Over the last two years the number of private equity investments in the UK has fallen by over 50 per cent, due mainly to an absence of debt and the high returns required by investors.
However there are signs that the private equity firms are looking to invest once again, and it seems that despite concerns over imminent cuts in government spending, they have the healthcare sector in their sights.
Indeed, according to the recent annual survey by Grant Thornton, private equity firms are targeting healthcare as the sector they would most like to invest in, with 47 per cent of respondents indicating it is where they are most likely to be active over the next 12 months.
Despite the appeal or potential profitability of the technology or market, every private equity professional will tell you that they invest in management teams, as it is these groups that actually make things happen. This is no different with the health sector and increasingly, therefore, private equity firms now conduct rigorous, extensive due diligence on the individuals and the team on which their investment depends.
But for those healthcare companies with a compelling market opportunity looking to attract investment, it is important to be equally clear about what would make the ideal investor. This will depend on the investment, but conducting rigorous due diligence on the individual investors makes sense, since they will become an important member of the team for a number of years.
Based on our experience of assessing management teams on behalf of private equity investors, as well as working with a range of investors themselves, there are a number of important questions that can help the due diligence process for both parties.
The starting point is, of course, the investment strategy. What is the investor looking to achieve by investing in a healthcare organisation? Given that an organisation’s value is usually based on a multiple of its profit, an investor is aiming to significantly increase profit and to increase the multiplier of profitability. Increasing profit will mean selling more products to more people, as well as ensuring an aggressively managed cost base, and increasing the multiplier will in turn mean selling a range of more valuable products to a broader range of valuable people.
In assessing a healthcare management team, investors are therefore looking to answer a number of obvious but potentially intangible questions: does the team have the proven skills and capabilities to deliver the investment strategy? Is the balance of skills within the team reflective of future priorities as well as current ones? Can the team manage the business through what is likely to involve dramatic growth and organisational change?
In return, the management team should be clear about what the investor will bring that will help the company deliver the strategy. What does the investor contribute that the management team needs and cannot get any other way? For example, if the strategy requires entering a new market, does the investor have strong, valuable contacts in that market? Does the investor have proven experience in helping their investments enter new markets?
Alternatively, the strategy may involve bringing a new innovation to market, or driving out manufacturing efficiency. What operational expertise can the investor bring? What experience of executing similar strategies does the investor have?
Private equity firms recognise that supplying capital and financial engineering skills is not enough to ensure a successful investment. With debt harder to secure, and investments being held for longer, a high return requires operational improvement, not just improved economics; ‘alpha as well as beta’.
In assessing a firm, most investors particularly focus on three crucial roles, regardless of the sector in which they are targeting: the chief executive or managing director, the chief finance officer or finance director, and the business development or sales director.
Within the healthcare sector, investors want to back chief executives who can manage the often challenging “white coats and suits” relationship between science and commerciality. A chief executive needs to demonstrate that they have the respect of both parties yet will not shy away from going against both in pursuit of a value-creating goal. The chief executive is expected to be able to create a clear strategy based on insights from the wider market place in addition to a well-informed view of the organisation’s current capabilities.
A healthcare chief executive will sometimes have the unusual task of managing a business where costs exceed revenue. Investors are looking for the allocation of costs to those activities that can create value, and the eliminations of those costs that do not. This can be more challenging for a healthcare firm to articulate than other markets.
It seems obvious that healthcare management teams and investors need to get to know each other properly prior to an investment being made. We have seen instances where the team of managers, investors and non-executives all only meet one other for the first time at the first board meeting. Expecting the team to work based solely on technical background, commercial experience and financial incentives seems risky – and is often proved to be.
As the healthcare sector becomes a target leading into 2011, these are valuable lessons for both parties to keep at the forefront of their minds.
Jonathan Chocqueel-Mangan is managing director of Tyler Mangan