In recent years, private fund managers have faced significant headwinds in connection with capital formation and fundraising efforts, including in the private equity space.
New firms in particular face barriers to entry in an extremely competitive market at a time when investors have limited capital to deploy and are focused on the rate of distributions from their current fund investments.
In 2024, however, funds focused on healthcare investments show signs of bucking these trends as capital floods into highly specialised firms.
The lower middle market specifically has served as a viable target for capital in search of above market returns in this sector.
In fact, many firms that adopted investment strategies limited to healthcare and healthcare-adjacent businesses have been generating relatively outsized returns.
This has drawn growing interest from capital.
Trending industries such as value-based care serve as useful targets for investors willing to underwrite more niche windows of opportunity.
Limited partner (LP) interest in healthcare-specific investment strategies has also allowed new firms to emerge that have chosen a specialist approach to investment opportunities.
These LPs are attracted not only to healthcare, but to improving healthcare systems globally via capital deployment and investment in infrastructure that can enhance access and deliver better outcomes.
The combination of outsized returns and a socio-politically impact investment opportunity in healthcare has led to an LP base that is willing to bear risks and deploy capital.
These LPs are also attracted to the competitive advantage afforded to firms that focus on a highly specialised market, such as healthcare.
At McDermott’s 2024 HPE Miami event, we polled a large audience of industry professionals on their outlook for the fundraising environment.
A majority of those polled do not expect private equity fundraising to return to 2021 levels over the next three years, nor do they think 2024 will be a better market for first-time managers than 2023.
Instead, four out of five of attendees surveyed agreed that large funds and established managers will take a growing share of total fundraising, as has been the trend the last few years.
Standing out in such an environment is challenging, but healthcare strategies appear to have an edge in standing out.
THE ADVANTAGE OF FOCUS: SPEED, RISK AND UNDERSTANDING
Healthcare specialisation in private equity firms generates several distinct benefits as funds identify sophisticated projects, act quickly and bear risks.
All levels of firm personnel of an effective healthcare specialised private equity firm, from analysts and directors to investment committees, are highly educated and familiar with relevant elements of the healthcare systems in question.
This can remove information asymmetry issues sometimes present in the relationship between investors, committees and LPs.
At specialised firms, managing directors can quickly identify the projects many generalists may miss, analysts can quickly model opportunities, and well-versed investment committees can then swiftly measure risk and approve complex opportunities that could face more information barriers in committees run by generalists.
Having built strategies focused on niche areas of the healthcare economy, specialised firms can also deploy the same models repeatedly on different but related targets, benefitting from the efficiency of not having to start from scratch each time.
Additionally, as healthcare investing has matured so has the sophistication of its LP base.
LPs have familiarised themselves with megatrends in the healthcare economy, whether that relates to the intricacies of US systems, such as Medicare and Medicaid or the country-by-country nuances in play when navigating pan-European roll-up strategies.
Educated LPs allow fund managers to easily communicate complex healthcare investment strategies and take risks without the fear of alienating investors.
A well-informed LP becomes an asset and an advocate for a firm rather than a roadblock.
THE DEALS OUTLOOK
Most attendees at HPE Miami 2024 shared via the event polls that they were optimistic about the outlook for healthcare transactions this year, suggesting there will be more opportunities for fund deployment.
The labour market challenges that beset healthcare assets in 2023 will not likely disappear in 2024, but buyers seeking scalable assets with sustainable growth levers can expect more deal flow.
Signs of credit markets opening in the first half of the year, along with bid-ask pricing convergence, suggest healthcare private equity activity should unlock in the coming months.
Nearly half of those surveyed at HPE Miami felt that prices will settle over the next year at a level closer to the prices that buyers are willing to pay, with 46 per cent predicting transactional activity will not ramp up until the fourth quarter of 2024.
We expect to see the current focus on organic growth maintained, along with an increasing appetite for investment in companies making use of new technologies, such as generative artificial intelligence (AI), to drive time and cost savings.
Pharma services is predicted to be the most active subsector.
With the pharma industry anxious for faster drug-to-market activity and with pharma services the obvious catalyst to make that happen, the great promise that tech and AI present when it comes to fueling clinical trial subject recruitment and results analysis further explains investor appetite.
The physician services space is also expected to be busy with deals, while digital health and health IT will offer the best returns for growth equity.
As transactional activity rebounds in the complex healthcare space, specialisation will continue to serve as a differentiator both in relation to fundraising and dealmaking.
The return to specialisation has proven within the healthcare sector to be appealing to investors looking to increase their exposure to the sector, as such, it’s little wonder that dedicated healthcare managers stand ready to reap rewards from a more robust market going into 2025.
Key Takeaways
- Fundraising environment has been challenging for many PE funds for the last few years.
- Specialist healthcare strategies are attracting investor appetite.
- LPs are drawn to potential outsized returns and opportunities for positive societal impact.
- Newer managers need a way to stand out in a market dominated by established managers
- Specialists often benefit from quick executions and an industry specific understanding of risk.
- The complex healthcare regulatory landscape favors experienced players.
- Well-informed LPs are familiar with megatrends in the healthcare economy.
- With the deal market picking up (but still highly nuanced), specialists are likely to thrive.
Find out more about McDermott, Will & Emery at mwe.com
