Capital Gains

    In 2002, the venture capital company 3i led a £267m buy-out of
    the care home operator Westminster Healthcare. When Westminster was
    sold on, late last year, to Barchester Healthcare, it was valued at
    £525m. In just over two years 3i had quadrupled its initial
    investment and gleaned over £220m at an internal rate of
    return of over 80 per cent.

    It is figures such as these that have had venture capitalists
    increasingly drooling over the social care sector. The introduction
    of stringent new regulatory standards for care homes, a growing
    involvement of the private sector and changes in the way local
    authorities commission services have created a care industry that,
    in financial parlance, is “ripe for consolidation”.

    In practice this means smaller care providers being swallowed up by
    medium-sized companies which, in turn, are merging to form national
    conglomerates backed by venture capital. With their greater
    purchasing power and lower central overheads, these larger
    companies are able to operate more efficiently than their small
    counterparts and strike harder bargains with cash-strapped local
    authorities. As the smaller providers get squeezed out of the
    market, the larger companies pick up their business, generating
    juicy returns for their venture capitalist backers.

    In the past year alone multi-million pound management buy-outs have
    been announced at the Four Seasons care home group; the care home
    property company NHP; the Orchard End Group which provides
    specialist care homes for adults with permanent learning
    difficulties; Green Corns which runs care homes in the North West
    for children aged eight to 18 with behavioural problems; Farrow
    House which provides adolescent care services on the east coast of
    England, and Herts Care which provides crisis care homes for
    children in the West Country.

    What all this financial activity means for the staff and service
    users is difficult to determine. Clearly one concern must be that
    as the men in suits move in, pressure to reduce costs and maximise
    profits will inevitably jeopardise the standards of care.

    However, according to Andrew Rome, this need not be the case. Rome
    is managing director of Sedgemoor, a nationwide firm providing
    residential care and education for children and young people with
    emotional and behavioural difficulties. In 2000 the company
    underwent a £13m buyout backed by venture capitalists
    ECI.

    Although the new regime has given the firm scope to expand the
    services it offers, Rome says that most of its young residents will
    hardly have noticed the difference.

    “On one level there’s been no difference at all,” he says.
    “Sedgemoor has always been a private firm, so all that’s changed is
    we now have a different set of shareholders.” The quality of
    services on offer is as high, if not higher, than it has ever been,
    claims Rome. “Because of the new standards and regulations in the
    industry we now have very specific indicators of quality of
    service, and that has given us clear evidence of how our service is
    improving,” he says. “Even comparing 2004 with 2003 we can see that
    the quality of service is improving.”

    Although the extra financial muscle offered by Sedgemoor’s venture
    capital investors has helped make this improvement possible, Rome
    emphasises that it is not all about money.

    “One of the things that venture capital firms can bring is a
    certain synergy and strategic focus to the development of a
    company. It’s not just about the extra funding. They also bring in
    new people with new expertise and help the firm grow in ways that
    might not have been possible before.”

    Sedgemoor has more than doubled in size since the 2000 buyout.

    Rome predicts that venture capitalists’ interest in children’s
    services will not be shortlived. As the sector tightens up what he
    calls its “traditionally quite inefficient” working practices and
    local authorities seek out providers who can deliver a wide range
    of services that all exceed the new minimum standards, there is
    likely to be little need for old-fashioned, family-owned care home
    businesses.
    “It’s clearly a unique period in the delivery of children’s
    services,” he says. “With the Children Act 2004 there is a clear
    political focus on improving both the standards and the
    commissioning of services. There are those who speculate that as
    local authorities improve their commissioning practices they will
    be looking towards the sort of contracts that the larger service
    providers are in the best position to deliver. So there will need
    to be quite a lot of consolidation within the industry.”

    One man who is constantly on the look-out for social care
    businesses to “consolidate” is Ryan Robson, a partner at Sovereign
    Capital, one of the country’s leading private equity investors in
    health and social care. Prime candidates for Sovereign’s attention
    are small to medium-sized care providers that have already forged
    good reputations with their clients and, importantly, their local
    authorities.
    “We are looking for businesses that are already offering a good
    level of service and are profitable,” says Robson. “They may be
    family-owned companies that have grown from nothing to, say, 10
    homes locally. But they don’t have the capital or the expertise to
    grow from local to national players.”

    Sovereign will help provide both the capital and the expertise,
    says Robson.

    A typical investment is between £5m and £20m. The company
    is also likely to bring in its own team of managers, offer
    continuing strategic advice and provide access to an extensive
    network of contacts.

    “As well as financial support what we are also good at is spotting
    managers who have come through the same sort of route but who have
    the skills to take the company to the next level.”

    Like Rome, Robson stresses that quality of service is of paramount
    importance when seeking to make a profit from the care sector.
    “This is not like investing in a manufacturing industry where you
    might want to go in and immediately start driving down the cost
    base. We are not about treating children or elderly people as a
    commodity. We are about improving services and the management
    infrastructure so that the company is able to offer the range and
    quality of services that local authorities are likely to
    commission.”

    Nevertheless, venture capitalists eventually expect to see a return
    on their investment. So, while most of the recent management
    buy-outs are considered to be medium to long-term investments, it
    is likely that many will be sold on in the not-too-distant future.
    Indeed, according to a recent report, up to £700m worth of
    assets in the older people’s care home sector are currently being
    prepared for sale as their venture capital owners seek to cash in
    on their investments.

    For many working in the social care sector, this horse trading in
    essential services for vulnerable people appears, at best,
    distasteful and at worst detrimental to the quality of services.
    But with the private sector’s involvement in social care continuing
    to increase and the ever present pressure on local authorities to
    improve standards while cutting costs, it is likely that the
    current trend for mergers and acquisitions will continue for some
    time to come.

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