In recent years, private equity (PE) purchases and roll-ups of physician practices have gotten a lot of attention in the media and in physician circles, mainly because of the opportunity they represent for physician owners to sell their businesses for attractive prices.
In fact, if you’re in a market where PE buyers are on the hunt for practice acquisitions, some of the selling prices you’ve heard might seem almost unbelievable. At least, they might if you’re familiar with the prices sellers can expect when selling to another practice owner, larger group, or, perhaps especially, a hospital.
A sale to private equity can definitely be financially rewarding. As I write this, I have just finished helping a client through the entire process of evaluating PE buyers, presenting his practice, negotiating a solid deal with his preferred buyer, and navigating the complexities and details of due diligence. The entire process took the better part of a year, but I’m happy to say that my client was rewarded for all the hard work of building his practice over many years—and not just with an impressive financial return. He also secured a promising future for his practice and his employees. It can be done!
But if you’re contemplating selling and wondering if those big numbers you’ve heard mean you should only focus on PE buyers, there are a few distinct features of PE deals that can help explain, at least partly, why the prices are higher than offered by other buyers. These differences are important to understand and consider as you contemplate an exit strategy for yourself and your practice. Comparing PE offers you’re hearing about to transactions involving other types of buyers, price alone might not yield an accurate, apples-to-apples comparison. A PE sale might offer more potential upside, but there will be conditions to the deal that differ from a more typical business sale—conditions that affect how much a seller can actually expect to net. You’ll want to factor these into your analysis of your options.
Here are three common features of PE deals that drive their offers higher than other types of sales:
1) PE deals are priced based on cash plus equity
When you sell to a “conventional” buyer like (your existing partners or employed physicians, a fellow practice owner, or a hospital), the price you’re offered will be the amount of cash you can expect to change hands, just as when you sell another asset like a house. But in a PE deal, it’s typically assumed that the seller will receive a significant portion of the sales price in the form of equity in the entity acquiring your business. The buyer’s motivations to make equity a significant part of the transaction include reducing their own cash outlay and encouraging sellers to contribute to the success of the combined entity.
That equity (also called shares or stock) in the new business could potentially be worth much more down the road, assuming the buyer’s plans go well. But the wait for that payday could be long—and there are no guarantees. That’s why lawyers and other advisors often recommend that sellers happily accept that equity but make their decision based mainly (or only) on the cash portion of the offer (usually 70-80% of the total).
So, for example, if you’re offered a $2 million dollar price for your practice with 30% of the payment in stock, that means the cash portion is at most $1.4 million. If you’re feeling very conservative, you might consider that lower figure the actual value of the deal (and even potentially try to negotiate a higher cash percentage).
2) You might not receive all of the cash portion immediately—or even soon
Another common feature of PE-style deals: deal prices based on future performance of your business.
In other words, the cash amount you’re offered might be paid out over a period of years, and it might be contingent on either your business meeting certain benchmarks, you personally achieving certain productivity targets, or both.
If your goal in selling is to retire, this feature could be a significant drawback to a PE sale, as it could delay your retirement considerably. While you might be able to negotiate an earlier retirement than the firm four or five years out that the buyer might be looking for, that might mean giving back some of that attractive sales price. And even if you stay with the new business, your payout can still be reduced if the benchmarks are missed.
You will also likely find that your salary during those years of “earning out” will be much less than you’re used to paying yourself. (Possibly even just a fraction of what you’re used to living on.) And you’ll no longer be the boss—you’ll have one, perhaps for the first time in decades. That will be an adjustment that may make it harder for you to stick it out for the maximum payout.
Lastly, in all cases, a significant piece of your cash payment will likely be held back for 18 months or more to guard the buyer against unexpected problems (e.g., undisclosed liabilities) and for cash flow in the early months post-deal.
3) Post-agreement repricing can happen
Another potential wrinkle with a PE deal: the possibility of repricing after due diligence.
Typically, the deal terms will specify that your practice earnings (EBITDA, or earnings before interest, taxes, depreciation, and amortization) will be evaluated by a third-party due diligence provider (hired by the buyer). At the end of that process—which usually takes months—you may learn that your earnings are projected to be less than expected.
Because your deal was most likely be priced as a multiple of your EBITDA, the buyer will automatically lower the value of your offer if the due diligence shows lower projected earnings.
Here’s an example of the math (a very simplified one). Let’s say your historical or projected EBITDA (pre-offer) is $800K per year. You’re offered $4 million, meaning your deal is priced with a multiple of 5x your earnings. You sign a letter of intent accepting the price, but then the due diligence comes back with an adjusted projection of $740K EBITDA for the current year. That might be the result of an anomaly that you can explain away, but that might not matter. With this new information, the deal could automatically be repriced to $3.6 million—$400K less.
Can you renegotiate to hold the line on the offered price? Defend your original projected EBITDA? Possibly—especially if you have some adept accounting or consulting help to evaluate and possibly contest the revision. But the buyer can also decide to walk away rather than pay more than their new price. (After months of negotiating and due diligence, you might find it a lot harder to do so.)
Keep in mind that PE buyers will be quite focused on paying a price they consider correct based on the numbers. While there are some situations in which you may have more negotiating power (perhaps your location(s), unique lines of business, key staff or systems present an unusual intangible value), you may not find you have much sway.
It’s worth noting, also, that this safety valve is one reason PE-backed groups can offer such aggressive prices. They know that they can automatically walk them back if the numbers turn out differently than expected. This is important to know when negotiating: a PE group may be more willing to increase their offer than other entities simply because they are prepared to lower it as a result of diligence. By that time, your other options may have expired and you’ll be facing the hard choice of taking a reduced offer or walking away.