Why Structure Beats Price When It Comes to Selling Your Group Practice

Building a successful group practice is incredibly hard.?The journey is long.?It’s emotional and constantly stressful.?

And it doesn’t always end the way you originally intended.?Everyone has visions of dollar signs in their eyes, but all too often, the final process to transact the business leaves too many people unfulfilled – or at least feeling like they came up short.

Why is that??

Primarily because they have unrealistic expectations around process, outcome, and the actual dollars.

Another reason is because they fail to work with an advisor who can educate them on the aspects of deal structure.

And deal structure often matters more than price.?

Getting Clear on What You Really Want

Have you ever heard someone say: “I want a 10X multiple for the sale of my business”?

Please don’t do that.

If your business generated $1,000,000 in EBITDA and you found a buyer who would offer you $10,000,000 for it, then that would satisfy your criteria of 10X.?Done deal.?Transaction closed.?

But what if the structure was ten equal annual earn-outs based around increasing performance standards.?That’s $1,000,000 each year you “ring the bell” by hitting your performance metric.?Is that what you were wanting?

Did you plan to work another 10 years??And can you continue to grow your business reliably every year to hit the metrics?

Granted, this is an extreme example, but it illustrates the old saying in the world of M&A (from the context of the Buyer): “I’ll let you name the price, but I get to determine the structure.”

Cash vs Equity vs Multiples

Deals are basically comprised of some amount in cash to the seller and some amount of remaining equity that the seller “rolls” into the parent company.?You hear phrases like “80-20” or “60-40” where the first number represents the percentage in cash and the second is the percentage in equity.?

Valuation is a function of cash flow and risk, and the structure of the transaction impacts both.?

A private equity-backed buyer has a limited war chest of funds to use to get deals done, so more cash up front to the seller means it depletes the war chest faster.?More cash up front also shifts the burden of risk more onto the buyer while giving the seller more security.?

For this reason, transactions having a higher “cash up front” component typically carry a lower multiple.?

The opposite is equally true.?A transaction with more rolled into equity helps the buyer’s war chest of cash go further while mitigating more of the risk burden on them.?As you would imagine, transactions with greater equity roll amounts typically result in slightly higher multiples.?

Valuing Cash vs Equity

If you’ve spent your entire working life building a successful business, you probably want some amount of cash in the bank to reward you for the risks you took.?But equity in another company carries some level of risk with it.

And much as it is in most areas of life, those opportunities with greater levels of risk often carry greater levels of potential return.? Rolling “a lot” into equity in the new company could result in a significant windfall when the parent company recaps, but it could also underperform and yield not much more than what you originally started with.? Rarely do these ventures fail outright and go to zero, but there is that risk.

Cash gives you security.?If the valuation is high enough and the cash amount is large enough, that may be all you and your family need.?And maybe a nominal equity roll is more akin to “playing with house money” at that stage.?

On the other hand, you may want the security of cash along with the likelihood of some level of equity appreciation for a greater blended rate of return.?It’s important for you and your advisor to be clear on your expectations and aligned on the structure you want at the risk tolerance level you’re comfortable with.?

Buyers Are Not All Alike

There are essentially two types of buyers in our world: strategic buyers and financial buyers.?A financial buyer is a private equity group or family fund or rich uncle who is going to make an investment in your business in exchange for an ownership stake in the business, but all too often they’re not going to bring a ton of resources to the table (other than cash...) to help you build a bigger business. They’re also going to ask you to roll more equity into the new company because they want you to share in the risk with them. Equity aligns interests very efficiently.?

A strategic buyer is an existing Enterprise-level DSO that is already operating in the marketplace.?These are typically private equity-backed entities and their private equity partners tend to recapitalize the business every 5 to 7 years – meaning one private equity group reaches their internal rate of return expectations and sells their position to a new incoming private equity group.?At this point of “recap,” most prior sellers cash out their equity position.?

These “recap cycles” are incredibly important because they can influence the projected return for your equity roll.? It’s critically important for your advisor to be able to model these outcomes over different time horizons so you can understand which one best fits your risk tolerance.??

Insider Trading…That’s Legal

Depending on your age, risk tolerance, income needs and probably 100 other factors, you might elect to “roll” as much of the transaction into equity as the Buyer would allow (usually up to ~40%).?Most Buyers share conservative projections on the internal rates of return on equity rolls in the 2-3X range within 3 to 5 years of a holding period.?

I haven’t had many public company stocks or other investments triple in value over five years, so if you believe in the buyer (and yourself), this could be a tremendous investment opportunity.?Take the time with your advisor to model all of this out because it can absolutely create the difference in which Buyer you go with.?If you roll a lot, then you should plan on a longer hold period before the parent company “recaps” and distributes out the return on your investment.?This “second bite of the apple” could add anywhere from 1 to 5 years or more onto your timeline.?

Concluding Thoughts

So, how long will it take to sell your business??The short answer that hides the truth is 5 to 12 months.?

The real intent behind the question is: “How long will it take to sell for maximum value so I can be free and clear to be sitting on a beach or playing golf?”?And the honest answer to that is likely somewhere between 2 and 8 years:

• 6 months to 2 years to clean up and improve the business to increase the valuation
• 1 year to actually complete the sale process and transaction
• 1 to 5 years on post-sale commitment and the release of any equity roll

So, if your desire is to be “free and clear” in another 5 years, then you should probably start the discussion with your M&A Advisor…NOW.

If you’d like to spend a day with one of our advisors on an “Exit Strategy Planning Session,” we’d be happy to host you.

?

Have questions? Reach out to us here.

Posted by Perrin DesPortes, Co-Founder of Polaris Healthcare Partners

Join us this May!

Building Your Enterprise Platform Experience

Are you ready to take your business to a much greater level with much greater magnitude and more applications?

Join us for an action-oriented, tactical subject matter you've probably heard of before with no panel discussions.

Click?here?to learn more!