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.