- Private equity activity in healthcare increased 21% in 2020, creating fear of missing out
- Use your advisors’ help to stay on top of your 3- to 5-year plan
- Are you ‘sell-ready’? Get there so you can take action when the time’s right
With so much private equity (PE) activity taking place among medical and dental practices, many doctors and other practice owners are fearful of missing out on the opportunity to capitalize on PE firms’ rising interest in their businesses. Healthcare private equity deal volume increased by 21% to a total of 380 deals in 2020 — compared with 313 in 2019 — despite a 14% decline in total global PE activity.
Many trends, however, are motivating PE firms to seek out healthcare businesses ranging from dental or physician practices (of all specialties) to med spas, veterinary practices, and others. And those trends aren’t going away; because of the rising societal emphasis on health, wellness and the necessity of treating certain diseases, PE firms are seeing consistent returns from their healthcare investments and are not likely to lose interest in making new ones any time soon.
So while practice owners shouldn’t fear missing out on their PE opportunities, there are still many things for them to consider while weighing the possibilities of a private equity offering.
First Republic interviewed Michael White, CPA and Principal at CliftonLarsonAllen (CLA) (focused on Dental Service Organizations and Medical Service Organizations), on best practices for practice owners exploring their PE options. White has been focused on the consolidation in healthcare for the last decade. He specializes in structuring entities, building accounting systems, ensuring accuracy in reporting through proper budgeting and assisting in mergers and acquisition activity. CLA is the 8th largest CPA firm in the nation and serves over 7,000 doctors nationwide across all specialties.
Here are a few things White advises practice owners to keep in mind in preparation for a potential PE offering.
Valuations are high, but they come with caveats
Through networking or research, doctors and other practice owners may be hearing about peer-owned businesses engaging in private equity offerings at valuations that are many multiples of Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). This can be misleading as many business owners do not know what their EBITDA is nor how that translates to personal cash flow on an annual basis. It is important for practice owners to remember that PE valuations factor in all assets of the business in order to arrive at a proper EBITDA multiple.
Selling the practice to a private equity firm may have a significant impact on the business’ finances (and thus on the compensation paid to doctors and other highly valuable personnel). Before selling, doctors need to consider how valuable a liquidity event is to them, given how many years are left in their careers and how significant a pay shift — and role change — they may experience. How long do you intend to continue to practice post-transaction? What do you want your livelihood and your life to look like?
There’s also the question of how prepared a provider (or provider group) may be to finish investing in the business. Pre-offering, healthcare and dental practices need to have the ability to invest in facilities, equipment, and infrastructure inside and outside the business that can help support growth; pulling back on compensation in the early years of the practice can help free up the funds to facilitate those investments and improve the marketability of the practice down the line.
The level of infrastructure investment, among many other factors, can affect the valuation once a PE opportunity is on the table. Further, the level of indebtedness the practice has will impact the net cash flow received at closing. Many investments include cash at closing in addition to a rolled equity component to align the selling doctors’ interest with their new partner.
Spending time on your 3- to 5-year plan can pay off
Regardless of when your practice starts to see interest from PE firms, an offering has to line up with your own goals and timeline.
As medical and dental practices start to reach $10 million-plus in revenue, they often start to see interest from PE firms. For some — depending on location and specialty — it can start much earlier (as they reach above $2 million in revenue).
The “right time” to take a PE deal varies for every practice. (Some doctors may intend to build their practice to $100 million, for example, but take up a PE offering much earlier, such as when it reaches $20 million to $25 million.) The only way to know what’s right for an individual practice is for its owners to assess where they are in the lifecycle of the business, and develop a roadmap for achieving their objectives.
Planning for 3 to 5 years ahead is recommended; that way, any PE or other investors can understand practice owners’ intentions for the business and how those play into the PE firms’ strategy for investments.
It also provides enough time for practice owners to protect their assets (beyond just their physicians). Staffing, for example, is a critical concern for practices who prize their reputation for patient service and see it as a key selling point. Will your key staff members be around in 3 to 5 years, if you plan to sell then? What benefits do you provide that support retention? How would you explain the value of those benefits programs to a prospective PE firm?
Benefits are just one program you’ll need to consider as part of your assets and the holistic package you present to investors. Regularly bring all your advisors together to review your 12- to 24-month strategy, and make sure everyone invested in the practice’s future is communicating and on the same page about your long-term plans.
Being "sell-ready" always benefits your business
Of course, plans are always subject to change. Your practice may have a clear 5-year roadmap with the goal of a PE offering, for example, only to find operations upended by an unexpected event (such as the death of a partner or sudden retirement of a physician or key employee).
That’s why it’s wise to have the business in “sell ready” shape — that is, to have the business financials prepared as if you’re ready to sell at any time. Ensure you are telling the right story in your business financials on how profitable you are and what opportunities would arise with the right partner.
Being go-to-market ready with your financials is not just about being prepared to take a PE offer if a great deal happens to come along. It also prepares you to quickly handle associate buy-in, partner borrowing, bringing in other private investors from your network, or any other kind of financial transaction. It also prepares you in case you need to sell at an unexpected time, for unexpected reasons.
More importantly, being sell-ready helps you run the day-to-day operations of your business well (in line with your 3-5 year plan).
Consistency and viability across locations is key
If you are operating a multiple-location practice group, there are additional considerations to keep in mind. These often include:
Do all your practices look and feel the same? Do they perform the same way? Do you have a formula for success that private equity can invest in and multiply your collective success?
Practice structure and profitability
Are you running a successful practice or practice group? Does it take the right insurance for its patient base? Does it have key team members set up for success? Are you driving the right amount of profitability to the bottom line?
Where are your practices located geographically? There is truth to the adage “location, location, location.” Some markets are more attractive to growth and success than others; are your practices in high-value areas?
In Conclusion: Seizing opportunity when the time is right
The COVID-19 crisis proved the resiliency of healthcare businesses as PE investment targets, as many people went back to the dentist or visited their physician practice many months sooner than they patronized other sectors (such as restaurants or in-person retail). So while 2020 was an especially active year for private equity in the space, there’s no need for practice owners to rush their businesses to be ready for an offering. Taking a long view, and thoughtfully preparing your business with the help of expert partners, can ensure your practice is ready for a PE offering when the time is right for you.
The views of the interviewee of this article do not necessarily represent the views of First Republic Bank. You should consult with your own professional advisors to fully understand and evaluate the information provided in this publication before making any decision that could affect the legal or financial health of your business.
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