Borrowing a financing method pioneered by European merchants, a growing number of healthcare consultants and investment bankers are becoming healthcare investors.
With significant industry knowledge and contacts, these consultants and bankers believe they're in a good position to identify and nurture well-managed, undercapitalized healthcare businesses.
More industry insiders are seeking to invest directly in small to mid-sized healthcare companies handpicked for their growth potential. They hope to cultivate tomorrow's "Big Board" giants using a concept called "merchant banking."
The term merchant banking evolved from the 17th- and 18th-century merchants who pooled their money to buy spices in the East Indies for resale in Europe at a tidy profit. Europe remains a hotbed of merchant banks. But the term isn't widely used in the United States, making it difficult to come by a standard definition.
According to Dapray Muir, an Alexandria, Va.-based attorney who represents merchant-banking clients, merchant bankers are people who engage in venture capital services with a pool of funds consisting largely of their own money. That's different from investment banking, in which the firm serves as the intermediary between a company and investors, he said.
Some U.S. venture capital companies would fit the definition of a merchant-banking company, Muir said. However, a number of consultants and investment bankers interviewed by MODERN HEALTHCARE offered either looser or narrower definitions.
Some believe merchant banking is nothing more than a fancy description for plain, old "principal investing." For years, a number of investment banking firms have operated divisions that invest the firms' own principal. In some firms, those activities are called merchant banking.
Needed cash infusion. No matter what you call it, the entry of additional capital into the healthcare industry is good news for smaller, entrepreneurial healthcare service companies needing cash infusions to grow their businesses.
With more investors targeting healthcare, competition among financiers has intensified considerably. "A lot of people have figured out healthcare is a good place to be," said Paul B. Queally, a general partner with the Sprout Group, the venture capital affiliate of Donaldson, Lufkin & Jenrette in New York. "There's so much money chasing too few deals," he said. "For me. . .it's terrible."
The merchant-banking firms make their money by charging fees, taking a stake in the companies they've financed or both. However, because many firms negotiate fees and ongoing financial participation on a deal-by-deal basis, comparison shopping is difficult to do.
Carlos Ferrer, a 17-year veteran of CS First Boston, is one of the recent entrants into the field. In May, the New York-based investment banking firm announced that Ferrer would be organizing an independent merchant-banking fund dedicated to "active principal investments" in the healthcare industry.
Ferrer is currently meeting with potential investment partners. His firm, Ferrer & Co., will manage the merchant-banking fund on behalf of investors.
"The time is right. I think the opportunity is out there," Ferrer told MODERN HEALTHCARE.
He and his partners will invest in the fund, and CS First Boston is considering investing as a limited partner, Ferrer said. Other investors may include pension funds, university endowments, individuals and other healthcare companies. His goal is to raise $200 million for the fund by the fall.
A technology bent. Ferrer is particularly interested in providing growth capital to healthcare information-systems businesses, devicemakers and other ancillary service firms. He sees a slew of small, creative healthcare services companies that have been overlooked by Wall Street researchers.
"I look for opportunities like those where the market hasn't figured it out," he explained.
The fund will target public or private "middle market" companies worth $50 million to $500 million. Ferrer is seeking to identify companies that need capital to grow, to fund acquisitions or to restructure their own capital so they can finance acquisitions. He and his partners will rely on relationships in the healthcare industry to find investment opportunities.
The fund will invest private equity and "have an influence" on companies' boards of directors, Ferrer said. Depending on the company, the fund may take a significant minority interest, hold a majority control position or orchestrate a leveraged buyout.
Because every deal will be individually structured, Ferrer could not provide details on the cost of the capital. "It would be a lot less expensive than venture capital and more expensive than liquid institutional investment capital," he said.
While venture capital companies generally invest in riskier, start-up companies and demand a greater rate of return, institutional investors buy positions in mature companies, requiring a lesser rate of return, Ferrer explained. "So as the maturity and liquidity of a company goes up, the rate of return required to make those investments goes down," he added.
Ferrer's fund will be dedicated exclusively to healthcare. But it's a crowded field because healthcare has become a hot investment area.
Ziegler Securities, a Chicago-based investment banking firm, currently is negotiating merchant-banking financings to boost the creditworthiness of a couple of long-term-care providers, said Don A. Carlson Jr., Ziegler's president and chief executive officer. The firm also is considering opportunities to invest in emerging physician organizations, such as management service organizations and primary-care networks.
"I do see it as a growing area. It's an area that requires a tremendous understanding of the market," Carlson said.
A lot of physician organizations want to remain independent and need some capital to grow, perhaps as little as $1 million to $2 million, which is not enough to attract public investors.
"A lot of it becomes very venture-capital related. They're new and emerging companies. It becomes difficult to assess the credits, as you would customarily (review them)," Carlson said.
"The larger the medical organization it is in terms of number of physicians, the more comfortable you can get on the credit side," he said.
Unlike Ferrer's merchant-banking initiative, Ziegler isn't necessarily interested in owning or controlling the companies it finances, Carlson said. The firm would rather work "side by side" with the principals of those organizations to help them achieve their goals.
A new entry. Whether Jefferson Partners, a newly created merchant-banking firm, takes a stake in the companies it finances "totally depends on the deal," said Joe Wright, the firm's chairman.
Jefferson Partners is a spin-off of the Jefferson Group, a Washington-based consulting and government relations firm. The Jefferson Group conceived the merchant-banking venture as a way to leverage its position and experience with clients. The group will identify companies on the front end that are going to need financial assistance and help them on the back end to "be successful with the government," Wright explained.
Jefferson Partners plans to provide product development and expansion capital to high-technology research and development, telecommunications, environmental and healthcare businesses. These are industries that are regulated by the federal government and which represent the Jefferson Group's main lobbying activities. Jefferson Partners will arrange for private financing and enter a joint venture with an investment banking firm to tap equity offering capabilities.
In the healthcare arena, Jefferson Partners is interested in businesses such as home healthcare, lithotripsy, physician software and new types of hospitals.
"I think Jefferson is going to be in a really good position" to help small companies expand through consolidation, Wright said.