“Because of the Affordable Care Act, MACRA, and other related legislative changes, there’s a tremendous amount of consolidation happening in healthcare across a number of sectors and specialities,” says Jeff Swearingen, Managing Director at Edgemont Capital, a healthcare specialist investment bank.
As in any industry, investors are looking for companies that are growing quickly and “can clearly illustrate that growth,” says Paul Barrett, Senior Associate at BelHealth Investment Partners, a healthcare private equity firm in the lower middle market.
But the perceived value of healthcare companies can fluctuate widely thanks to evolving regulations, third-party payer dynamics, and other factors.
We asked six investment bankers and investors about best practices for healthcare businesses before a transaction.
1. Don’t let payer dynamics or other financial considerations get in the way.
“Financial reporting in healthcare can be tricky,” says Dexter Braff, President of The Braff Group, a healthcare specialist investment bank.
“For example, there are issues around billed amounts and how much a third-party payer actually pays. However, most folks trying to build a business do not spend much time worrying about revenue recognition and accounts receivable reserve policies — but when it comes time to sell, it’s important that the numbers reflect the financial performance of the business from a GAAP perspective. When people get this wrong, it costs them.” He advises all CEOs to get assistance from an industry specialist or hire someone to manage the process in-house. Getting a full or balance sheet audit is also a good idea.
“Clean financials are critical,” says BelHealth’s Barrett. He cautions CEOs and investment bankers to stay away from excessive adjustments and add-backs. “It’s tough to feel comfortable if a picture that’s not necessarily real is being painted.”
2. Approach R&D cautiously.
“We sometimes see business owners expanding into different service lines or pricing models just before a transaction. They may see a compelling upside,” but acquirers or investors may see the shift as muddying the waters, says Edgemont Capital’s Swearingen.
“Focus on the growth and profitability of the core business,” agree David Baker and Rod Rivera, Managing Directors of middle market investment bank Headwaters MB. For example, they caution healthcare IT businesses to pause any efforts that will require significant R&D resources. “If the product is not going to be revenue generating right away, consider holding off. The thing that can always win the day before a transaction is revenue growth.”
However, Baker and Rivera add, “You don’t want to change your strategy too much — because if for some reason you do decide to wait another year on a deal, you’ve put a valuable project on hold.”
3. Subject yourself to a (mock) compliance test.
“When buyers examine compliance issues in healthcare providers, they don’t simply adjust valuation based on compliance — for example, this company is 80% compliant, so I’m going to reduce the purchase price of my multiples 20%. It’s a gatekeeping mechanism. If a company is not 100% compliant, buyers simply don’t do the deal,” says Braff. “The question is not whether or not you think you’re appropriately complying with documentation requirements, but whether you’re complying at a level equal to or greater than that of the buyer.”
Acquiring a less-than-compliant company exposes the buyer’s whole business to the acquired company’s shortcomings. Braff recommends bringing in an external consultant to provide an independent evaluation of policies and procedures. In most cases, sharpening up policies doesn’t take a heavy lift, and can greatly improve a business’ attractiveness.
4. Target the right buyers.
In the medical devices space, for example, “financial buyers are generally looking for later-stage, FDA approved companies that are already generating significant revenue and EBITDA,” says Roger Kahn, Managing Director of Headwaters MB. Early-stage, pre-revenue companies which have great technology but haven’t brought a product to market are usually the province of venture capitalists.
As for strategic acquirers, their interest usually depends less on the company’s stage, and more on how the company’s product fits into their tactical vision. For example, Kahn represented FlowSense, an Israeli urine monitoring company, which was sold in 2013 to leading global healthcare company Baxter International. The acquisition helped Baxter International move closer to its goal of controlling all vital signs for ICU patients.
Kahn says medical device companies are in high demand today, with typical valuations hovering around 11-13x EBITDA.
5. Build the infrastructure to thrive in a value-based world.
“For a lot of healthcare providers, there is a substantial focus on lengths of stay, quality of care, and making sure they have the right infrastructure in place from both an IT and care-setting perspective to deliver in a complex, value-based world where patient acuity will continue to increase,” says Aaron Osmundson, Managing Director at healthcare investment bank Quadriga Partners.
“If you don’t have answers to how you’re contracting with payers and how you’re positioning yourself relative to your competition, those are absolutely things you should consider in advance of an exit. Right now it’s all about how you position your company in a world that’s going from fee for service to value-based care,” says Osmundson.
6. Anticipate regulatory whims…
… and don’t forget to take into account reimbursement changes, economic factors, changing clinical protocols, and other external issues as well.
“There’s more value lost in getting the timing wrong in the sale of a healthcare company than there is any other variable,” says Braff. Trying to “read the tea leaves” (or engaging an advisor who can help) is critical to maximizing value.
For example, in 2005, legislation known as the Deficit Reduction Act put a 36-month cap on reimbursements for Medicare home oxygen equipment. Valuations for home respiratory businesses, which had been generating as much as $10,000 in purchase price per oxygen patient, plummeted over a five period to $1,000 per patient. “There’s been greater than a 90% contraction in value based on a relatively simple — and not necessarily predictable — change in reimbursement policy,” says Braff.
“J.P. Morgan once said, ‘I made a fortune getting out too soon.’ As a CEO, pay attention to the winds, listen to what people are saying and what’s happening in Congress. Look at your own performance and ask how the world might perceive it,” advises Braff.