How to understand the evolving market of selling practices and ASCs
“I’m ready to sell my practice, and I’ve been hearing a lot about private equity. What amount can I sell my practice for?”
I receive inquires like this more and more frequently as the ophthalmology industry continues to see a heightened buzz around private equity (PE). While the question is a straightforward one, finding the answer is not always as simple. To help doctors and ASC owners better understand the potential opportunity — as well as create realistic expectations — this article focuses on how PE firms value practices and ASCs.
BACKGROUND ON VALUATIONS
While the methods for valuing a practice are limited, it is the reason for conducting the valuation that determines the valuation method used, along with any direction from legal documents. Below I describe two common scenarios when valuation is done and the key factors in calculating it.
Most frequently, asset valuations are conducted as part of a physician-to-physician practice sale. In that scenario, we focus on tangible assets (eg, equipment) and intangible assets (ie, brand name). The seller usually keeps the accounts receivable and the cash in the bank and is responsible for liabilities (excluding equipment liabilities assumed by the buyer). Because many physicians have experienced this scenario of selling or buying into a practice, they are most familiar with this method.
When large corporations, publicly held companies and PE firms value a practice and ASC, they look at the practice and ASC as they would any other business. They are buying into the profits of the company and its ability to generate cash flow; therefore, the business is valued based on that bottom line. Those who have been involved in an ASC transaction are more familiar with this method, as it’s the method for market value of ASCs.
THE TERM TO KNOW: EBITDA
Let’s consider the practice value inquiry I recently received from a physician. To ensure a smooth transition and longevity for his practice, we began by strategically considering why he wanted to sell and what type of partner he was looking for. Once that was complete, we were ready to look at value from the perspective of a potential buyer.
This doctor was interested in selling to a large corporation that owns other practices in his area. Though not PE-backed, this large corporation used the same financial model to determine value. So, our first step was to gather the financial information needed to run an “EBITDA” analysis: earnings before interest, tax, depreciation and amortization. You may hear some people call this your “free cash flow.”
EBITDA is one of the key factors used to determine a purchase price. Once the EBITDA of a business has been established, it is multiplied by a number ranging from two to 15. Multiples are determined by several factors, including earnings history, potential company growth, industry growth rates, competition, current market activity, customer availability, location, market share, products and services, ease of operation, available economies of scale and management team.
A 2019 survey by HealthCare Appraisers on ASC management companies found that market ranges for transaction multiples were most commonly between three and six for single-specialty ASCs (or minority interest), while controlling interest purchases had multiples ranging from five to nine.1
WHY EBITDA IS A CHALLENGE
During our discussion, I explained the valuation methodology to the physician. He quickly became excited, saying, “I took home $550,000 last year. Multiply that by five and my practice is worth $2.75 million!” Unfortunately, it’s not quite that simple.
Owner-physicians must remember that money earned for the work they do as a physician must be paid, and thus subtracted before determining profit. The $550,000 figure the doctor quoted was made up of two components: his compensation for performance and the profits of the practice. A new business partner will continue to compensate the doctor for his or her services; therefore, the free cash flow can only be determined after subtracting out a fair market rate for the cost of physician labor. Additionally, a comprehensive analysis of financial statements should be completed with personal expenses removed. Meanwhile, the income generated must be verified and subsequently related to the services and products sold. In this doctor’s case, his practice’s EBITDA was about $300,000.
Next, the doctor and I worked to determine the practice’s multiple. The doctor assumed a multiple of five based on several practice elements: It was well-established in the community, in a beautiful location, run efficiently and was not locked out of any payer contracts.
All positives — until he answered my next questions: “How much longer do you intend to work?” and, “Do you already have a natural successor?” In this case, the physician’s desire to work part time for two more years — along with the fact that he did not have a replacement or succession plan already in place — threw the future earning potential of the practice into question. As a result, it would be difficult to command a multiple of five. This inference was further supported when a little research revealed that two similar recent transactions made by the physician’s desired investor were only at a three multiple.
While somewhat deflating, another peek into history helped put the situation into greater perspective. About five years ago, BSM Consulting conducted an informal survey of practices. At that time, half of the reporting practices had eliminated intangible assets, frequently called “good will,” from their practice’s valuation method — many practice transactions then were at the price of tangible assets alone. So, though the doctor had hoped for a five multiple of EBITDA, any multiple of earnings now increased the potential selling price for the doctor than previous alternatives.
PREPARE FOR SUCCESSFUL NEGOTIATIONS
When determining valuation, remember that the context and purpose of the sale will help guide you. Understanding the methods buyers use to value a practice or ASC will also benefit owners in preparing for a future sale.
For those of you who are considering selling to PE (or another large company), start the process by understanding the factors that determine the multiple and strategically position your practice and ASC accordingly. Additionally, put yourself in the shoes of the buyer. Seek to understand value from its perspective to set appropriate expectations and help you choose the best fit.
Entering the transaction process with the right partner, along with a proper understanding of valuations, will ensure that negotiations do not break down during the due diligence process, thus saving you time, energy and money. OM