With the passage of the Affordable Care Act (ACA) and several large payor deals, the mid-late 2010s saw a flurry of Mergers and Acquisitions in the healthcare industry. Many major hospital groups were closing what felt like 2-3 deals a month for captive practices and other practices saw equity events with various private equity deals. Driven by an influx of cash as a result of COVID-19 stimulus, renewed investor interest (particularly in digital health) and practices that were looking to consolidate in order to better respond to the non-economic forces of the pandemic, during the second half of 2020 and throughout 2021 there has continued to be an increase in the number of deals for both practices and other healthcare-related industries. Before beginning down the road on M&A deals, here are some tips for potential sellers:
Have your “house in order”
As part of any M&A activity, one of the key steps will be the purchaser’s due diligence process. Being prepared prior to the start of any potential exit is critical for success. Prior to bringing in any outside party, a potential seller should first look to make sure they address any potential hurdles and they have proper records available. Sellers should make sure their compliance programs are up to date and all necessary regulatory matters are aligned. Provider compensation models should be reviewed and ensure that they are in writing. During the process purchasers will ask for substantial financial data that practices should make sure is available and complete. This may include historical financial statements, tax returns, billing and collection records, payor mix, referral sources, and more. Having your house in order prior to heading down the merger road can make the process both go smoother and help to identify and correct potential deal-breaking or changing items.
Know Your Worth
During 2021 valuations for privately held entities broke all the norms, and healthcare was no different. The standard 3-5x EBITDA (Earnings Before Interest Taxes Depreciation & Amortization) has grown to 6-8x, maybe even higher in some cases depending on the nature and profitability of your practice. Each sale is specific on the facts and circumstances of the deal and nothing is guaranteed, but sellers should be optimistic on the potential selling price. As part of being prepared, sellers should also work to identify any non-recurring or one-time expenses. As a result of the COVID-19 pandemic, many practices may have incurred one-time costs for additional PPE or other expenses which should be isolated. Additionally, sellers should understand and quantify any ownership “perks” which a purchaser may not inherit, such as travel or meals. Further, practices that may be selling only a part of their operation will need to think about how to normalize any shared overhead expenses. Many times sellers may present financials “as adjusted” to show these items and increase selling price. Finally, if you are planning on selling, start the process early of reviewing your operations and developing ways to increase EBITDA. Increases in technology spends, cuts in redundant staff, elimination of unneeded rent, and overall streamlining of operations can go a long way in increasing your EBITDA and you buy-out.
What About Taxes?
Taxes will play a major role in many M&A transactions. The exact taxation of the transaction can depend on many factors, and sellers should work with their advisors prior and during any transaction to understand the tax implications and to potentially identify any opportunities. Many of the transactions in the healthcare industry will be structured as a “stock” (or equity equivalent) sale, where the seller is selling the equity interest in the practice; this is particularly true when the EIN of the seller is crucial for ongoing operations by the buyer. If the buyer is an existing healthcare practice and the EIN of the provider is not necessary, many buyers will prefer an asset sale approach. While there can be many reasons for this, typically in an asset sale, the buyer is able to increase the depreciable basis of the assets and amortize any goodwill, thereby generating tax deductions; this is less beneficial for a seller as it will make some of the sale taxable at ordinary income rates. A seller will prefer a stock sale from a tax perspective, as this allows the seller to recognize capital gain (a sale of a partnership (LLC) interest will, in substance, work like an asset sale for a seller). As a buyer steps into the shoes of the seller, the additional amount paid above the asset basis of the seller’s assets does not create a favorable tax asset and therefore this is less preferred by sellers. Often the structure of the deal (asset vs stock) can influence the purchase price, as a seller in an asset sale will look for a higher price given the increased tax burden.
Selling a business, particularly a healthcare practice, can be both a very stressful and exciting time. A seller that is prepared and armed with knowledge will be in the best position to maximize their selling price and minimize any complications along the way.
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.