The Pitfalls Private Equity Firms Need to Avoid When Evaluating an Addiction Treatment Center - Circle Social Inc

The Pitfalls Private Equity Firms Need to Avoid When Evaluating an Addiction Treatment Center

A growing number of Private Equity firms are looking to get into the addiction treatment space, but many are jumping in without a firm understanding of the field or the value-added operational knowledge necessary to make successful investment in the space.

Addiction treatment remains an incredibly immature market. The small size of the space, lack of regulation, and an explosion in insurance payouts following the passing of the Affordable Care Act created massive revenue opportunities for those that got in early.

However, the 40% to 60% margins experienced during this phase have passed. PE firms are about 5 years too late to the party. 10% to 20% margins are the emerging norm assuming a treatment center has lean operations in place (and most don’t).

There is still great opportunity in the space. Large numbers of distressed assets can be bought for pennies on the dollar (case in point is the purchase of Elements Behavioral Health after bankruptcy filings) if a firm has the leadership talent to right-size the businesses. However, my experience has been that most PE firms currently buying in this market do not have the operational expertise necessary to fix a broken center, so these opportunities come with much higher risk profiles.

For firms seeking opportunities not requiring industry specific expertise, there are a number of pitfalls a savvy firm needs to be aware of so as to avoid any out-sized risk or over-valuation. I’ll cover the 9 most prominent below.

1)  Best to Avoid Anything in Florida, California, and Arizona

While there are certainly some diamonds to be found in the rough if one looks hard enough, it’s often not worth the effort or the extra risk with so many other (and growing ) opportunities existing across the country.

Florida, California, and Arizona are the epicenters of over-saturated markets and illegal patient-brokering. At one point, there were over 1,300 treatment centers in Palm Beach County, Florida alone. Bad publicity hangs like a pall over these states and a shadow is cast over even the good providers. Investing in a center in these areas is asking for an uphill battle. The same operator with a detox in Pennsylvania or Georgia may see a constantly full center, while their center in Florida sits consistently under 50% census.

Many of the operators in these areas grew only through patient-brokering, overpriced Adwords (now called Google Ads) dependence, and tit-for-tat referral relationships with other treatment centers. Since so many centers were dependent on patient-brokering and Adwords, both of which are now illegal or unsustainable for admissions acquisition, the referral market has also dried up.

Additionally, an unknown, but what I guess to be significant amount of revenue in these three states, was generated through the re-admissions of individuals discussed in my article on A Brief History of Addiction Treatment Marketing. These were individuals who never had an interest in getting into recovery and were courted by unscrupulous centers to milk insurance policies for all they were worth.

Insurance providers have caught onto the game, often paying out little to nothing for an individual that is on their 10th rehab stint in under 24 months. Also, many of these individuals were brought in through patient-brokering and kickbacks, being offered free cigarettes, an Xbox, or even cash to come into the center. While no data exists, I’d be willing to bet a full 20% of the market in these states consisted of these kinds of individuals engaging in what basically amounts to insurance fraud.

Those were also some of the easiest and lowest cost admissions, so cutting out that 20% is one of the reasons centers in these states have seen significant and sustained drops in their census.

2)  Many Centers Have Excessive Legal Risk

While a history of patient-brokering is the most egregious illegal practice, many centers engage in a number of others, often without even knowing it. Due to the lack of business expertise in the addiction treatment space, compliance has rarely been a concern. The field tends to operate off of the assumption that, “if everyone else is doing it, it must be OK.” Obviously, “everyone else was doing it” is not a legal defense that holds any water in a court of law.

Here are illegal practices to look out for:

  • Waiving of or failure to collect deductibles.
  • Paying for insurance policies for those who did not have them pre-admission.
  • Purchasing of flight tickets or any other inducement to enter treatment.
  • Lack of HIPAA compliance:
    • No annual staff trainings.
    • Emailing and texting PII and PHI between staff members. (This is a problem at almost every single center).
    • Use of client testimonials without attendant HIPAA waivers.
    • Online/website forms that allow the mixing of PII and PHI to be submitted. For example, a Contact Form or Verification of Benefits Form that requests potential client contact information with an open field for “Message” or even check boxes such as “Is this for yourself or a loved one?”
  • Texting or phone calls following up on online inquiries without appropriate privacy policy on website.
  • Patient-brokering.
  • Excessive drug testing to milk insurance policies.
  • Kickback relationships with labs, hospitals, or sober living facilities.

Insurance Can Clawback Reimbursements Even if the Center Faces No Legal Action

I’ll also note in this section that, aside from legal risks, there are insurance clawback risks as well. Insurance payers may decide to perform an audit and clawback millions of dollars in reimbursement for sometimes as far back as 2 years of payouts for reasons such as:

  • Non-collection of deductibles by the center.
  • Inducements into care, such as flight purchases, cigarette purchases, or direct cash kickbacks to patients.
  • Overly frequent and unreasonable drug testing, both in the frequency and in the number of substances screened. For example, someone entering treatment for opiates should not necessarily receive a drug screen for cocaine and other drugs as well just to get a higher reimbursement.
  • Not stepping patients down to lower levels of care in time frames dictated by their insurance policy. This is an odd one as the treatment center is taking a loss to provide a higher level of care than provided by their individual policy, but it has been known to happen.
  • Poor documentation, falsification of documentation, or even too much copy pasting by clinical staff.

Every PE firm should have a compliance checklist that they go over with every potential acquisition. In addition, I would go as far as to say that it’s a requirement that clauses are added into the contract stating that the original owners are liable for any disclosed or undisclosed legal risks for up to two years after the purchase. A trust should be set up in which a portion of the purchase proceeds reside to cover any potential legal liabilities that are only to be released after the 2-year period.

3)  Over-reliance on Limited Marketing Channels

The most common pitfall in this area is centers whose census depends largely on digital marketing leads, such as those coming from Adwords (Now Google Ads). Cost per acquisition from Adwords and other online sources often average about $4,000 in 2018, but can climb as high as $15,000 depending on skill level of staff/vendor and the seasonality of the industry.

Multimedia admissions, including TV, billboards, Facebook, and general SEO should account for no more than 30% of admissions for a center with 100 beds or less. For programs with more than 100 beds, up to 40% may be appropriate.

The reason for this is that the acquisition cost is just too high, particularly with the reduction in reimbursement rates seen over the past 2 years. An ideal blended cost of acquisition across multimedia and business development referrals is 3 times the average day reimbursement rate.

On the other hand, multimedia marketing is incredibly important for the long-term sustainability and growth of the program. Some centers, particularly smaller ones, have an over-reliance on referrals. This is also not good because they’re not building brand equity through outbound marketing campaigns nor are they building long-term value in Google rankings through SEO.

If a program is dependent only on other treatment programs for referrals, this is another big red flag. Programs need to have diversified referral streams coming from professions allied to the field (DUI attorneys, counselors, psychologists, etc.), local communities, and alumni.

A healthy center will have 60-70% of their admissions coming from referral sources. Within that number, 15-20% of those referrals ideally come from alumni and their families.

In addition, any strong relationships with hospitals, EAPs, unions, professional organizations, and Indian tribes are particularly appealing. Just make sure the center doesn’t have just one key relationship that’s driving the majority of their admissions. We had one client that had a full 60% of their admissions coming from a single government union contract for nearly 10 years. Upon losing the contract, they were unable to recover.

In general, programs should avoid reliance on call buys from 3rd parties. The cost per admission (CPAs) on these sources are simply unsustainable for most programs and no long-term brand equity is built.

Avoid Programs with Lead Aggregating Digital Assets

Some programs have depended for years on lead aggregation sites, both ones they own or ones they purchase inquiries from. While these have historically been a very lucrative form of investment, both the general public and Google itself has devalued these sites

With much of the negative publicity on the industry focusing on such sites, customers are more aware. Also, in the summer of 2018, Congress called the 8 major lead aggregators to face an inquiry into their practices, signaling that the government is watching these quasi-ethical practices very closely.

Google has also updated its algorithm to de-prioritize such sites in search and I expect future algorithm updates to continue that trend. For example,, owned by American Addiction Center, saw a 30% reduction in overall call volume between one day and the next with Google’s “medic update,” which devalued aggregator and for-profit healthcare information sites.

Additionally, programs that own such sites are unable to obtain LegitScript verification, which is essential to the marketing success of any program today. Both Google Ads and Facebook require LegitScript verification to advertise on their platforms, and those two platforms are the most effective treatment marketing channels currently available to centers.

4)  Weak Local Presence and Dependence on Fly Away Admissions

The destination rehab model is dying for many reasons.

  • More local programs are popping up across the nation, reducing the need to send a loved one to another state.
  • Some insurance policies require admission into in-state programs only.
  • PPO policies, which most out-of-state programs rely on for reimbursement, have increasingly high deductibles that most Americans can’t afford. The average PPO deductible for a family is up to $12,000 a year now.
  • Google algorithms are prioritizing local searches more and more, reducing the ability to rank organically and even lower quality scores for Google Ad campaigns when there is a mismatch between a programs physical location and the area in which it’s trying to rank or advertise.
  • All the negative publicity surrounding the rehab industry has encouraged families to opt for sending loved ones closer to home, where they can be more confident that quality care is being provided.
  • Successful treatment outcomes are more likely when an individual remains connected to social supports – mainly family and employment.

Out-of-state is not necessarily a problem. For example, programs in Nashville will often have patients coming from nearby Kentucky and Indiana as they are so close to the borders.

But, generally speaking, a regional model with most admissions coming from within a 150-mile radius is ideal. For OPs and MAT clinics, where individuals are likely to still be working, the ideal radius is 30 miles or less.

Additionally, successful treatment centers are heavily involved in their communities. If there are not existing relationships with the most obvious local collaborators – police, firefighters, local drug abuse task forces, schools, judges and drug courts, etc. – it’s a sign that they don’t know how to build the relationships necessary for long-term success. That also makes it easier for a competitor to set up a program across the street and quickly take over market share.

5)  Undifferentiated Care

With the explosion in addiction treatment centers across the country, consumers have more choices than ever on where to go. Many centers make the mistake of trying to cast as wide a net as possible, accepting everyone and anyone into their program.

This may include substance abuse, gambling addiction, sex addiction, eating disorders, and basically anything else people may call about.

This is a mistake. Treatment is becoming a commodity in this sense and it’s unclear to the consumer what value one program offers over another. Additionally, centers are not able to build up specialized clinical excellence and awareness in specific communities because they try to be everything to everyone.

Not to mention the fact that there are some large differences between issues such as sex addiction, substance abuse, and eating disorders. These issues all require specialized treatment programming. Speaking with patients at centers where they are in mixed groups of individuals with various issues, they have many complaints.

Specializing within demographics can also be as valuable as specializing in disorders. Programs that focus on a specific demographic such as LGBTQ, pilots, nurses, baby boomers, etc. all have the potential for lower costs per admission in relation to marketing dollars, better treatment outcomes, and higher levels of satisfaction among both staff and patients.

Developing highly specialized tracks or treatment programs is one way in which the fly away/destination rehab model will remain sustainable.

Are Opioid Only Programs a Good Investment?

Some investors have started to shy away from MAT only programs that are overly focused on treating people struggling with opioid addiction. I don’t foresee the opioid problem disappearing too fast over the next 5 years, but there is certainly a trend away from opioid use. Meth and cocaine, in particular, are coming back strong. And alcohol always makes up about 50% of people struggling with addiction in the US. Overall, MAT investment is actually climbing in the US at the moment and you have to remember that Methadone clinics have been around for decades now, far before the opioid crisis reared its ugly head. So, clearly, there is still a lot of opportunity here.

The reason for caution is that MAT programs use either Suboxone/Subutex, Vivitrol, or Methadone. These only work for opioids. There are also drugs like Naltrexone that can be used for alcohol, but they are not widely used by the treatment community at this time. While the opioid epidemic has created a strong market for MAT at the moment, this could certainly shift as other drugs of choice become prevalent.

So the key with any MAT acquisition would be that there is potential to extend out into other forms of care. For your traditional continuums of care from detox to out-patient, there are no concerns as to whether or not the majority of patients are struggling with a particular drug as these programs are set up to handle all substance abuse issues and can take on patients to meet need in any area.

6)  No Continuum of Care or Follow-up

The effectiveness of treatment is largely dependent on long-term care of a year or more combined with continuity for that care. Insurance payers have understood this for a long time and the general public is beginning to understand it as well.

Stand-alone detoxes, residential facilities, or even IOPs do not provide continuity of care for the patient, resulting in higher rates of relapse. The addiction treatment field’s success is ultimately measured by one thing – treatment outcomes. Any play in this space needs to prioritize long-term treatment outcomes above all us, because that is what will create future value.

By providing all levels of care, a program creates feeders across the continuum. Someone in outpatient that has a severe relapse, can go into detox. Someone in detox can step down to PHP or IOP. This is a better strategy than relying on referrals from other providers offering different levels of care.

In addition, whether or not a program provides continuing outpatient services post-discharge, it is critically important for a patient’s sustained recovery that some form of regular communication is maintained. This can take the form of call and email follow-ups, outcomes tracking by 3rd party vendors, and even apps. Anything that keeps the patient connected to care increases their chances of staying in recovery.

From a business perspective, this also increases the likelihood of referrals. Centers that do not have robust alumni programming see 10% to 15% less referrals than similar programs that do. Since alumni referrals are one of the lowest cost channels for admissions, this should be a focus for any successful program.

Insurance payers recognize all this and are likely to provide higher reimbursement rates for programs that offer a full continuum and strong alumni programming. Many referrants also prefer to know that patients they refer will receive consistency in their care as well.

If a program does not provide multiple levels of care, they should have very good relationships with those that do. This needs to be much more than a referral relationship and should be an exchange of treatment plans for individuals moving between the centers. It is always possible to start with 1 to 2 levels of care and build out as needed as well.

7)  Few or No In-network Contracts

The previous model for centers was either cash pay or, more common the last 8 years, PPO policies. These policies paid out much, much better than in-network, so few centers went in-network.

However, all that has changed in the past 2 years. PPO policies have increasingly high deductibles, as high as $12,000, and they are starting to reimburse at rates comparable to in-network.

Due to the change in coverage benefits, individuals and their families are preferring to go to in-network providers as well, which means less PPO admissions all around.

Another advantage of in-network policies is that providers will be listed on the payers website, in employee handbooks, and can be recommended by a company’s HR department or EAP program.

In-network facilities are the way of the future and any program relying on out-of-network contracts is going to find itself with a steadily decreasing census and higher patient acquisition costs. Only smaller bed facilities will find this model sustainable.

Most programs have recognized this need now, but payers are sometimes limiting applicants into their pools, especially in states like Florida, Arizona, and California where they are more wary of the quality of care being provided.

8)  Lack of Leadership & Organization

The fact is that there is an extreme dearth of leadership talent in the addiction treatment space. Knowledgeable clinical staff are everywhere, but finding CEO, COO, and CMO level staff is extremely difficult.

The reason for this is mainly that most people who have built centers either have clinical expertise, but lack business knowledge, or simply founded their program after getting into recovery themselves. There is nothing wrong with that, but it does mean that there is simply not as much of a business background, especially regarding scaling larger operations, as you’ll find elsewhere in health care.

Due to the lack of business knowledge in the space overall, people just copy each other regardless of the effectiveness of a particular practice or process. This is why you’ll see small 30-bed facilities using ridiculously expensive Salesforce CRMs, many centers waving deductibles, or a center’s marketing team reliant only on Adwords and referrals from partner centers.

Innovation is rare and there is also little outside talent brought in to foster a diversity of perspectives.

This gap in leadership and organizational expertise leads to problems with lack of systematized staff training (or, very often, no formal training at all), a lack of overall systems (I see centers still using Excel spreadsheets or not even doing basic things like call tracking), no clinical oversight, lack of outcomes tracking, no regular communication between teams, and a host of other issues that are often readily apparent upon touring a program.

As a PE firm looking to invest in the space, you should expect to need a team of experts you can call in to fill in gaps and create systems and processes to foster growth. This talent is going to most likely be found outside the space or in people who are now in it, but came from outside.

9)  No Outcomes Tracking

This is now a requirement by accrediting bodies CARF and JCAHO. It’s also being increasingly scrutinized by insurance payers AND the general public. As the owner of a marketing agency focused on the addiction treatment space, I can tell you that any marketing focused on positive outcomes performs very strongly.

In addition, research has shown that just the very act of tracking clinical outcomes increases clinical efficacy, probably because clinicians start to pay attention to what works and what doesn’t, making adjustments appropriately. This makes sense, we can’t learn from our mistakes if we don’t know if it’s a mistake or not in the first place.

Some numbers to track:

  • AMAs (those leaving Against Medical Advice) should be under 10% per month in any program.
  • Less than 12% relapse at 30 days. Less than 15% relapse at 180 days (internal Cigna policy guidelines).
  • The average success rate for most programs at 1 year (if using total abstinence as a benchmark) is 10%. A really good program would have a 30% success rate. Anything above that would bring in to question how that’s tracked. Some centers track on their own or only track those who they get in touch with, and it’s not uncommon for a previous patient to lie about whether or not they’re still sober. Some programs follow a more harm reduction approach and may not use absolute sobriety as a success metric, which would be examined on its own merits, but abstinence tends to be the norm for current success metric tracking.

Centers should always be using an objective 3rd party to track their data. This provides believability, consistency, and, usually, the ability to benchmark across other providers the 3rd party is also tracking.

Do Your Due Diligence and Be Able to Add Operational Expertise

Sounds pretty obvious, but I know a lot of investors or firms that have jumped into the space without understanding it, ending up with low performing assets that end up losing them money or closing in under 12 months.

In particular, I’ve seen a lot of investors branching out from the senior care or skilled nursing space. Senior care and skilled nursing are VERY different from addiction treatment. Many owners and investors make the false assumption that they are similar enough that they’ll be able to bring their current knowledge and skills to this new space without much adaptation or specialized knowledge. This is not true and one needs to be very careful in their research before moving forward. Hopefully this guide provided ways in which to do so.

While this space has growth potential, there is a general downward trend in the sustainability of previously highly profitable ventures like pure detoxes, residential, and labs. What programs often really need is someone with operational expertise to come in and help them either right-size a center or take one with mediocre performance and bring in operational expertise or platforms that will help them grow significantly.

Need some help evaluating a center or deciding if it’s the right fit for your firm? Get in touch with us below. We do on-site visits and external audits to determine the overall health and potential for growth in an addiction treatment center.

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About the Author

Nick Jaworski is the Chief Growth Officer of Circle Social Inc. Seeing a real need for innovative, ethical recovery center marketing and growth, he launched Circle Social to help the best addiction treatment centers connect with people who needed their help the most. He is also the proud father of the most beautiful girl in the world. You can most often find him sharing thoughts on digital marketing and cracking jokes on Twitter or Snapchat as @NBJaworski.