comprehensive overview of the drivers behind the rise in healthcare bankruptcies, the influence of private equity firms on the deal market, emerging trends in healthcare deals, challenges faced by distressed companies, anticipated industry changes, and the regulatory considerations impacting healthcare transactions.

Factors Contributing to Increasing Healthcare Bankruptcies

According to Cunha, several key factors contribute to the mounting number of bankruptcies within the healthcare sector. 

She notes, “Occupancy in senior living and skilled nursing facilities is still recovering from the impact of COVID-19 and faces new competition. While there are many occupied units, occupancy rates are still below pre-pandemic levels due to inventory growth in recent years.” 

Furthermore, she highlights the challenges posed by skyrocketing labor and supply costs, driven by labor shortages, inflation, and lingering supply chain disruptions caused by the pandemic. 

“COVID-related government funding, which provided temporary relief to healthcare providers, has been exhausted,” she says. “Now, providers face the challenge of repaying the advanced repayments received during the pandemic.” 

Additionally, the limited ability to pass cost increases to payors hampers the financial sustainability of healthcare providers, particularly hospitals and skilled nursing facilities, in the face of rising expenses. Lastly, low returns on invested assets and interest rate increases imposed by the Federal Reserve contributed to the financial instability of healthcare providers. As a result of these market forces, organizations have been forced to implement Director Redundancy measures to lower operational expenses.

Private Equity’s Role in Reshaping the Healthcare Deal Market

Private equity firms have played a significant role in reshaping the healthcare deal market, as Cunha underscores. She points out that private equity provides various opportunities, particularly for independent physician practices traditionally seeking alignment with hospital systems to gain leverage in negotiations with payors. 

However, with private equity investments in specific specialties, physician practices now have more options for alignments. Cunha explains, “Private-equity-backed management service organizations offer physicians greater autonomy while still providing leverage in negotiating better reimbursement rates with payors.” 

While private equity’s interest in healthcare remains strong due to the industry’s resilience and the availability of capital, concerns have been raised regarding whether patient care takes precedence in its profit-driven business models.

Current State of Healthcare Deals

Exploring the current state of healthcare deals in the first two quarters of 2023, Cunha shares valuable insights. She acknowledges that overall deal volume in healthcare has declined compared to previous years. 

However, the historical context reveals that significant deal activity is still ongoing. Notably, private equity deals in healthcare reached nearly $90 billion in 2022, marking the second-biggest year on record. Although valuations have cooled and buyers are increasingly focused on diligence, specific areas such as physician practice management, orthopedics, cardiology, and behavioral health continue to exhibit strength.

Challenges Faced by Distressed Companies

As highlighted by Cunha, distressed companies in the healthcare industry face unique challenges. One significant hurdle arises from payor contracts, mainly when operating on compressed timelines. Obtaining consent from payors for contract assignments within a timely manner can prove challenging. 

Furthermore, buyers assume existing liabilities before the assignment, adding to the complexity. 

Cunha suggests that bankruptcy can mitigate these challenges by allowing parties to define liabilities and factor them into the sales price. Additionally, some bankruptcy courts view government provider agreements as statutory entitlements rather than executory contracts, thus alleviating the burden of successor liability.

Anticipated Trends and Changes in the Healthcare Industry

Cunha mentions the continued consolidation trend when discussing anticipated trends and changes in the healthcare industry. She states, “With interest rates in flux, and margins being squeezed by increased labor and supply costs, independent health care providers will struggle without bargaining power with payors for better reimbursement rates.”

She highlights the impact of these trends on investors, healthcare institutions, and professionals within the industry, adding, “These trends will provide opportunities for healthcare systems and private equity and will drive deal volume this year. As more and more healthcare providers find themselves struggling financially.”

Advice for Buyers and Sellers in Healthcare Transactions

Based on her experience advising buyers and sellers in healthcare transactions, Cunha offers valuable advice in the current climate. She emphasizes, “Diligence has got to be a greater focus. In the past few years, there was so much deal activity and competition for deals that diligence did not seem to be as big of a focus.”

In the current environment, buyers must be more strategic in their acquisitions and spend time on diligence to ensure informed decision-making and mitigate potential risks.

Strategies for Companies Dealing with Distressed Healthcare Assets

For companies grappling with distressed healthcare assets, Cunha recommends seeking counsel from experts who understand the intricacies of such transactions. Distressed transactions present opportunities, but they also carry risks that need to be comprehensively understood. 

Considerations for unsecured creditors, fraudulent transfers, and successor liability necessitate creative solutions that can be achieved with the assistance of a knowledgeable legal advisor.

The Role of Restructuring in Supporting the Healthcare Industry

Regarding her work in restructuring and its support to the healthcare industry, Cuhna highlights its significance. 

“Having both a background in restructuring and health care mergers and acquisitions is very helpful in today’s climate as buyers, sellers, and distressed companies may require unique solutions to help facilitate the best outcome for the company and the various constituents that need to be considered in a distressed transaction,” she explains.

She also emphasizes the importance of considering alternatives to bankruptcy, stating, “While bankruptcy is a useful tool, it is expensive and not always the right choice depending on the transaction.”

Regulatory Changes and New Legislation Impacting Healthcare Providers

Cunha discusses the regulatory changes and new legislation that healthcare providers must be aware of. She cites a trend by states to oversee healthcare transactions, with some requiring pre-approval of such transactions. 

“For instance, California has created the Office of Health Care Affordability to monitor and manage healthcare costs and will conduct cost and market impact reviews of certain healthcare transactions,” she says. “Other states like New York, Connecticut, Delaware, Massachusetts, Nevada, New Jersey, Oregon, Rhode Island, and Washington have also enacted or proposed legislation that increases the oversight over healthcare transactions.”

Conclusion

In our conversation with Andrea Cunha, we gained valuable insights into the increasing number of bankruptcies within the healthcare sector and the evolving landscape of healthcare deals. 

Factors such as the lingering impact of COVID-19, escalating costs, and limited ability to pass expenses to payors contribute to the distressed market. Private equity firms significantly reshape healthcare deals, offering opportunities while raising concerns about patient care prioritization. 

The first two quarters of 2023 show a slowdown in deal volume but strength in specific areas. Distressed companies face unique challenges that require careful navigation, potential solutions through the bankruptcy process, and expert guidance. 

Anticipated trends include continued consolidation and the need for strategic decision-making. Diligence becomes paramount for buyers and sellers, and seeking expert advice is crucial for companies dealing with distressed assets. The role of restructuring is significant in supporting the healthcare industry, while regulatory changes add complexity to operations and transactions.