Private fund managers are facing significant headwinds concerning capital formation and fundraising, including in the private equity (PE) space. New firms specifically face barriers to entry in a competitive market where investors have limited capital and are focused on the rate of distributions from their current investments.
In 2024, healthcare investment funds show signs of bucking these trends as capital floods into specialized firms. The lower middle market specifically has served as a viable target for capital in search of above market returns.
Many firms that adopted investment strategies limited to healthcare businesses generated outsized returns, resulting in growing interest from capital. Trending industries like value-based care serve as useful targets for investors willing to underwrite niche opportunities.
Limited partner (LP) interest in healthcare-specific investment strategies has also allowed new firms to emerge that chose a specialist approach to investment. These LPs are attracted to improving healthcare systems globally via capital deployment and investing in infrastructure that enhances access and delivers better outcomes. 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 focused on a specialized market.
At HPE Miami 2024, we polled industry professionals on their outlook for the fundraising environment. Most don’t expect PE 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. Instead, four out of five of attendees surveyed agreed that large funds and established managers will take a growing share of fundraising.
The advantage of focus
Healthcare specialization in PE firms generates several benefits as funds identify sophisticated projects, act quickly, and bear risks.
All personnel within an effective healthcare-specialized PE firm are highly educated and familiar with relevant elements of the healthcare systems in question. This can remove information asymmetry issues present in the relationship between investors, committees, and LPs.
At specialized firms, managing directors can quickly identify projects, analysts can quickly model opportunities, and well-versed investment committees can quickly measure risk and approve opportunities that could face information barriers in other committees. Having built strategies focused on niche areas of healthcare, specialized firms can also deploy the same models on related targets, benefitting from not having to always start fresh.
Additionally, as healthcare investing has matured so has the sophistication of its LP base. LPs familiarized themselves with healthcare megatrends, whether that relates to the intricacies of US systems or the country-by-country nuances in play when navigating pan-European roll-up strategies. Educated LPs allow fund managers to communicate complex healthcare investment strategies and take risks without the fear of alienating investors.
Deals outlook
Most HPE Miami 2024 attendees are optimistic about healthcare transactions this year, suggesting there will be more opportunities for fund deployment. The labor market challenges that beset healthcare assets in 2023 likely won’t disappear, but buyers seeking scalable assets with sustainable growth levers can expect more deal flow.
Signs of credit markets opening in the first half of 2024, along with bid-ask pricing convergence, suggest healthcare PE activity should unlock soon. Nearly half of those surveyed felt prices will settle at a level closer to what buyers are willing to pay, with 46% predicting transactional activity won’t increase until the fourth quarter of 2024.
We expect the focus on organic growth to remain, along with an increasing appetite for investment in companies utilizing new technologies 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 catalyst to make that happen, the promise that tech and artificial intelligence 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 healthcare space, specialization will continue to serve as a differentiator for fundraising and dealmaking. The return to specialization has been appealing to investors looking to expand their exposure to healthcare. It’s little wonder that dedicated healthcare managers stand ready to reap rewards from a more robust market going into 2025.
Key Takeaways
- Fundraising has been challenging for PE funds.
- Specialist healthcare strategies are attracting investors.
- LPs are drawn to outsized returns and opportunities for positive societal impact.
- Newer managers need 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 healthcare megatrends.
- With the deal market improving, specialists are likely to thrive.
The writer is Ian Schwartz, Global Head of Investment Funds at the US-based law firm McDermott Will & Emery
