By Craig Hauben, President & CEO, MediSpend

November 2024 – The rise of Private Equity (PE) capital as a prime funding source for private healthcare companies has put a lot of pressure on these companies to deliver financial results quickly.  PE funds have limited lifespans.  Most are chartered to be around for 10 years with the option to extend to 11 or 12 years in total.  Keeping in mind that most companies don’t get their investments from a PE fund at the very beginning of the fund and need time to market and transact the company, a company can only expect a PE fund to be involved for 3-5 years on average.  And in this time the fund will be looking for a 3x return on their money, at a minimum, to call it a success.

PE companies and their portfolio companies have historically had two main levers to pull to drive the financial results they seek:

Financial Engineering: At its core, this is about leveraging differentials in multiples paid for different elements of a business rather than improvements to the core business.  For example, a small business might sell for 3x revenue where a business at scale might sell at 5x revenue.  So, if the bigger business can buy the smaller business, when it eventually sells, the revenue from the small business (now part of the total revenue of the bigger business) sells for the same 5x, or more than twice what the smaller business would fetch on its own.

There are lots of different kinds of financial engineering, but the most common are mergers and acquisitions, business transitions (e.g. make it seem like it’s a tech business, which sells at a higher multiple) and severe cost cutting initiatives.

Operations Engineering: This is good old execution: focusing on the nuts and bolts of the business and making it run better. This could be focusing on how the product is delivered to drive better gross margins or making improvements in the product to sell more and retain more customers.  In the end, this is the old idea of building a good, long-term sustainable company and driving financial value from that.

As you might imagine, Operations Engineering is much harder and less predictable than Financial Engineering.  One can get very precise in the value of multiple expansion from an M&A transaction, often without worrying about integration the acquired company, since it can continue to be run as it as is.  Making investments in people and processes doesn’t fit well into a spreadsheet.  As a result, in the 1980s 51% of value creation came from Financial Engineering[i].

The frothy years of the last decade or so have put serious pressure on Financial Engineering schemes:

• A high-interest rate environment makes M&A, which is usually debt funded, much more risky
• The high valuations being paid for good companies have made traditional restructuring less impactful
• As deal volumes have cratered, business fundamentals have become the more attainable strategy

The result is that financial engineering now accounts for only 25% of value creation.  Additionally, newer studies show that the ability to grow revenues organically has created more value than all efforts to reduce costs, expand earnings multiples, and improve free cash flow combined according to the BCG 2010 Value Creators Report.

Now that the focus is returning to Operations Engineering, what should we be considering?

• People Matter: the environment of the company, the people in it, and how they work together can be as important as anything else. Having a strong culture that people feel connected to cannot be under estimated.
• Build for Scale: Understanding the stage of your business and developing the appropriate controls and processes for that stage is important. To put the controls of a $1B company on a $25M is a mistake.  Companies need to balance the risks they take throughout the business with their need to breath and grow freely.
• Growth Matters: Knowing that more value is placed on growing a business, keep your focus there first. If that means adding new product or expanding into new markets, as opposed to winding down investments in product, sales and/or marketing, those are probably good investments.
• Owner not Investor: People who think like investors sometimes make short term decisions at the expense of long-term gain. That is the nature of investing.  By continuing to keep your focus on growing a great company, you are more likely to make the right decisions for the business.

And I would say, in closing, if you are considering an investment from a PE firm, or any investor for that matter, you should ask for and understand their thesis.  You should know what assumptions they are making and make sure that you are aligned with them.

[i] Ted Bililies, “Private Equity Needs A New Talent Strategy,” Monday Business Review, October 26, 2023, accessed via Factiva, January 16, 2024

About the Author

Craig Hauben is an executive with more than 30 years of experience in healthcare and technology, and an investor with an exceptional track record as an operator and a broad portfolio of private placements.

As the President and CEO of MediSpend, a SaaS provider of compliance software to life sciences companies, Craig orchestrated the transition of the company into a high-growth organization and globally dominant player illustrated by 5 years of win rates above 60%.  With the original charter being to transition the founder/CEO and position the company for exit, enterprise value increased by more than 300% in the less than 3 years it took to recapitalize the company.  Continuing on for another 3 years culminated in the transition to positive cashflow from operations and 370% improvement in EBITDA.  Moreover, this occurred during the turbulent times of COVID, the Great Resignation and historically high interest rates.

As an operator, he is known for generating swift results when stepping into underperforming organizations and highly competitive markets. His strengths are in moving product markets and driving substantial growth. He is recognized for creating unique product strategies, improving go-to-market organizations, driving value through inorganic growth, and pushing executive teams and boards beyond their comfort zones to attain outstanding outcomes.  As an investor, he is involved with businesses in and out of health care, with a wide variety of tech-forward and service-forward models.

Craig has operated in a variety of advisory roles including as a Board Director, as an Advisory Board member, and as a Board Director of a not-for-profit. In addition, Craig has had Board reporting responsibilities at several companies including Healthfirst and CareConnect (health plans), Arro Health (health care services) and MediSpend (life sciences SaaS software provider).