Private equity investments in healthcare provider practices are getting more mature and changing the way buyers and sellers approach transactions. These types of deals, which started taking shape in the 2010s with many platforms established from 2015 through 2023, are becoming more varied and complicated, creating shifts in deal structures.
Deal activity has been high across dentistry, veterinary, and the physician specialties, with more than 100 private equity backed platforms established and completing their own add-on deals.
Most of these healthcare verticals, where private equity platforms have been largely established, are entering a more mature stage now, leading to a slower rate of completed add-on deals. This is mostly dictated by a lower supply of high-quality seller practices on the market.
As a result, we are seeing important shifts in deal structure, and in many respects, larger differences in EBITDA calculations, valuation, and how transaction proceeds are paid than we did historically. Some buyers have become more conservative. Others have become more comfortable and aggressive. Some major differences include:
Partial Buyouts
Some buyers are shifting to deal structures that essentially acquire part of a practice. While they are still buying control of the practice, they leave a minority ownership position with the selling providers. After the deal, the sellers typically receive distributions in keeping with their shared ownership.
There are important differences within this deal type that sellers should be wary of, including
- Management fees,
- Chargebacks to the practice, and
- Preferred distributions to the buyer.
These contingencies can limit a seller’s future distributions in favor of the buyer. Stronger alternatives offer a more direct splitting of profits before any corporate expenses.
Earnouts
Some buyers are incorporating earnouts into their deal structures. An earnout is a mechanism whereby a portion of transaction proceeds are paid when the selling company meets a certain milestone. These milestones are typically operational, for example, increasing revenue or EBITDA to meet a threshold. Other growth milestones are also common, like adding an additional provider or location.
We have started to see more “maintenance” earnouts, where funds are paid if a seller maintains its revenue or some other metric for a defined period after closing. The intent is to avoid productivity dips after the deal closes.
Of course, many offers do not include an earnout. Our preference is to avoid earnouts when possible, but they are sometimes appropriate as a growth incentive or when they fit into an overall transaction structure that is highly attractive. Again, this illustrates the importance of seeking multiple offers and negotiating each before choosing a winner.
Post-Transaction Compensation
Different buyers may structure their acquisitions using different post-transaction compensation formulas for selling providers, even within the same specialty. That is because many selling shareholders are also healthcare providers who work in their professional capacity, directly generating revenue for the business. This is common in professional services, including medicine, law, consulting, and more.
In all these industries, a properly structured deal includes a post-transaction compensation formula for the selling shareholders. Such compensation being for the professional services they deliver post-transaction. Those formulas are used in calculating the selling company’s EBITDA, and its valuation (all the provider-owner’s historic compensation is added back to EBITDA and then go-forward compensation is subtracted). Different post-transaction compensation formulas will create different valuations.
In physician services and dental, those compensation formulas are usually a percentage of personally performed collections. For example, a physician producing $1 million of collections per year is paid 35% of collections, or $350,000 as post-transaction compensation.
There are variances among these formulas, however. We have seen private equity buyers in ophthalmology use 30-40% of collections, often depending on the provider’s sub-specialty. We have also seen different percentages offered for different lines of service (e.g., research revenue or drug margin vs. general services).
It is important for sellers to consider variances in post-transaction compensation as part of a total deal. It is a lever that affects transaction value and is a choice between money now and money later, and effectively, how much of the business is sold.
Rollover Equity
Selling shareholders often receive “rollover equity” as a portion of transaction value, especially in medical practice and dental deals. The term reflects that a portion of the seller’s ownership interest is exchanged, or rolled over, for an ownership interest in the buyer organization. In an example deal, 70% of transaction value is paid in cash, and 30% is paid in the buyer’s equity shares.
The amount of rollover equity often varies. Some buyers will offer more cash while others will use more rollover equity in their offers. The type of rollover equity also varies since buyers have different corporate structures and share classes (types of ownership interests or stock). Some buyers have only one type of stock, while others use preferred stock in addition to common stock, sometimes with multiple share classes within each type.
Important differences among types of rollover equity can include:
- How they accrue value,
- Their priority for payment in a sale or bankruptcy, and
- Any rights or obligations attached (ability to sell, requirements to remain in practice, etc.).
The complexity and variance here is another reason that sellers should seek and compare multiple offers and review them with qualified advisors.
Creating Choice and a Strong Bargaining Position
Sellers can best navigate varied offers and deal structures by soliciting multiple buyers in a competitive process with the help of an experienced advisory team. This can increase a seller’s knowledge and bargaining position and provide a choice among future partners. In addition to increasing value, a competitive sales process can help identify and improve the negative parts of a given offer, leading to the best possible terms and outcome.
The team at FOCUS Investment Banking specializes in representing healthcare providers, especially in transactions with private equity groups and PE-backed companies. For more information about our services and sell-side process, please contact Eric Yetter, Managing Director and Healthcare Team Leader at [email protected] or 615-477-4741.
