If you are a practice owner, avoid these mistakes in the months and years leading up to a sale of your practice
After advising the owners of more than 20 physician groups, med spas and other healthcare services companies successfully selling their practices and talking with hundreds more who were thinking about selling, we have seen owners running into some common hurdles that prevent them from maximizing value and finding the best partner in a sale. The decision to sell is highly personal and the timing needs to be right for the owner/partners. The following outlines some of the most common pitfalls for sellers in selling their practice, and our suggested alternative approach for owners to pursue in the years and months leading up to a potential sale of your practice:
Waiting too long / too close to desired retirement to start a sale process: We run into this all the time, where physician owners approach us wanting to sell their practice and retire the day after they close the transaction. The reality is that most buyers will want the selling owners/partners, particularly if they are critical to overall production, to continue to practice for at least three years, but more typically five years, following the sale of their practice. This is especially true with smaller practices with fewer providers where the partners are often the largest producers in the practice. If they walk out the door after a sale, then much of the production and corresponding cash flows goes with them. Buyers have tools to help mitigate this, including requiring a significant portion of the purchase price (typically 30% of the proceeds from a sale) to be in the form of rollover equity, where sellers receive a portion of their proceeds from a transaction in the form of equity in the acquirer rather than cash at close. This rollover equity can sometimes have strings attached, including a requirement that the owners continue to be employed by the company to receive the benefit of the equity (e.g., they lose the equity if they retire).
BGP Advice: to maximize value and find the best partner when selling a healthcare practice, it is best to start a sale process at least five to six years before key partners’ anticipated retirement.
Not using sell-side advisors / signing an LOI before engaging an advisor: When I was in private equity and a partner at a family office, the most dreaded words we would hear when trying to acquire a company was “we decided to hire a banker and run a process.” Business buyers are always seeking to “get a deal” when investing in a company, which typically leads to better financial returns for the shareholders of the buyer. Further, the principals involved (private equity professionals, company CEOs/Presidents/Board of Directors, etc.) have a fiduciary duty to the shareholders of their company that requires them to act in the best interests of the shareholders of the company (i.e., the buyer in this case). Said differently, buyers not only have every financial incentive to get the best deal possible when buying a company, but also have an obligation to their shareholders to do so. When you add to this that most buyers of healthcare businesses are sophisticated acquirers (typically private equity firms or private equity-backed firms, where the principals have acquired dozens, if not hundreds of companies) pitted against physician partners and other business owners who typically sell a company only once in their careers, you end up in a lopsided negotiation that heavily favors the buyers. As a result, when sellers do not use advisers to level the playing field, they typically leave a lot of money on the table, often selling at a 15%-30%+ discount to market valuations. Experienced sell-side advisers will level the playing field with sophisticated buyers by running a comprehensive sale process, including: evaluating the practice’s financials and determining EBITDA (a proxy for earnings/cash flow that buyers use to value a business) before launching a sale process, preparing a comprehensive set of marketing materials, and reaching out to a broad set of potential buyers to solicit bids and determine the “market price” for the business. The goal of all of this is to provide the business owners with multiple potential partners to move forward with. Good sell-side advisors will provide guidance at every step of the process until close, helping ensure sellers do not leave money on the table or sign up for off-market/unfavorable terms. This allows owners to maximize the proceeds they receive in a sale, find the best partner, and get the best overall deal possible for the business owners, who have typically spent decades building their company and want to achieve specific goals through a sale. We have had some sellers reach out to us when it is too late, such as after they have already signed a Letter of Intent (LOI) to be acquired. Upon signing an LOI, the sellers lose much of the leverage in the negotiation because in the LOI they have not only agreed on most of the key terms of the deal, but also have signed up for a period of “exclusivity” with the buyer, preventing the sellers from marketing the business or entertaining other offers for a period. When it comes time to move forward with a transaction, you should also hire an attorney with experience advising physician practices in M&A. Physician practice transactions have unique structuring, tax and regulatory considerations, as well as market norms, that an experienced healthcare M&A attorney will be able to guide you through.
BGP Advice: To maximize value when selling your business and find the best partner, owners should always engage experienced sell-side M&A advisers to run a comprehensive sale process and solicit bids from multiple potential buyers.
Failing to grow the provider group and pursue other profitable growth opportunities in the years and even months leading up to a sale: Businesses are typically valued based on a multiple of the last-twelve months (LTM) of the company’s EBITDA (cash flow/profits) – for example, a buyer may value a company at 5.0x LTM EBITDA. The higher a company’s annual EBITDA, the more diversified/durable the company’s revenue streams and the stronger the growth prospects for the company, the higher the multiple of EBITDA a buyer is willing to pay. In the years leading up to a sale, we often find owners will dial back their focus on growing their business in the following ways, which leads to less interest from buyers and owners receiving a lower valuation for their practice than they could have achieved with more focus on growth leading up to a sale. Some example of this include:
1) Failing to grow the provider team and diversify the practice’s production: Imagine you have two different practices – Practice A has one physician owner responsible for 85% of the practice’s production and one mid-level provider who handles the other 15%; Practice B has three physician partners, each accounting for 20% of the annual production and four mid-level providers accounting for 10% each. Even if the EBITDA of the two practices and their growth prospects were identical, buyers would value Practice B much higher. With seven providers and no individual provider accounting for more than 20% of production, Practice B is a much less risky investment than Practice A, where nearly all the production is from one individual. Buyers are acquiring your practice for a multiple of annual earnings/cash flow with the expectation the annual cash flow from the acquired practice will continue to grow after the acquisition. A buyer is willing to pay you in advance (the multiple) for the future cash flows the business produces. For example, if a buyer offers 6x EBITDA for your practice, they are effectively willing to pay 6x your annual cash flow in advance to own your business. For the buyer to get a return on their investment, they need the cash flow of the practice to at least stay flat, but preferably grow during their investment period. This stream of cash flows is much riskier in Practice A than Practice B – if the 85% producer in Practice A gets hit by the proverbial bus in Year 2 after acquisition, effectively the whole stream of cash flows the buyer purchased goes away before the buyers have even gotten back to breakeven on their significant upfront investment in the practice. The stream of cash flows from Practice B is far less risky, as even if one of the top partners exits the practice in Year 2, Practice B is still retaining 80% of the production and associated cash flow that they acquired. While not ideal, it is far more likely that the buyer cannot only replace the 20% of production they lost in this scenario, but also grow beyond this over a typical 4-to-5-year investment horizon. Further, in Practice B, given the practice is not as reliant on any individual provider, it is far more likely a buyer would be willing to allow one of the physician partners to retire before the typical five-year requirement and not penalize the sellers with a significant reduction in up front purchase price.
BGP Advice: Given this, growing your provider group, and spreading the production of your practice across more providers will typically increase the value of your practice and afford you and your partners more options after a sale.
2) Scaling back on profitable growth opportunities: In the years leading up to a sale, we sometimes see owners cutting back on profitable growth opportunities – choosing not to expand to another location or a larger space when they are fully-utilizing their existing space; deciding to not go through the effort to recruit, hire and train additional providers; delaying investment in equipment/capabilities to expand service offerings. This is understandable, as these opportunities require a substantial investment of time and money by the practice owners and their teams at a time when the owners may be eyeing the “finish line” after years of practicing. But rather than selling from a position of strength, these decisions often lead to practices going into a sale process with little to no historical growth or growth prospects. Buyers value businesses with strong tangible growth opportunities higher than companies that are flat or down with limited near-term growth potential. Again, think of the two practices in the scenario above. In this case, Practice A and Practice B are Orthopedic groups. Practice A’s owner has been eyeing a sale and retirement for years and has foregone making investments in profitable growth opportunities. Meanwhile, payers have continued to squeeze reimbursement rates and staff costs have continued to rise, leading to declining EBITDA. In this scenario, the market may value Practice A at 6x LTM EBITDA. Practice B has also been struggling with the same reimbursement rate and staff cost challenges but has been able to more than offset these by starting an ASC, bringing physical therapy into their offices, and opening an immediate care location, all while expanding the provider group to deliver these expanded patient offerings. Practice B will receive a significantly higher valuation than Practice A, not only because buyers will value the practice at a higher multiple due to its growth trajectory, but also because the EBITDA presented to buyers will be higher. To build on this, let’s say Practice B just launched the immediate care location and brought on the physical therapy team 6 months ago – an experienced sell-side adviser will push to get you “credit” for this growth as if the immediate care and physical therapy teams were fully ramped up for a full year and the market (i.e., buyers) will generally give you credit for this in a sale. This can be meaningful – if in the above example, the immediate care and PT added $50k per month to your practice’s EBITDA, experienced advisers would reflect a full year or $600k of EBITDA from these recent growth investment in the financials presented to buyers (even though technically only 3-4 months of fully ramped production from these investments are reflected in the actual financials prepared by your CPA). Let’s say buyers value Practice B at 8x LTM EBITDA due to its higher growth trajectory – this would result in buyers paying an additional nearly $5 million (8x the additional $600k of annual EBITDA) – that’s $4.8 million of cash and rollover equity going to the selling partners of Practice B by continuing to invest in growth opportunities and receiving the full benefit of two service offerings launched within the last 6 months!
BGP Advice: To maximize your EBITDA and valuation multiple in a sale, stay entrepreneurial and aggressive pursuing profitable growth opportunities in the years and even months leading up to a sale.
Not having “your house in order” when you launch a sale process
- Financials: Financials should be prepared by a professional CPA, preferably monthly
- Regulatory: Work with regulatory attorneys to ensure ongoing compliance with Anti-Kickback Statute, Stark Law, HIPAA and state regulations
- Employees: Ensure all employee contracts (particularly with providers) are signed and compliant with current laws and regulations; review compensation of key providers in your practice and make sure it continues to be competitive in your market today (losing a key provider during a sale process can create significant issues and can even stop a transaction from happening in extreme cases)
- Partners: Make sure you are on the same page with your partners in terms of timing of a sale, goals in a sale, etc. Consider accelerating the timeline for key non-partner physicians to become partners – this ensures they benefit from a sale and helps keep them engaged before, during and after the sale process.
Selling from a position of strength – the practice is profitable with strong growth prospects and many providers delivering great patient care – and then hiring experienced advisers to put your best foot forward and bring multiple potential buyers to the table will allow you to get the highest price for your practice, find the best partner and ultimately achieve your goals in a sale.
Reach out to Andrew Adams at [email protected] to discuss further.