Chicago Pacific Founders, whose portfolio company Pinnacle Dermatology recently acquired Spencer Dermatology Associates in Indiana, invests in lower middle-market healthcare service providers. Besides its dermatology company, the firm has also built portfolios of retirement living communities and dental practices. CPF, with offices in Chicago and San Francisco, was founded in 2014 by Mary Tolan, who previously founded Accretive Health; Larry Leisure, former operating partner at Kleiner Perkins; and Vance Vanier, former president of Verinata. We asked Tolan for her views on middle-market healthcare services trends and about CPF’s investment approach.

What trends are driving the need for healthcare services in the U.S., and what types of services are growing?
Healthcare services are growing across the board with the aging of our population as life expectancy continues to climb. They are also driven by lifestyle-related issues such as body mass index, prescription pain medication dependence, and alcohol and substance abuse. There is also a growing realization of significant under-treated mental and behavioral health issues that can also have additional negative effects on physical health. There are significant growth trends in services that create value for patients and the healthcare system. The emphasis is on how to improve clinical outcomes and patient experience while also making healthcare more affordable. An example is a trend toward less expensive modalities of care. What services can be safely and effectively performed on an outpatient basis versus requiring a hospital stay? There is a general trend toward the outpatient or ambulatory setting. There is also a growing trend toward value-based payment models. An example would be a primary care practice that cares for their patients and is accountable for clinical quality outcomes. Physicians in these models have realized that better quality care actually costs less because their patients have reduced complications and re-admissions to the hospital. This value-based accountable model can apply in various settings where the specialty doctor is in essence the lead doctor for that patient. For instance, a patient with significant heart disease might have their cardiologist in the “captain of the care team” role. There are other opportunities as well. Improved care coordination for those suffering with serious chronic conditions that are reliant on expensive specialty medications can bend the cost curve. Over the past decades we seen a surge in prescriptions spending and specialty drugs in particular. Greater accountability and economic alignment by the care team can yield both meaningful improvements in clinical outcomes and more appropriated use of high-cost medications. Similarly, we are also seeing opportunities in the post-acute space to benefit from stronger care coordination, such as in short-stay rehab after surgery. Indeed, any clinical approach that expeditiously helps patients get back home and to their usual lives can benefit from a value-based payment model.

What is fueling M&A in healthcare services?
Healthcare services is probably the largest fragmented market in our country. There are thousands of very small healthcare services entities. For instance, we have approximately 175,000 dentists and 85 percent of them work in small practices with one or two doctors. When these practices are aggregated there is the ability to invest in technology such as digital scheduling and automated payments, cutting-edge equipment and supplies, the optimal support team such as hygienists, and specialists like orthodontists and periodontists. Furthermore, more corporate resources bring the added benefit of investment in training and staff development. Indeed, we are in the early and exciting stages of observing the benefits that scale, investment and technology can bring to a variety of the fragmented industries within healthcare. We also feel there is a need to both demonstrate regional relevance and utilize the negotiating power that comes with scale.

How is the regulatory climate affecting M&A in healthcare services?
It is in the public interest to always have choice and competition. The most significant regulatory considerations are when the largest player in a market wants to become even bigger through acquisition. The regulatory process must evaluate if sufficient market competitive forces remain. These considerations frequently affect the dominant hospital system in a given geography.

Tell us about CPF’s investment strategy and the makeup of the firm’s leadership team.
We focus on finding care models that are delivering superior clinical quality and patient experience in a more affordable way. We get excited about partnering with enlightened business and clinical leaders who want help to become a regional or national leader in their domain. Our team is comprised of people who have founded and operated healthcare companies and “have walked in the shoes” of the founders and CEOs who become our partners. Our team is also comprised of members who bring deep background and experience in private equity investing in healthcare companies. On a firmwide level we also understand it’s not just about scale; it’s also about increasing regional relevance and gaining negotiating leverage with payers.

What is your outlook for middle-market M&A in healthcare services?
The outlook is very positive for any healthcare entity that is delivering differentiated care quality in an accountable model.