Is now a good time to sell your medical practice to a private equity group?

Healthcare practitioners are feeling the squeeze.

A constellation of challenges has been making it harder to maintain a thriving, profitable practice. They didn't begin with Covid, but the pandemic accelerated trends that were already challenging the viability of smaller practices.

Small practitioners who want to increase their scale and financial resources to remain financially viable have several options overall.

For one, the lockdown offered a vivid illustration of what it was possible to do remotely. The ongoing need for technology investments is the new reality. Healthcare is also suffering from a labor shortage: Nurses and medical technicians are migrating to agencies that can match them with the highest bidder, typically a large healthcare organization.

Add diminishing Medicare reimbursements and supply-chain shortages that are driving up prices for essential consumables (syringes, cotton swabs, etc.), and you have an unforgiving set of market conditions.

So how to respond? In this environment, staying small doesn’t make sense anymore. The way most practices currently deliver care will become even more costly and less effective. Smaller practices of 10 to 40 doctors have less bandwidth to make expensive changes and, some cases, they won’t survive. Private equity buyers have stepped into the fray, offering a way out for practice owners at compelling valuations. But this demand won’t last forever.

If a private equity firm makes a compelling offer for your practice, you should probably seriously consider it. Here’s what practice owners should know:

Possible buyers abound

Small practitioners who want to increase their scale and financial resources to remain financially viable have several options overall. One is a basic merger with another practice, which can achieve some economies of scale that the two independents would not enjoy on their own. Another is to be absorbed by and become an employee of a larger healthcare organization, which offers instant access to a greater level of institutional resources.

Those scenarios could make sense for some practices, but the private equity sector is emerging as an increasingly active player in the healthcare market, and can offer an enticing value proposition, particularly for practitioner-owners who are nearing retirement and looking to transition their practice.

Private equity firms typically offer a combination of immediate cash and shares of their existing business to the owner, buying the practice and folding it into a larger healthcare organization. The seller then becomes a shareholder in the combined entity and is in line for a payout upon exiting the business.

Why is now a good time to sell?

The healthcare services industry has been seeing a heavy volume of mergers and acquisitions. Deal volume in the third quarter of 2022 did dip 11% from the previous period, according to Provident,1 which described the market as having "normalized to sustainable levels following a record-breaking year in 2021." In the same period, however, capital investments surged by almost 76%, signaling "continued investor appetite," according to Provident.

While money is moving into the sector, it's not without limits. Amid rising interest rates and signaling from the Fed that more increases are coming, money is not getting any cheaper, so private equity valuations for healthcare practices are likely to hold steady, or even decrease in the near future, which means that if you're considering a sale, now is the time.

Valuations for healthcare practices at 11 to 14 times EBITDA weren't unheard of last year. Now a multiple of five-to-eight-times EBITDA is more typical.

How to scrutinize the offer

Even if the numbers work, practice owners should go into any transaction with their eyes open. Probably first and foremost, they need to evaluate a potential buyer to ensure that it will be a good cultural fit for the practice. Do they have the same commitment quality and service as you do?

By their nature, private equity firms make investments in businesses they believe they can make more profitable by improving efficiencies. That could take the form of investing in technology that will at once improve care and make the practice more efficient. It could also mean that they expect to increase doctors' patient loads to a level you're not comfortable with. These discussions need to happen ahead of any sale.

Practice owners should also take a close look at the employment agreement that a private equity buyer is offering. Since they’ll be merging into a larger organization and potentially working alongside other doctors, they should secure provisions that protect them from getting squeezed out or marginalized within the organization — in essence, ensuring that their new employer won't impinge on their productivity levels.

To be certain, selling a practice isn't the right move for everyone. Some practices might be able to navigate the challenges of hiring top talent in a tight market, dealing with declining reimbursements, and investing in technology. If you've been managing all that while controlling costs, maintaining a strong CAGR, and seeing a rising EBITDA, you might be well situated to remain independent.

But for the many practices that aren't in that position, a sale can make a lot of sense. One way or another, with the headwinds facing the healthcare industry, practices will either evolve or go extinct.

Osman R. Minkara is Founder and CEO of CIG Capital Advisors, an investment, wealth management and business advisory firm serving entrepreneurs and senior executives in healthcare and other niche marketplaces.

Reference

1. Q3-2022 Market Update: Healthcare Services M&A Market Activity Levels Remain Consistent. Accessed January 29, 2023. https://www.providenthp.com/expertise/q3-2022-market-update-healthcare-services-ma-market-activity-levels-remain-consistent.