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M&A: Why Physician Practices Are Attractive During A Recession To Private Equity

10/18/2022 Ely Friedman
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M&A: Why Physician Practices Are Attractive During A Recession To Private Equity

An economic recession is difficult for any business to navigate.  Physician practices however actually stand out as shining stars during downturns as a result of their 1) stable or growing demand, 2) recession resistant nature of the industry, and 3) unique service offered. Select specialties experience an increase in demand (neurology, behavior/mental health, etc.) due to the challenging environment people find themselves in including but not limited to depression, loneliness, regression of mental ability to cope, etc. Healthcare is an industry investors historically flock to during recessions as a known safe haven. There were approximately 100 physician practice transactions in 2008. What these investors would later find out, according to CEPRES (private markets data & analytics platform), is that healthcare PE investments made from 2006 through 2008 returned nearly a full additional turn on invested capital ($1 dollar invested and $1 returned being 1 turn or $1 dollar invested and $2 returned being an additional turn) vs. nonhealthcare PE investments during the same period. Sophisticated investors study historical trends and invest accordingly, focusing on healthcare deals vs. nonhealthcare deals.

As a result, demand for these practices is heightened by the limited number of viable (stable or growing) businesses for private equity to invest in. An increased demand and a limited supply of willing sellers creates an increasingly attractive market for physicians. The more specialized and higher demanding the services are, the more attracted investors will be.

Why Sell To Private Equity

A sale to private equity is a much more valuable alternative for retiring physicians. While traditional retiring physicians would only receive a nominal amount for their remaining accounts receivables, a sale to private equity would result in multiple years’ worth of compensation ‘sold’ as proceeds from the sale. Private equity groups do require some amount of a transition period for these retiring physicians which results in a need to plan ahead. It’s important for larger practices to keep in mind that retiring physicians substantially contributed to the infrastructure (critical hires, ancillary agreements/revenue streams, software/systems), which younger physicians benefit from and this infrastructure is attractive to private equity. Furthermore, there are many examples of success private equity partnerships where back-office services (payor negotiations, IT, HR, finance, ancillary services, acquisitions etc.) are supported by the private equity group which lead to significant growth and large returns for investors and physicians alike. In many cases, these physician practices would have realized this success over time but with the support of private equity, they are able to achieve this success much earlier and without the full cost/risk associated with this growth.

What Does It Mean to ‘Sell’ To Private Equity

Physician practices tend to allocate all remaining earnings each year to shareholders as bonuses to minimize taxes. As a result, the amount ‘sold’ to private equity is effectively, an amount or percent of this total annual earning / compensation (20%-30% most commonly). The pre-close level of total annual compensation is often referred to as ‘par’ or ‘original comp’. The amount ‘sold’ is not lost.  An experienced private equity group will ‘cure’ or increase the physician’s compensation by a variety of initiatives (payor negotiations, ancillary services, supplier agreements, etc.). In some cases, physicians may receive proceeds from the ‘sale’ and then earn more than their pre-close original or par compensation after these initiatives are fully realized.

 

Where To Learn More

Any physician practice considering a sale should seek a healthcare experienced M&A advisor. Education prior to going to market is very important.  Physician practice deals are highly tailor-made, mathematically complicated, and have numerous ramifications that apply to the shareholders both pre- and post-close. What makes matters even more complicated is the private equity group has its own proprietary method/‘model’ that it adheres to when acquiring practices, which also has varying implications. Because of this, it is truly difficult to decipher ‘the best deal’ based on the merits of any offer that is received unless a healthcare experienced M&A advisor is able to 1) ask the right questions of the aggregator, and 2) study the full post-close ramifications (which may include multiple compensation models).

High quality M&A advisors prevent surprises by educating shareholders in advance of any market launch (or subtle meet-and-greet). The education doesn’t stop on the front end, it only gets more advanced as time progresses.  MSO fee details, post-close comp model for shareholders, ancillary revenue opportunities, how post-close ownership ‘works’ (local level vs. MSO level), and more attributes about the sale require further education to shareholders.

Without good education shareholders tend to get confused and become disenfranchised with the process as they learn ‘new’ things that they should have known from the beginning.  This may drive a lack of consensus amongst the shareholder base.  A lack of consensus can then derail a deal or result in a waste of time and money.

For more information contact Ely Friedman, Director of M&A with VonLehman CPA & Advisory Firm at efriedman@vlcpa.com

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