With various headwinds resulting in down volume in 2023, buyers and sellers alike find themselves asking whether 2024 will see a rebound in deal activity. As we begin 2024, we have highlighted the issues and trends that private equity (PE) investors should consider when evaluating transactions in the healthcare sector.

1. Healthcare Continuation Funds: Strategic Considerations

BY BRYAN BYLICA

With a sluggish 2023 for platform exits, an increasing number of PE funds looked to continuation funds to offer liquidity to their limited partners (LPs). With the outlook for the first half of 2024 still uncertain, PE funds should continue to evaluate continuation funds as a viable option. A continuation fund is a general partner-led secondary transaction that is designed to offer LPs liquidity with respect to their interests in one or more mature portfolio companies within an existing PE fund. Continuation funds offer LPs in a PE fund the option to either cash out their investments before the underlying portfolio investments generate liquidity on their own or to retain their investment and "roll" into the continuation fund (and often make an additional incremental commitment to support the mature portfolio company(ies) in the continuation fund). Continuation funds are often formed to extend the life of a successful fund, enabling the fund manager to retain and manage mature, high-performing assets for an extended period rather than selling them prematurely. This strategy can be beneficial for both fund managers and investors, allowing for increased flexibility and potentially higher returns. It also offers the opportunity for institutional secondary investors to invest in high-performing portfolio investments managed by experienced sponsors. A typical continuation fund transaction will be led by a single institutional investor experienced in secondary transactions or a small group of experienced secondary investors that will negotiate the terms of the continuation fund transaction and the continuation fund structure.

Continuation funds in the context of healthcare investments operate similarly to those in general PE. These funds are particularly relevant in the healthcare sector, where the development of innovative therapies and technologies may require longer investment horizons. The continuation fund model offers fund managers the flexibility to extend the life of a healthcare fund nearing the end of its term to allow high-performing portfolio companies the time they need to reach their full potential while providing additional capital to support the continued growth and development of these portfolio companies, while at the same time offering liquidity to LPs that wish to exit the investment.

Considerations when utilizing continuation funds include:

  • Alignment. Ensure that the interests of the existing and new investors align in terms of investment horizon, risk appetite, and return expectations. New investors will also seek alignment with the general partner through the reinvestment of crystallized carried interest and often an investment of fresh capital.
  • Valuation and Pricing. Carefully assess the valuation of the portfolio investments being transferred to the continuation fund to ensure a fair and transparent pricing mechanism. The existing fund's advisory board often plays a role in approving the valuation of the portfolio investments, given the inherent conflicts of interest in continuation fund transactions.
  • Transaction and Fund Structure. Design a continuation fund transaction and fund structure that is tax efficient for selling, rolling and new investors and accommodates the specific needs and preferences of both rolling and new investors.
  • Due Diligence. The lead investors will conduct thorough due diligence on the portfolio companies being transferred to the continuation fund to identify any potential risks, challenges, or opportunities that may impact the continued performance of these investments. Representation and warranty insurance is generally available for continuation fund transactions where the existing investors desire a "walk away" deal.
  • Legal and Regulatory Compliance. Ensure that the continuation fund adheres to all relevant legal and regulatory requirements. Given the highly regulated nature of the healthcare industry, it is crucial to navigate and comply with healthcare-specific regulations, including understanding and addressing any changes in healthcare laws that may impact the portfolio companies. Compliance with patient data security and privacy laws, FDA regulations, and other industry-specific standards is paramount. Potential risks and challenges associated with regulatory approvals, clinical trials, and market access, among others, can significantly impact the success of healthcare investments.
  • Reimbursement Landscape. Assess the reimbursement landscape for the healthcare products or services offered by the portfolio companies. Changes in reimbursement policies and healthcare payment models can influence the financial viability of healthcare investments.
  • Technological Innovation. Stay attuned to evolving healthcare technologies and innovations. Continuation funds in healthcare often involve companies at the forefront of medical advancements, and it is crucial to understand the competitive landscape and potential disruptions.
  • Long-Term Commitment. Recognize the longer time frames typically associated with healthcare investments. The continuation fund structure should align with the extended development timelines often required for healthcare companies to bring products to market and provide sufficient capital to support these ongoing development needs.
  • Communication and Transparency. Maintain open and transparent communication with existing and incoming investors throughout the process. Clearly articulate the rationale behind the continuation fund and make comprehensive disclosures about the process, mechanics, risks and obligations of each of the interested parties.
  • Exit Strategy. Develop a well-defined exit strategy for the continuation fund, taking into account the optimal timing and method of realizing returns for investors, along with the unique market dynamics of the healthcare sector. This may involve an eventual sale, public offering, or other strategic options for the portfolio companies.

By incorporating these considerations, stakeholders in a healthcare continuation fund can navigate the complexities of the industry and maximize the potential for successful, long-term investments.

2. Diversity of Offerings and Agility is Key for Pharma Services Companies

BY SHANNON WILEY

Drug commercialization, distribution, and reimbursement are among the most complex and highly regulated industries. With the effects of the Inflation Reduction Act's Drug Price Negotiation Program on the horizon for 2026, a heavily vertically consolidated drug commercialization channel, continued compressed margins for healthcare providers, and macro-economic trends constraining drug utilization, we expect biopharma and investor focus in 2024 to be on pharma services companies that offer dynamic solutions to clear the pathway for patient access and extend the vitality of a product throughout its life cycle. Post-launch drug and biologic strategies will likely take into consideration the following industry trends:

  • Distribution and Reimbursement Challenges. Pharmacies and pharma services companies that have the agility to successfully navigate distribution and reimbursement challenges are key elements of a successful channel strategy. Cell and gene therapies are perhaps the most complicated use case, but drugs that have both medical and pharmacy benefit coverage or are not self-administered also present challenges. This flexibility should extend to managing logistics and cold chain, navigating board of pharmacy regulations, clearing complex reimbursement challenges under both medical and pharmacy benefits, coordinating with prescribers and administration sites, and often, ensuring Risk Evaluation and Mitigation Strategies compliance.
  • Hub and Patient Services Companies. Having the dexterity to navigate the labyrinth of reimbursement challenges facing brand products is table stakes for hub and patient services companies. Varied benefit design, ever-changing payor requirements for how prior authorizations can be processed, and data privacy laws, among others, are obstacles to providing a streamlined, transparent, and tech-reliant solution. Hub and patient services companies with a broad range of offerings spanning enrollment, reimbursement support, manufacturer-free drug program management, and adherence monitoring are likely to win out over companies offering biopharma one part of a piecemeal solution.
  • Data-Driven Insights. Across all pharma services companies, the ability to generate data-driven insights is key. Beginning as early as pre-commercialization and extending to the end of a product's life cycle, clean and actionable data drives market access. Whether it be supporting expanded payor coverage criteria, understanding prescribing and utilization patterns, or targeting reimbursement challenges, crisp and actionable data is invaluable for biopharma companies.
  • Geographical Access to Care. Geography is also a factor in access to care. Whether it be due to a rural location, socio-economic considerations that limit access to sites of care, or even our "on demand" culture, drug manufacturers look to pharma services companies to bridge the gaps. Consumer-driven prescribing with integrated dispensing, alternative sites of care for non-self-administered drugs, technology applications to reduce steps and redundancies are just some of the solutions upon which biopharma companies rely.

3. Continued Market Response to 340B Program Court Decision

BY JEFF DAVIS

In 2024, we will continue to see healthcare providers who participate in the federal 340B drug pricing program consider opportunities to expand their use of discounted drugs purchased through the 340B program and increase access to program savings. This comes on the heels of a recent federal district court decision ruling against the government's narrow interpretation of a 340B-eligible "patient." Under the 340B statute, safety net providers can purchase outpatient drugs at discounted prices and use them for their "patients." The more individuals who qualify as eligible patients, the more 340B drugs a provider can use and the more program savings a provider can generate.

On November 3, 2023, a judge in the U.S. District Court for the District of South Carolina overturned part of the government's interpretation of what a 340B-eligible patient entails. In Genesis Healthcare Inc. v. Becerra, the court ruled in favor of a 340B provider (Genesis) that challenged an audit finding issued by the Health Resources and Services Administration (HRSA). HRSA took the position that Genesis committed diversion in violation of the 340B statute by using 340B drugs for individuals who were not the provider's patients because the prescriptions were not written at the provider's locations and did not originate with Genesis. The court found that a prescription does not need to originate with the provider to be 340B-eligible, although the patient must still have had an initial provider encounter, and the provider must still have an ongoing relationship with the patient.

As we begin the new year, 340B providers and their pharmacy partners will continue to consider the impact of the Genesis decision on their 340B programs, including whether there are opportunities to update their policies on patient eligibility to qualify additional prescriptions as 340B-eligible. 340B providers also will continue to consider whether opportunities to update 340B policies may help mitigate the impact of drug manufacturer restrictions on the use of 340B drugs through contracted pharmacies, which have diminished the ability of 340B providers to generate program savings in recent years. These developments are also likely to impact deal activity in and around this space on a go-forward basis.

4. Value-Based Care in 2024

BY DANIELLE SLOANE & JULIA TAMULIS

Tensions created by an aging population, provider shortages and the increasing number of Medicare beneficiaries aligning with an accountable care organization (ACO) or choosing Medicare Advantage (MA) coverage (that is expected to exceed 50% of Medicare beneficiaries in 2024) are likely to encourage continued focus on value-based care in 2024, including through new entrants, consolidation and joint ventures. The industry - payors, providers and investors alike – has gained confidence and experience with negotiating and implementing value-based care models and sharing risk on patient populations throughout 2022 and 2023. Much of this growth has been facilitated by companies providing technology, data analysis and care management resources to coordinate care and address social determinants of health. Primary care continues to play an important role in this space, but there is momentum in other specialty areas, including behavioral health, palliative care, oncology and cardiology.

We anticipate value-based care companies will increasingly leverage innovative technology that can help streamline operations, improve the patient experience and facilitate the business of healthcare in order to both reduce costs and allow caregivers to focus on patients. The accuracy and agility of that technology and the data inputs will be important in order to keep up with regulatory changes in 2024. For example, in 2024, CMS will begin implementing a number of changes to its Hierarchical Condition Categories (HCC) risk adjustment model as part of the shift to Version 28. Accurate coding remains critical, particularly as risk adjustment data validation audits could result in extrapolated overpayment determinations under MA for payment years 2018 and later, which could have a significant financial impact on MA plans and their downstream contractors.

Moreover, with the recent growth in value-based care, we anticipate increased competition for attracting and engaging patients. The patient is central to effectuating a value-based care model, including obtaining, maintaining and motivating patients to take steps to improve their health. Those in the value-based care space will need to be careful that greater competition does not result in aggressive or misleading marketing tactics, which would be likely to garner the attention of enforcement agencies given the regulatory limitations surrounding marketing, including recent changes and proposals to strengthen those limitations.

Given the above factors, we anticipate continued market consolidation in 2024 as value-based providers and investors aim to improve economies of scale by increasing the size of their risk-based populations.

5. CRO Investment: Key Due Diligence Questions

BY CLINT HERMES

The already enormous global clinical trial market is continuing to grow, and site management organizations (SMOs), contract research organizations (CROs), formal and informal study site networks, and other clinical research businesses are stepping up to meet this demand. As noted in our Healthcare Trends & Transactions: 2023 Year in Review, the U.S. clinical trial site market, at approximately $16 billion, is estimated to grow at a cumulative annual growth rate of 6.8% through 2025. Although investors navigating challenges in other healthcare sectors may see investment in the research space as an attractive alternative, it has its own unique considerations.

When exploring a potential investment in the research space, questions PE investors should ask include:

  • Clinical Trial Agreements. Does the company enter into clinical trial agreements (CTAs) with research sponsors to perform studies as a research site would, or does the company agree to perform some or all of the research sponsor's own responsibilities?
    • If the former, how does the company engage investigators and study sites, and how do important CTA terms get passed on to them? How much of the site payments does the company retain, and what contractual risks does the company assume for these studies?
    • If the latter, the company is a true CRO and will be regulated by the Food and Drug Administration (FDA) as if it is the study sponsor. More extensive FDA-related due diligence should be performed if an investment in a CRO is considered.
  • Federally-Funded Studies. Does the company agree to conduct federally-funded studies? Many companies in this space began conducting federally-funded studies during the COVID-19 pandemic without realizing the extent of the compliance obligations that accompany federal funding.
  • Investigator-Initiated Research. Does the company support any investigator-initiated research? This research carries more prestige and the possibility of developing important intellectual property, and supporting it is often necessary to attract star investigators, but this also involves more regulatory and contracting challenges.
  • Third-Party Payors. Does the company bill any third-party payors for study-related services, or does it advise study sites about what study costs can be billed to third-party payors? SMOs will often perform payor coverage analyses for clinical trials because the financial viability of some trials depends on permissible claims submission. Doing this incorrectly, however, creates risk under the False Claims Act.
  • Quality Study Concerns. Does the company have a history of study quality concerns? These might have been raised by the FDA through an FDA Form 483 or by a study sponsor audit.

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