Investors Still Betting Big on Behavioral Health Despite Government’s Scrutiny of Private Equity

Every story is better with a villain. In the eyes of the federal government, the behavioral health treatment industry’s villain is private equity.

At least, that’s the impression of lenders and private equity investors.

Despite this view, lenders and PE believe that increased scrutiny on private equity from the Federal Trade Commission and the Department of Justice (DOJ) is mostly “noise,” and have identified segments of behavioral health ripe for investment.

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“PE is going to get very scrutinized for either making too much money or having a negative impact on the health care industry,” Tim Bubnack, managing partner at HCAP Partners, said at the Behavioral Health Business INVEST event. “Hopefully it’s a little bit more noise than the reality of stiff regulations that are going to really affect the behavioral health sector. … I think we’ll all be able to live with it.”

San Diego-based HCAP is a private equity firm focusing on lower middle market companies, generally with $3 million to $10 million in EBITDA. HCAP invests in health care, software, services and manufacturing industries. In March, HCAP merged three behavioral health companies to form a new platform called PAX Health. 

Tim Bubnack, managing partner at HCAP Partners
Tim Bubnack, managing partner at HCAP Partners

The FTC and DOJ have been very active during the Biden-Harris administration, Bubnack added, and PE scrutiny tends to increase in an election year. If federal agencies were to take action against private equity, it would likely start with very large transactions, he said.

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Distinctions exist between the FTC and DOJ’s regulations, Tal Lefler, managing director of corporate finance at Capital One Healthcare, said at INVEST.

“The FTC is primarily focused on something like a roll-up of a practice management group,” Lefler said. “Their perception is, a PE fund buys up all the physician practices to raise prices and drive their own profit. I might argue that you have to be big to be able to negotiate with the payers, but I don’t think the FTC would agree.”

McLean, Virginia-based Capital One Healthcare provides financing for middle-market health care companies. The lender leads deals for several behavioral health providers including Lifestance Health (Nasdaq: LFST), BayMark Health Services and Behavioral Health Group (BHG). In May, Capital One refinanced US HealthVest, a psychiatric hospital company, in a deal worth $130 million. 

Money invested in the behavioral health industry creates access and competition, Lefler said, in an argument for PE’s involvement.

DOJ oversight, meanwhile, is necessary, and the agency is “doing good work,” he said.

“If you’re doing things the right way, you may run across [the DOJ], you may get fined here and there,” Lefler said. “But ultimately, I think they’re barriers to entry. … It’s a little bit harder for someone to come in because of all this regulatory scrutiny.”

Tal Lefler, managing director of corporate finance at Capital One Healthcare
Tal Lefler, managing director of corporate finance at Capital One Healthcare

While increased scrutiny may be noise, it is not helped by instances like Steward Health Care’s downfall, Lefler said.

PE firm Cerberus Capital Management bought a slew of community hospitals from 2010 to 2016, adding to their chain under the name Steward Health Care. The business made its executive and investors “fortunes,” while failing to properly staff, stock and maintain its facilities, according to PBS. Reporters identified 15 cases in which a person died “in a Steward hospital that did not meet professionally accepted standards due to a lack of staff or a lack of supplies and equipment.”

For investors, compliance is key, Lefler said. Avoiding investing in companies with open litigation or such other problems, could be devastating for investors,” he said.

Increased oversight may make it difficult to enter the market, but behavioral health remains an attractive place to invest. Some subsectors represent especially tantalizing opportunities for investors.

The substance use disorder (SUD) treatment industry is an overlooked opportunity, Lefler said, in part because rates of SUD remain high in America. Additionally, some private equity firms are now “long in the tooth” for investments made between 2010 and 2020 and are trying to scrape some return on their investment.

The autism therapy industry has been an especially active segment in 2024, Lefler added, and is still very active with a “huge tailwind.” HCAP Partners is currently evaluating an autism platform, Bubnack said.

The outpatient mental health industry is fragmented, Bubnack said, with few large platform companies in the space, representing huge potential for dealmaking.

“Valuations are attractive in this space, reimbursement rates are very attractive,” he said. “There’s lots of tailwinds right now with regard to reimbursement. If you’re an investor like us, we’re looking to exit. So I think over the next three to five years and beyond, it’ll be a very, very robust marketplace for exits.”

Overall, the persisting need for behavioral health services and preventative care to keep people out of emergency rooms will keep investors interested in the space, Bubnack said.

“This is a massive opportunity of underserved care right now,” he said. “There are not enough providers to address the behavioral health issues that our society has. Period. So that’s a huge driver. It’s a huge challenge as well, but we think there’s an amazing opportunity.”

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