Finances

How to Make a PE Deal that Includes a “Second Bite” of Profitability

By Steve Sunder

Jan. 22, 2020

There is a great opportunity for profitability when you sell your practice. If your buyer is backed by a private-equity firm, that opportunity may not be limited to the initial sale. Some sellers to PE-backed buyers are enjoying what has been referred to as the “second bite.”

In this scenario, the PE-backed firm which the practice owner sold to is sold to an even bigger company, providing the practice seller with a percentage of the profits from the sale of the PE firm.

Here is what to know and do to set yourself up to profit from the sale of the PE firm you sell to.

How Does the “Second Bite” Work?
The practice owner/optometrist retains minority ownership in the practice after the sale transactions. The majority of the practice–60 percent or more–is acquired by the PE firm. The owner receives compensation for the percentage purchased by the PE firm in cash, while the remainder is retained as minority equity ownership in the PE firm. The “second bite” comes into play when the private-equity firm decides to sell and the minority equity ownership cashes out again in this second transaction.

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This is a great option for the seller as they liquidate their owner equity, have a smooth transition plan and have a smaller day-to-day role in the practice. They get cash upfront with the potential for greater financial growth down the road.

PE can be a good partner for you financially because the combination of its capital and business intelligence can stimulate faster revenue growth.

Selling to the right PE firm can help you diversify your net worth with a partial cash buyout out while retaining a minority position in the PE firm, which is a bigger, more diversified and stronger company that will be monetized (also known as sold again) in the next 5-7 years, effectively providing a second bite at the apple.

It is important to note that not all PE-backed buyers are open to providing an opportunity for this second bite to sellers. For example, according to reporting by Vision Monday, VSP Ventures’ acquisition philosophy is a 100 percent equity purchase of the practice in which there is no “second bite” for the simple reason that VSP Ventures has no intention of selling to a larger company.

How Do I Find a PE-Backed Buyer Offering a Possible Second Bite?
There are two private capital camps: Private equity and venture capital (VC). VC will invest early with minority equity positions to foster the growth of high-potential companies, while private equity firms are more diverse in their equity-investment portfolios.

Revenue growth is principal for a PE firm because they require liquidity, meaning they will need to exit the investment in a few years, and during the ownership tenure, they need to generate value to realize their return on investment. Typically the PE firm holds the investment for 5-7 years before selling…many times sold to another PE firm.

When selling to a PE-backed buyer you should research the company to ensure it shares your vision for growing eyecare and can provide the financial, professional and operating resources required to accomplish your goals and provide your patients with the best eyecare services possible.

What Do You Have to Give In Return for Possibility of a Second Bite?
Having it state in your contract that you retain a percentage of ownership that entitles you to a piece of the profitability from a future sale of the PE firm usually means a lower sale price to the PE firm.

This is a trade-off of a lower initial sale profit for the potential of greater profit in the future. For example, say you retain a 20 percent minority equity ownership in the PE firm and the firm increases its EBITDA, your “second bite” has the potential to be greater than your “first bite” as your equity position in the PE firm is much greater than your original sale value. The “second bite” can produce a terrific incremental return.

That’s just what a group of ODs I knew experienced. The group sold its equity for upfront cash along with an equity stake in the PE firm, the larger business entity.

The sellers were looking for that second bite of the profits of the sale of the bigger company in 5-7 years when the company value would be greater and a recapitalization would occur, growing the company even bigger. The doctors’ percentage of the pie from the sale of the PE firm was much bigger than the original cash payout, as the PE company is now valued at multi-millions of dollars more than it was when it bought the practices belonging to the group of ODs.

What Should I Stipulate in the Sale Contract for the Second Bite?
If you agree to a transaction that includes a rollover requirement in which you retain equity, make sure these equity shares are the same class of shares as held by the PE firm — whether preferred or common. Your shares should rank in seniority alongside the PE firm’s own shares in the company (there are exceptions to this, but as a rule they should be the same class of equity). Also, make sure to address what happens to those shares when and if your employment terminates.

It is also important to consider the challenges associated with retaining a percentage of ownership in the practice. You will need to focus on delivering immediate results to the PE firm. Operational performance, as shown by cost efficiency and strong revenue growth, will be paramount. PE firms want to see owners who act with urgency to drive the business forward.

Key Questions to Ask PE-Backed Sellers Related to Second-Bite Opportunities
Is the PE firm a recapitalization? Meaning, do they allow owners/optometrists to both sell a portion of their practice and continue to participate in future growth?

Many, if not most, owner-optometrists’ personal wealth is tied up in the practice they’ve built over the years. This is often a doctor’s sole retirement plan. A PE recap allows the owner-optometrist to unlock a portion of their equity, enabling them, among other things, to diversify their financial portfolio and to do estate planning.

What Experts Should I Tap to Help Me Through the Sale & Negotiation Process
Setting yourself up for a second bite of profitability after your sale to a PE-backed buyer can be aided with the right expert help, including:

  • A good personal estate planning lawyer
  • A CPA experienced in business sale transactions and tax liability
  • A trusted, certified investment banker with experience in similar business transactions
  • A mergers and acquisition advisor
  • Certified practice valuator
  • Firms that represent private equity recapitalizations.

 

Steve Sunder is a health-care consultant with over 20 years experience in the eyecare industry at a multi-location practice, and as a consultant to other practices. To contact him: steve@sundervisionsolutions.com

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