PE’s “laser focus” on ophthalmology

The answers to five key questions regarding private equity transactions.

It seems like every week or two that an industry newsletter or publication announces that another eye-care practice has entered into a major transaction with a private equity (PE)–backed company. This transaction activity has increased substantially over the past several years. Physicians First reported that the number of PE firms investing in ophthalmology alone jumped from five firms in 2016 to 20 by October 2018 and each of these “platform” companies is seeking so-called “add-on” acquisitions to grow.

With this increased activity, you may be receiving calls about being purchased, and you likely are hearing about other groups in your market doing so. As a result, you may be wondering, “Should I consider a transaction with a PE company now?”

Before moving forward, it is essential that eye-care groups and their executives understand the answers to five key questions.


It is hard to deny that transformation is well underway in the health-care industry, as evidenced by:

  • Substantial consolidation among hospitals and other providers
  • Changing reimbursement
  • More focus on providing care in outpatient settings
  • The gradual shift to value-based payment programs
  • The greater need for advanced EMR, data analytics and care coordination capabilities

These changes are impacting the operations, strategy and profitability of physician groups across the country, and larger, well-capitalized organizations with seasoned corporate executives and a robust infrastructure are best positioned to be successful in this changing industry environment.

In the eye-care sector, an aging population that is facing increased chronic vision-related diseases, such as diabetes, has accelerated the demand for eye-care services. At the same time, ophthalmology is a highly fragmented specialty, and many practices include multiple ancillary service lines, such as optometry, general ophthalmology, glaucoma, oculoplastics and retina services. Additionally, ophthalmology offers a number of cash-pay opportunities, all of which are seen as attractive to PE investors.


There is substantial uncertainty regarding how any medical group’s operations, revenues and profitability will look in three to five years. Market valuations of a physician practice are based on a variety of factors, such as:

  • A multiple of the practice’s “adjusted EBITDA” (described in more detail below) — usually, the higher the EBITDA, the higher the “multiple”
  • The number and age of physicians and midlevel providers and the diversity of services and subspecialties
  • The number of offices and geographic reach
  • The extent and sophistication of the practice’s corporate infrastructure (e.g., CEO/practice administrator, CFO, HR director, billing department)
  • The number of “ancillary” services operated by the practice (e.g., surgery centers, cash-based services (LASIK, premium services), eyeglass/optical)
  • “In-network” status with key payers in the region and diversification of payer mix
  • The ability to grow the business both organically and through in-market acquisition

Within the context of PE transactions, the determination of value is normally based on a multiple of EBITDA, or earnings before interest, taxes, depreciation and amortization. It is often used to describe the “free cash flow” of a business. Free cash flow is the amount of cash available for capital expenditures, debt service and distribution to the owners of a business. It is calculated by subtracting from revenue the cost of goods sold and operating expenses of the business, including a market rate of compensation to the selling physicians.

When using a “multiple of EBITDA” valuation method, buyers assume they are acquiring the business free and clear of any encumbrances. To the extent there is debt on the balance sheet at the time of closing, the seller is normally required to pay off the debt out of the sales proceeds.

The multiple applied to the adjusted EBITDA corresponds to the buyer’s expected rate of return on capital invested in the transaction. Generally, there is good faith negotiation between the buyer and seller on the purchase multiple as well as other deal terms.

In arriving at EBITDA, it is common to eliminate one-time gains or losses as well as non-recurring revenue and expenses. As noted, the compensation of the selling physician(s) is “normalized” to a rate of pay likely to be paid to the physicians after closing. This is normally a percentage of professional collections in the range of 30% to 35%. Other items that are typically adjusted in arriving at the EBITDA include:

  • Excess- or below-market rent paid to shareholders/related entities
  • Excess or deficient owners’ compensation
  • Personal travel and entertainment
  • Above-market fees paid to a related entity
  • Litigation expenses, payments or recoveries
  • Extraordinary one-time casualty expenses (i.e., hurricane)
  • Any one-time expenses incurred in conjunction with the sale transaction, which would include legal, accounting or consulting fees

Although there are several other methods of valuing a business, the multiple of EBITDA approach is the most within the context of the sale of physician practices to PE buyers. (For a sample EBITDA calculation, see Figure.)

Figure. Multiple of EBITDA: Sample valuation


A variety of general factors are important to consider before entering into a transaction with PE, including the following:

  1. Ability to “monetize” the value of the practice in several respects:
    • Achieving an attractive valuation of the practice enterprise
    • Terms of a buyout, including up-front cash and an agreed-upon percent of total consideration that might be rolled into equity in the successor management company
    • Opportunity to sell “rollover” equity at a subsequent recapitalization event. This opportunity is normally available within three to seven years following the close of the initial purchase transaction
  2. Continued control by physicians over clinical aspects of the medical practice
  3. Loss of control by physicians over business/operational aspects of the practice
  4. Benefits of enhanced revenues and market share based on:
    • Strategic advantages of professional practice management by seasoned executives and centralized “corporate infrastructure”
    • Strategic advantages of greater capital to invest in practice growth, advanced EMR/data analytics, care management staff, etc.
    • Benefits of economies of scale from experienced corporate infrastructure (finance, billing, credentialing, HR function, etc.), capital investments and group purchasing (health benefits, malpractice insurance, equipment, supplies, etc.)
    • Benefits of more effective negotiation of third-party payer contracts
  5. The impact of a transaction on physicians at all stages of practice — early career, mid-career and late career
  6. The impact of a transaction on management and staff
  7. The quality, integrity and track record of the financial partner


In many states, non-licensed individuals are prohibited from having an ownership interest in a medical practice or, in some cases, directly employing physicians under a legal doctrine called the prohibition on the corporate practice of medicine (CPOM). As a result, non-physician investors need to carefully consider how to structure the transaction to address a particular state’s CPOM rules. In many cases, they can form an administrative services organization (ASO), which enters into an administrative support contract with the group to manage non-clinical operations and provide non-clinical staff in exchange for a fee.

Another important consideration with respect to structuring these transactions is the tax impact on the selling physicians of forming an ASO if required (described above) as well as the sale/investment transaction. In some instances, the ASO can be formed tax-deferred or otherwise in a tax-efficient manner. Further, in connection with the sale to investors, sellers ideally want the benefit of long-term capital gains treatment (at a much lower tax rate) as opposed to ordinary income (a higher tax rate). Thus, it is important that the group retain financial and tax advisors early on to best navigate these issues.


If a physician group elects to pursue a strategic transaction, then in order optimize the practice’s value and enhance the future success of the partnership, the group should get the practice’s “house in order” well in advance of a courtship. To do so, the group should ensure that its billing, compliance and other operational functions are robust and appropriate — and make any beneficial changes in advance — to enhance the perceived value to investors.

The group should prepare for its potential partner/investor to conduct comprehensive due diligence. Moreover, before entering into a “letter of intent” or other agreement, the practice should conduct stringent “reverse due diligence” on its prospective partner/investor in regard to such investor’s:

  • Other experience with physician services
  • Financial wherewithal
  • Prior investment success in other sectors,
  • Overall organizational “culture” (including site visits and private meetings with physicians who partnered with them more than a year ago)
  • Approach to both day-to-day operations and future growth and investment


Many sectors within the health-care industry are trending toward strategic consolidation, and transaction activity has been growing at a very fast pace for ophthalmology practices around the country. It is important that board members and executives of ophthalmology groups obtain a full understanding of the various terms, dynamics and details of these strategic transactions so that they can best assess whether their group and its physicians would benefit from such transactions in the near future.

If such assessment results in a positive conclusion, they should more formally explore the potential feasibility of, and otherwise prepare the practice for, pursuing such a transaction. If the conclusion of such assessment is negative, at least an informed decision was made, with their eyes wide open, and the group can stay the course into the future. OM

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