According to Bloomberg Law, there were 181 private equity deals for all types of physician practices last year (Modern Healthcare, July 24, 2019). However, as more physician practices look to take advantage of the current private equity climate, it is important for the practice to understand their numbers from the perspective of an outside investor.
Physician owners may not be clear on the practice’s value/valuation, the practice’s financials, the fair market value (FMV) of physician owners’ compensation, or the practice’s compliance risk and exposures – from a potential capital partner’s point of view. They may be considering a private equity transaction before having a well-defined understanding of what they are selling, why they are selling, or doing their own due diligence.
Market trends indicate that physician practice consolidation is growing as senior physicians are moving to retirement and looking to monetize their initial investment, and other physicians are looking to increase their focus more on the practice of medicine and less on the administrative and back-office challenges of operating a stand-alone practice. In addition, there is significant activity with single specialty roll ups by private equity groups – particularly with dermatology, ophthalmology, gastroenterology, dentistry, orthopedics, urology and anesthesiology.
While healthcare valuations remain high, buyers are performing more due diligence pre and post letter of intent (LOI). As a result, it’s advantageous for physician practice groups to perform sell-side financial due diligence before selling to private equity groups or other potential investors. If the physician owners and practice management are informed and prepared, the process will go more smoothly for both the practice and the private equity group, leading to a better outcome.
If you are considering selling to a private equity group or other investors, understand your numbers from an investors’ perspective before you come to the table. Asking these questions to help you prepare for a potential sale will enhance your process and the likelihood of a successful transaction.
It’s important to first understand why the physician practice wants a majority private equity investor or capital partner, and why the individual physician owners want to sell. Determine whether certain individual shareholders are looking to exit and ensure all physician owners are on board with the potential transaction. Possible reasons for selling the majority ownership of the practice to a private equity investor include:
Before you move to the next step with a potential investor, have a solid understanding of why you want to sell.
Before entering discussions with a private equity investor or negotiating an LOI, it’s essential to understand the value of the practice and each of the physician owners’ production and compensation. In addition, work to clean up the practice’s financials, as most independent practices are on a cash/modified cash basis of accounting and private equity groups will be looking at financial statements on an accrual basis of accounting.
Engaging experienced M&A valuation, accounting/tax and legal advisors, and having an independent valuation of the practice and fair market assessment of physician compensation, will enable you to enter the transaction from a position of knowledge and strength. Keep in mind that post-transaction, physician owners will be paid not as owners, but as employees. Employed physician compensation typically is production based, and physicians should understand how their production translates to fair market value compensation.
Before considering selling your practice to a private equity group, be sure you know any potential risks (financial, compliance, and legal) and be prepared to disclose them. Risks and exposures could negatively impact the valuation of the practice and the structure of the transaction – as well as the likelihood of the transaction closing.
For example, billing and coding issues could cause significant delays in closing a transaction. Even if billing and coding errors were unintentional, they raise a flag for buyers who tend to then expand the scope of the compliance due diligence review to ensure there are no other regulatory surprises waiting. Being transparent and proactive about these potential types of issues will have a positive impact on the transaction closing and the practice’s valuation. Practice management and owner integrity is key.
Another critical area where risks should be disclosed is the HIPAA Privacy and Security program. Potential investors want to understand if they are buying a possible set of security breaches that have not yet been detected or disclosed. Take a no surprises approach when it comes to cybersecurity.
Due diligence is not just for buyers/investors. Be sure to vet private equity groups and potential investors as part of your pre-LOI or post-LOI due diligence process. Gain an understanding of the management style and expectations of your new capital partners and check references on them. Remember that current owners will become employees, and they need to be prepared to be comfortable in their new roles post-transaction. The new owners will be looking at the practice from a business and compliance standpoint. Nothing is off the table for analysis (before and after closing), including low performing employees and company perks. “We’ve always done it this way” will no longer be an accepted standard.
Although private equity investors don’t want to get a reputation of stalled or re-traded deals, significant issues that come up during the due diligence process can’t be ignored. When valuations don’t hold up, potential investors have to change the deal structure, reduce the purchase price, wait on stronger results, or walk away. Make sure your financial house is in order before talking to potential investors. Due diligence on the front end will make life easier for everyone in the long run.
Consult an advisor who knows the potential issues, risks and exposures from both sides of the transaction. An expert who represents both buyers and sellers of physician practices can best advise sellers what the buyers are looking for in a due diligence process. To a physician practice, this assessment becomes increasingly important as they prepare to sell a majority of their ownership to private equity groups.
Content provided by LBMC’s Lisa Nix. Lisa Nix is shareholder and practice leader for LBMC’s Transaction Advisory Services group. Nix has more than two decades of experience in public accounting and healthcare and has more than a dozen years of experience leading healthcare M&A transaction services teams for both strategic and financial buyers. She can be reached at lnix@lbmc.com.
